Risk Management Presentation November 19 2012

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International Association of Risk and Compliance Professionals (IARCP)

1200 G Street NW Suite 800 Washington, DC 20005-6705 USA Tel: 202-449-9750 www.risk-compliance-association.com
Top 10 risk and compliance management related news stories and world events that (for better or for worse) shaped the week's agenda, and what is next
Dear Member, Today we will start from something really interesting: The compensation in financial and nonfinancial sectors before the crisis. We always try to predict the future, and to figure out when we will have the next market bubble (which can also be an opportunity). A market bubble is forming. Can we use the gap in the compensation (together with other information like the growth to GDP ratio etc.) to learn more about it? How? I wait for your comments. We will share the best answer with all members, and we will give a CRCMP program to the winner. We will discuss something different now. The Federal Reserve will approve dividend increases or other capital distributions only for
I nternational Association of Risk and Compliance Professionals (I ARCP) www.risk-compliance-association.com
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companies whose capital plans are approved by supervisors and who are able to demonstrate sufficient financial strength to continue to operate as financial intermediaries under stressed macroeconomic and financial market scenarios, even after making the planned capital distributions.
This is very interesting. On one hand, under the Basel iii rules, banks need to have more common equity Tier 1 capital. So banks must attract investors. On the other hand, it becomes more and more difficult to pay dividends. Is it a flaw, an oxymoron? Which are your thoughts?
We will share the best answer with all members, and we will give a CRCMP program to the winner. You can read more about the dividends at Number 1 below. Also A cyclist has made a strong start to the race. But, as it happens, he has overestimated his strength. After a while, he has to pedal harder just to avoid falling over. His energies are flagging and he is on the point of collapsing from exhaustion. His mistake was to treat a long-distance race as a series of ever-shortening sprints. His horizon was too short; the cumulative effort is finally catching up. And yet, he struggles on. The global economy is not so different from this sportsman.
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It gained new force from a powerful wave of globalisation and the suppression of inflation.
But the resurgence of the financial cycle made it feel, for a while, stronger than it really was. Market participants and policymakers did not see through this illusion. And, every time that a financial boom turned to bust, they would simply try harder, re-applying the same old nostrums.
Their horizons were too short; and the cumulative impact of their efforts is catching up with them: stocks of private and sovereign debt have been growing beyond sustainable levels and the policy room for manoeuvre has been shrinking dramatically
Who said that? Claudio Borio, from the Bank for I nternational Settlements, in one really great presentation where he covers economic cycles as well! He continues - at N umber 3 of our list: Our historian would go one level deeper. He would ask: Are banking crises, like Tolstoys famous unhappy families, all different?Or are they more like his happy ones, which are all alike?
You must read it!!!

Welcome to the Top 10 list.
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Agencies Provide Guidance on Regulatory Capital Rulemakings

The U.S. federal banking agencies issued three notices of proposed rulemaking in June that would revise and replace the current regulatory capital rules. The proposals suggested an effective date of January 1, 2013.
A full version of the Group of 20 communique:

We, the G20 Finance Ministers and Central Bank Governors, met to assess progress on the fulfillment of the mandates given to us by our Leaders, to promote robust growth and job creation and to address ongoing economic and financial challenges.
On time, stocks and flows: Understanding the global macroeconomic challenges

Claudio Borio Bank for International Settlements
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PCAOB Regulatory Initiatives

James R. Doty, Chairman Practising Law I nstitute, New York, NY
Introductory statement
Mario Draghi, President of the ECB, Vtor Constncio, Vice-President of the ECB, Frankfurt am Main
Steven Maijoor, ESMA Chair
Developments in European Financial Reporting Regulation and Enforcement

Meet the Experts, London
Speech by the Chancellor of the Exchequer, Rt H on George Osborne MP

(to the Royal Society)
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The Challenges of Understanding Labor Market Trends

Dennis Lockhart, President and Chief Executive Officer Federal Reserve Bank of Atlanta
Large Exposure Regime Groups of Connected Clients and Connected Counterparties

Interesting parts
AIMA ANN OUN CES AIFMD IMPLEMENTATION PROJECT

The Alternative I nvestment Management Association (AIMA), the global hedge fund association, has announced its AIFMD I mplementation Project ahead of the release of the final implementation text of the Alternative Investment Fund Managers Directive (AIFMD) by the European Commission.
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Agencies Provide Guidance on Regulatory Capital Rulemakings

The U.S. federal banking agencies issued three notices of proposed rulemaking in June that would revise and replace the current regulatory capital rules. The proposals suggested an effective date of January 1, 2013. Many industry participants have expressed concern that they may be subject to a final regulatory capital rule on January 1, 2013, without sufficient time to understand the rule or to make necessary systems changes. In light of the volume of comments received and the wide range of views expressed during the comment period, the agencies do not expect that any of the proposed rules would become effective on January 1, 2013. As members of the Basel Committee on Banking Supervision, the U.S. agencies take seriously our internationally agreed timing commitments regarding the implementation of Basel I I I and are working as expeditiously as possible to complete the rulemaking process. As with any rule, the agencies will take operational and other considerations into account when determining appropriate implementation dates and associated transition periods.
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The Federal Reserve Board on Friday launched the 2013 capital planning and stress testing program, issuing instructions to firms with timelines for submissions and general guidelines. The program includes the Comprehensive Capital Analysis and Review (CCAR) of 19 firms as well as the Capital Plan Review (CapPR) of an additional 1 1 bank holding companies with $50 billion or more of total consolidated assets. The aim of the annual reviews is to ensure that large, complex banking institutions have robust, forward-looking capital planning processes that account for their unique risks, and to help ensure that institutions have sufficient capital to continue operations throughout times of economic and financial stress. Capital is important to banking organizations, the financial system, and the broad economy because it acts as a cushion to absorb losses and helps to ensure that any such losses are borne by shareholders, not taxpayers. Institutions in the CCAR and CapPR programs will be expected to have credible plans that show they have sufficient capital to continue to lend to households and businesses even under severely adverse conditions, and are well prepared to meet Basel I I I regulatory capital standards as they are implemented in the United States. Firms' capital adequacy will be assessed against a number of quantitative and qualitative criteria, including projected performance under the stress scenarios provided by the Federal Reserve and the institutions' internal scenarios. Boards of directors of the institutions are required to review and approve capital plans before submitting them to the Federal Reserve.
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"The Federal Reserve has been focused--and will remain focused--on ensuring the nation's largest financial institutions have enough capital to weather severe, unexpected conditions and still continue lending to households and businesses," Gov. Daniel K. Tarullo said.
The 19 bank holding companies in the CCAR have increased their aggregate tier 1 common capital to $803 billion in the second quarter of 2012 from $420 billion in the first quarter of 2009. The tier 1 common ratio for these firms, which compares high-quality capital to risk-weighted assets, has more than doubled to a weighted average of 10.9 percent from 5.4 percent. One part of the CCAR and CapPR reviews is an evaluation by the Federal Reserve of institutions' plans to make capital distributions, such as dividend payments or stock repurchases. The Federal Reserve will approve dividend increases or other capital distributions only for companies whose capital plans are approved by supervisors and who are able to demonstrate sufficient financial strength to continue to operate as financial intermediaries under stressed macroeconomic and financial market scenarios, even after making the planned capital distributions. In a change from prior years, following the Federal Reserve's assessment of the initial capital plans, CCAR firms will have one opportunity to make a downward adjustment to their planned capital distributions from their initial submissions before a final Federal Reserve decision is made. As in 2012, the Federal Reserve will release summary results for the 19 CCAR firms including its projections of capital ratios, losses, and revenues under the Federal Reserve's severely adverse scenario. In 2013, the Federal Reserve will release two sets of post-stress data for each firm.
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One set will reflect the capital distribution assumptions prescribed in the stress testing rule mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act to enhance comparability of results.
The other will include ratios based on each firm's own planned capital actions as proposed in their initial CCAR capital plan submissions, as well as ratios based on any adjustments made to planned capital distributions. While the aims of CapPR are the same as CCAR, there are a number of important distinctions. For example, the Federal Reserve's assessment of capital plans under CapPR will not be based on supervisory estimates derived from independent supervisory models, but instead solely on an assessment of the firms' own capital plans and internal capital planning and stress testing practices that support them. Further, the Federal Reserve will not publish a summary of bank-specific results for CapPR in 2013. The Federal Reserve wanted to give firms as much time as possible to prepare their submissions and therefore is issuing the instructions ahead of the release of the macroeconomic and financial market scenarios. The Federal Reserve will require institutions to use the scenarios in both the stress tests conducted as part of their capital plans and in the stress tests that are part of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The Federal Reserve expects to release the scenarios at 4 p.m. EST on Thursday, November 15. Institutions will be required to submit their capital plans no later than January 7, 2013.
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The following is a full version of the Group of 20 communique:

1.We, the G20 Finance Ministers and Central Bank Governors, met to assess progress on the fulfillment of the mandates given to us by our Leaders, to promote robust growth and job creation and to address ongoing economic and financial challenges. 2.We will do everything necessary to strengthen the overall health and growth of the global economy. Our main focus in the period ahead will be to rebuild confidence and to reduce risks and volatility in international financial markets; contribute to a faster pace of economic recovery and job creation, and promote the foundations for strong, sustainable, and balanced growth. We are firmly committed to open trade and investment, expanding markets and resisting protectionism in all its forms. 3.We have made significant progress in implementing the commitments established in the Los Cabos Growth and Jobs Action Plan. Substantive measures have been adopted in Europe, including the launch of the European Stability Mechanism, the decision of the ECB on Outright Monetary Transactions, the agreement by European leaders to establish a single supervisory mechanism for banks, the adoption and ongoing implementation of the Compact for Growth and Jobs, and the reforms and fiscal consolidation carried out by a number of European countries. Other countries with policy space have implemented actions to support aggregate demand. Major central banks have taken further unconventional measures in line with their respective mandates which are welcomed.
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4.Global growth remains modest and downside risks are still elevated, including due to possible delays in the complex implementation of recent policy announcements in Europe, a potential sharp fiscal tightening in the United States, securing funding for this year's budget in Japan, weaker growth in some emerging markets and additional supply shocks in some commodity markets.
The reduction of global imbalances has not been sufficient, and in many countries the process of necessary deleveraging by the private and public sectors is ongoing and unemployment remains high.
Complete and timely implementation of all of our policy commitments is critical in order to continue to reduce risks and secure a durable and strong recovery.
5.We are committed to build on the policy measures taken in recent months. Current reform momentum in the EU on structural, fiscal and financial fields needs to be continued with the view to improving competitiveness and promoting financial stability. In this respect, we welcome the recent decision by European leaders to agree on a legislative framework by January 1st 2013 on a single supervisory mechanism. We look forward to the operational implementation of the single supervisory mechanism in the course of 2013 and to the completion of the technical discussions on the future of the ESM direct bank recapitalization instrument, within a broader strategy of completing the architecture of the EMU.
6.We will ensure our public finances are on sustainable paths, in line with the medium-term Toronto commitments in the case of advanced economies.
In light of the weak pace of global growth, they will ensure that the pace of fiscal consolidation is appropriate to support the recovery.
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Countries which have fiscal space will let the automatic fiscal stabilizers operate as appropriate. Those with sufficient space stand ready to support demand as needed in the shortrun should economic conditions deteriorate. The United States will carefully calibrate the pace of fiscal tightening to ensure that public finances are placed on a sustainable long-run path while avoiding a sharp fiscal contraction in 2013. In Japan further progress in medium-term fiscal consolidation is needed. By the next Summit, advanced economies agree to identify credible and ambitious country-specific targets for the debt-to-GDP ratio beyond 2016, where these do not currently exist, accompanied by clear strategies and timetables to achieve them. 7. The weak pace of global growth also reflects limited progress towards sustaining and rebalancing global demand. We commit to achieving external and internal adjustment in a way that supports and sustains growth and leads to global rebalancing. In this regard, we reiterate our commitments to move more rapidly toward more market-determined exchange rate systems and exchange rate flexibility to reflect underlying fundamentals, avoid persistent exchange rate misalignments and refrain from competitive devaluation of currencies; to boost domestic sources of growth in surplus economies, and boost national savings in deficit economies. We reiterate that excess volatility of financial flows and disorderly movements in exchange rates have adverse implications for economic and financial stability. We commit to the implementation of ambitious structural reforms aimed at promoting output and employment.
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We have also made progress in strengthening our Accountability Assessment framework by agreeing on a set of measures to inform our analysis of our fiscal, monetary and exchange rate policies.
We will consider a range of indicators and approaches to assess spillover effects, progress towards commitments on structural reforms, and our collective achievement of strong, sustainable and balanced growth. 8.We welcome the continuation of the process to strengthen IM F resources to safeguard global financial stability and enhance the I MF's role in crisis prevention and resolution. Since the Los Cabos Summit, additional pledges have been received from more members, and total commitments add up to US$461 billion. Furthermore, we welcome the formalization of the first set of bilateral borrowing agreements under the agreed modalities comprising US$286bn, which represent more than half of the Los Cabos' 2012 pledge. We call for the finalization of the remaining bilateral agreements. 9.We welcome I MFs Executive Board decision on the use of US$2.7bn of additional resources from the windfall gold sales profits for the Funds Poverty Reduction and Growth Trust and call on the membership to provide the assurances needed for this to take place. This effort reinforces the international communitys will to reduce poverty by boosting financial assistance to low income country members. 10.We remain committed to the full implementation of the 2010 Quota and Governance Reform.
Although significant progress has been achieved, as of October 2012 the conditions for the entry into force of the 2010 Quota and Governance Reform have not been fully met.
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We reaffirm the urgency of making these important reforms effective and call on members who have yet to complete the process to do so as soon as possible.
The process of I MF reform will enhance its legitimacy, relevance and effectiveness. 11.We are committed to completing the comprehensive review of the quota formula, to address deficiencies and weaknesses in the current quota formula, by January 2013 and to complete the next general review of quotas by January 2014. We agree that the formula should be simple and transparent, consistent with the multiple roles of quotas, result in calculated shares that are broadly acceptable to the membership, and be feasible to implement based on a timely, high quality and widely available data. We reaffirm that the distribution of quotas based on the formula should better reflect the relative weights of IM F members in the world economy, which have changed substantially in the view of a strong GDP growth in dynamic emerging markets and developing countries. We reaffirm the importance of continuing to protect the voice and representation of the poorest members of the I MF. We call on the I MF membership to develop the consensus needed to complete the review by January 2013. 12.We welcome the strengthening of the I MF's surveillance framework through the adoption of the new Integrated Surveillance Decision, and we welcome the introduction of the Pilot External Sector Report to strengthen multilateral analysis and enhance the transparency of surveillance. A transparent and evenhanded framework of surveillance is key to achieve ownership and traction of policy recommendations by the I MF, thus making surveillance more effective.
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13.We note the World Bank and other I nternational Organizations' (IOs) progress report on implementation of the G20 action plan to support the development of local currency bond markets.
We look forward to full implementation of the action plan in 2013 to ensure a broad ownership of the diagnostic tool among potential users, and further reporting on progress by the World Bank. We welcome ongoing regional initiatives to promote local currency bond markets.
We will deepen work on these issues under Russias Presidency.

14.We acknowledge the importance of long term financing, particularly for infrastructure investment, recognizing that work on this subject will foster an environment more conducive to long-term investment, effectively helping to boost jobs and growth. We ask that the World Bank, I MF, OECD, FSB, UN and relevant I Os undertake further diagnostic work to assess factors affecting long-term investment financing including its availability. We look forward to receiving this work in early 2013 to provide a sound basis for any future G20 work. 15.We remain committed to the full, timely and consistent implementation of the financial regulation agenda, and discussed the latest FSB reports on the progress in implementation of agreed reforms. We endorse the conclusions and recommendations of the fourth progress report on the implementation of the G20 commitments to OTC derivatives reforms and the BCBS report on implementation of Basel I I I. We agree to put in place the legislation and regulation for OTC derivatives reforms promptly and act by end-2012 to identify and address conflicts, inconsistencies and gaps in our respective national frameworks, including in the cross-border application of rules.
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We agree to take the measures needed to ensure full, timely and effective implementation of Basel I I , 2.5 and I I I and its consistency with the internationally agreed standards.
We look forward to receiving for our April meeting the BCBS report on the consistency of measurement of risk-weighted assets. We endorse the Charter for the Regulatory Oversight Committee which will act as the governance body for the global Legal Entity I dentifier system to be launched in March 2013.
16.We acknowledge progress made in the design and implementation of policy measures to strengthen the resilience of the financial system and reduce systemic risks.
In particular, we welcome the publication by the FSB of an updated list of global systemically important banks, the BCBS framework for dealing with domestic systemically important banks, and the I nternational Association of Insurance Supervisors (IAIS) consultation paper on policy measures for global systemically important insurance companies.
We commit to make the necessary changes to resolution regimes to enable authorities to resolve SIFIs.
We welcome the initial integrated set of policy recommendations to strengthen the oversight and regulation of shadow banking together with expanded data monitoring. We call for finalized policy measures by the St. Petersburg Summit for oversight and regulation for shadow banking that can be peer-reviewed. 17.We also welcome the recommendations to increase the intensity and effectiveness of SIFI supervision, and the FSB's roadmap to accelerate implementation of the FSB Principles for Reducing Reliance on Credit Rating Agency Ratings.
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We encourage further work to enhance transparency of and competition among credit rating agencies and ask I OSCO to provide a report on ongoing work at our meeting in April.
We support measures to strengthen the transparency of financial institutions and recognize the contribution of the Enhanced Disclosure Task Force. Recognizing the need for adequate statistical resources, we endorse the progress report of the FSB and the I MF on closing information gaps, and in particular look forward to the implementation of the data reporting templates for global systemically important financial institutions. We are concerned about the slow progress achieved toward a single set of high quality accounting standards. We encourage the International Accounting Standards Board (IASB) and Financial Accounting Standards Board (FASB) to complete work promptly, and report to our next meeting. In relation to LIBOR, EURIBOR and other financial benchmarks, we welcome actions taken and ongoing reviews to identify measures to address weaknesses and restore confidence in benchmark and index setting practices and welcome the coordinator role of the FSB as agreed. We ask I OSCO to provide by our April meeting a report on the next steps on the functioning of credit default swaps markets. We expect the FSB to continue monitoring, analyzing and reporting on the unintended consequences of regulatory reforms on EMDEs. 18. We welcome the FSB's progress in implementing the measures endorsed at Los Cabos to strengthen its capacity, resources and governance. We look forward to its establishment as a legal entity by our next meeting and its full implementation by September 2013.
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We call on the FSB to report back on how it intends to keep under review the structure of its representation.
19.We welcome the observed increase in jurisdictions' adherence to international regulatory and supervisory cooperation and information exchange standards, as stated in the FSB status report, and call for further progress. 20.We remain committed and encourage the FATF to continue to pursue all its objectives, and notably to continue to identify and monitor high-risk jurisdictions with strategic Anti-Money Laundering / Counter-Terrorist Financing (AML/CFT) deficiencies. We look forward to the completion in 2013 of the revision of the FATF assessment process. We encourage all countries to adapt their legal framework with a view to complying with the revised FATF's Recommendations, in particular the necessity to identify the beneficial owner of corporate vehicles, and we look forward to the assessment of the effectiveness of the measures countries take and their compliance with the global standards in the next round of Mutual Evaluations. 21.We commend the signings of the Multilateral Convention in Cape Town and further progress made towards transparency as reported by the Global Forum whose membership has increased. We look forward to a progress report by the Global Forum on the effectiveness of information exchange practices by April 2013. We welcome and endorse the improved OECD standard with respect to information requests on a group of taxpayers and encourage all countries to adopt it when appropriate. We will continue to implement practices of automatic exchange of information and call on the OECD to analyze the safeguards, mechanisms and milestones necessary to increase its use and efficient implementation in a multilateral context.
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We also welcome the work that the OECD is undertaking into the problem of base erosion and profit shifting and look forward to a report about progress of the work at our next meeting.
22.We welcome the work stated in the final 2012 Global Partnership for Financial Inclusion (GPFI) progress report on implementing the five recommendations set out in 2011 and the progress on implementing the G20 Principles for Innovative Financial I nclusion, including through concrete actions by developing and emerging countries to meet their commitments to the Maya Declaration.
We commend the additional commitments to the Maya Declaration made in Cape Town in 2012, and encourage countries to measure progress through national data collection efforts.
We welcome the decision to establish the Alliance for Financial Inclusion (AFI) as a permanent network for knowledge creation, exchange and policy dialogue. 23.We welcome the first GPFI Conference on Standard-Setting Bodies and Financial I nclusion as a substantial demonstration of growing commitment among Standard Setting Bodies (SSBs) to provide guidance and to engage with the GPFI to explore the linkages among financial inclusion, financial stability, financial integrity and financial consumer protection. We also commend the work done to continue improving SMEs financing and their environment. 24.Together with the implementing partners, we look forward to updates on the G20 Financial I nclusion Peer Learning Program and encourage the commitment to other initiatives that promote Financial I nclusion. 25.For advancing the financial consumer protection agenda, we acknowledge the work done by the I nternational Financial Consumer Protection N etwork (FinCoNet) to support the exchange of best practices and look forward for a progress report by the G20 Summit in St. Petersburg in 2013.
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We also welcome the implementation of the action plan by the G20 OECD Task Force on Financial Consumer Protection and progress achieved in Cartagena, including in the field of national strategies and financial education for women, by the OECD I nternational Network on Financial Education (INFE).
26.We welcome the number of proposals received in response to the 2012 Mexico Financial Inclusion Challenge: Innovative Solutions for Unlocking Access. We congratulate the finalists and the winner. 27.In Los Cabos, Leaders recognized that excessive commodity price volatility has significant implications for countries, increasing uncertainty in the economy, and endorsed the conclusions of a report on the macroeconomic impacts of excessive commodity price volatility on growth. Ahead of the 2013 Summit, we will report progress on the G20's contribution to facilitate better functioning of commodity markets, considering possible areas for further work outlined in the report. 28.We reaffirm our commitment to improve transparency and functioning of commodity markets. We welcome the progress made in the implementation of the Agricultural Market I nformation System (AMIS) which will provide more transparency on physical markets for agricultural commodities. We welcome the I EF's recommendations to improve the reliability of the JODI -Oil database.
We welcome the report prepared by the I EA, the I EF and the OPEC on increasing transparency in international gas and coal markets and ask these organizations to propose practical steps by mid-2013 that G20 countries could take to implement them.
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We welcome progress on the JODI-Gas database and look forward to working with it in 2013.
We welcome the report on recommendations to improve the functioning and oversight of oil Price Reporting Agencies, and ask IOSCO to liaise with the I EA, I EF and OPEC to assess the impact of the principles on physical markets and report back. We also ask I OSCO to report progress on the implementation of the principles in 2013.
We reaffirm our commitment to enhance transparency and appropriate regulation in financial commodity markets, and thus we welcome IOSCO's report on the implementation of its Principles for the Regulation and Supervision of Commodities Derivatives Markets.
29.In Los Cabos, Leaders highlighted that green growth and sustainable development policies have strong potential to stimulate long term prosperity. We will voluntarily self-report again in 2013 on our efforts to incorporate green growth and sustainable development policies into structural reform agendas, taking into account the outcome of the UN Conference on Sustainable Development (Rio+20). We will report back to our leaders on the progress made to rationalize and phase-out over the medium-term inefficient fossil fuel subsidies that encourage wasteful consumption, while providing targeted support for the poorest. We will develop a voluntary peer review process on such fossil fuel subsidies and present a report on the outcomes to our Leaders in 2013. We welcome the OECD report on pension funds financing green initiatives. 30.Recognizing that the UNFCCC is the forum for climate change negotiations and decisionmaking at the international level, we
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acknowledge that climate finance is a relevant issue to be discussed amongst G20 Finance Ministers and Central Bank Governors.
We welcome the progress report by the G20 Climate Finance Study Group on ways to effectively mobilize resources for climate finance. We will continue working towards building a better understanding of the underlying issues among G20 members taking into account the objectives, provisions and principles of the UNFCCC, and report back to our Leaders in 2013. 31.We recognize that disaster risk financing policies are necessary for an overall Disaster Risk Management (DRM) strategy. We appreciate and welcome the combined efforts made by the World Bank and the OECD, with the support of the United Nations, to broaden the participation in the discussion on DRM by highlighting the central role that financial policymakers play to support other areas of Government and civil society in dealing with disasters. We welcome the G20 /OECD voluntary framework for disaster risk assessment and risk financing which provides a detailed guideline that aims to facilitate the implementation of more effective DRM strategies. We encourage further efforts by the World Bank and OECD in cooperation with other relevant international organizations to leverage the voluntary framework in order to address remaining challenges. 32.We commend Mexico for chairing the G20 in 2012 and look forward to Russia's presidency in 2013.
The Finance Track

The Finance Track in the G20 focuses on financial and economic issues; these include providing solutions to the current economic problems, economic stabilization and structural reforms, increasing international coordination for crisis prevention, correction of external, fiscal and
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financial imbalances, providing resources to increase global liquidity, and strengthening the international financial system.
The Finance Track is composed of all G20 Finance Ministers and Central bank Governors who meet regularly during the year to discuss the current economic global problems and take coordinated actions towards their solutions; these meetings are attended also by I nternational Organizations such as the IM F, World Bank, OECD or the Financial Stability Board. Organizationally, the track operates with working groups formally established within the G20 but also through close cooperation with international financial entities. Currently the Finance Track of the G20 is organized in the following major areas: I.Framework for Strong, Sustainable and Balanced Growth Working Group (Co-chaired by Canada and I ndia) II. Financial Regulation III. Financial Inclusion, Financial Education and Consumer Protection I V . I nternational Financial Architecture Working Group (Co-chaired by Australia and Turkey) V.Energy and Commodities Markets Working Group (Co-chaired by Indonesia and United Kingdom) a.Commodities Markets Subgroup (Co-chaired by Brazil and United Kingdom) b. Energy and Growth Subgroup (Co-chaired by Korea and United States) VI.Disaster Risk Management VII.Climate Finance Study Group (Co-chaired by France and South Africa)
The G20 has been a very effective forum of international coordination and cooperation for crisis mitigation and to foster economic growth and strengthen financial regulation.
It has also increased its scope to other relevant economic issues such as financial inclusion and education, disaster risk management, green growth or climate finance.
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Under the Mexican presidency, the Finance track launched the 2012 G20 Agenda on December 13-14th 2011 with a seminar in Mexico City.
In preparation to the Leaders Summit in Los Cabos in June, Finance Ministers and Central Bank Governors have met on February and April to discuss current relevant economic problems and have taken coordinated actions for their solution.
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On time, stocks and flows: Understanding the global macroeconomic challenges

Claudio Borio Bank for International Settlements
Introduction
It wasnt meant to be like this. The financial crisis that began in 2007 shattered the illusion of uninterrupted prosperity that had prevailed in much of the Western world. It was not the first time that this had happened. Doubtless, it will not be the last. Five years on, much of the advanced country world is still struggling to return to robust, sustainable growth. And the crisis has kept morphing before our eyes; it has now engulfed sovereigns too. The euro area is the new epicentre. But will the tremors stop there? In what follows, I will seek to provide a broad framework for thinking these issues through. How did we get here? Why? Where might we go from here? How might we extricate ourselves from our predicament?
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These are hard questions.

No one really knows the answers. But all of us have a perspective and a narrative that goes with it. This is just another one one that draws heavily on work done at the BIS. I will try to look below the busy and at times chaotic surface of the world economy.
The idea is to identify what one might call the shifts in its tectonic plates those deep forces that, slowly but cumulatively, can fundamentally reshape what we see on the surface and that economists call economic regimes.
I will highlight three such forces: financial liberalisation, the establishment of credible anti-inflation monetary frameworks, and the globalisation of the real side of the world economy. Each of them, taken in isolation, is undoubtedly a good thing.
All of them together are worth having and fighting for.

Yet I will argue that a failure of policy to adjust to them has played an important role in the crisis and its aftermath. It has given rise to the re-emergence of powerful financial cycles, whose booms and busts have caused havoc in the economy and have left us where we are today. But what is the link between all this and the title of my remarks? In fact, the title highlights two key aspects of the story. First, time.
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As the three deep forces gained full strength from the mid-1980s, they shaped an environment where, in Burns and Mitchells terminology, economic time has slowed down relative to calendar time.
That is, the macroeconomic developments that matter take much longer to unfold. The length of the financial cycle is much longer that of the traditional business cycle, of the order of 16 to 20 years or more compared with up to eight years.
Yet the planning horizons of market participants and policymakers have not adjusted accordingly indeed, if anything, they have shrunk.
This is a critical reason why the current problems have arisen and why it has proved so hard to solve them. And it has major implications for the sustainability of growth, for financial regulation, for fiscal policy and for monetary policy. We then come to stocks and flows. In the new environment, stocks have come to dominate economic dynamics, in particular the large stocks of assets and, above all, debt. Stocks build up above trend during financial booms, as credit and asset prices grow beyond sustainable levels, and generate stubborn overhangs once the boom turns to bust. Stocks raise serious policy challenges. In the presence of policy responses that react too little to booms and too much to busts in jargon, that are asymmetric stocks grow over consecutive business cycles. It takes longer to deal with them. And doing so is also politically more difficult, because of the serious impact on income and wealth distribution, both within and across generations.
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This is true of both private and public debt.

Failure to deal with stocks effectively could entrench instability in the system. If this diagnosis is right, the remedy is not hard to find, although it may be extraordinarily difficult to implement. In a nutshell, it is to lengthen policy horizons, to put in place more symmetrical policies, and to tackle the debt problems head-on.
Much of my discussion will seek to make these guidelines more concrete.

The ultimate risk of a failure to adjust is that of yet another epoch-defining shift in the tectonic plates the risk of a reversal that will take us back to an era of financial and trade protectionism as well as inflation. The structure of my remarks is as follows. The first section lays out the broad canvas. It considers the changing character of economic fluctuations, highlighting the role of the financial cycle and its link to structural institutional arrangements, policy decisions and horizons. The second section turns to the policy challenges. It begins with a brief summary of the current situation, seen through the lens of the financial cycle. It then explores, in turn, the immediate or more conjunctural challenge of how to return to self-sustaining and sustainable growth and then the longer-term or more structural challenge of how to adjust policy frameworks to address the financial cycle not to be interpreted sequentially, though.
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The discussion covers financial (specifically prudential) regulation and supervision, fiscal and monetary policies.
While my focus is on the global economy, I will also note the specificities of the European situation.
I. The broad canvas Stylised facts: an economic historians perspective

Imagine a future economic historian looking back at the big macroeconomic trends from the first oil shock of the early 1970s to our present day. What would he see as he cast his gaze over a longer historical timespan? Consider, in turn, the most salient outcomes, the intellectual backdrop, the features of banking crises, and institutional setups. In terms of outcomes, he would no doubt be struck by the major shift in the behaviour of inflation: from high and variable to low and stable, with the inflexion point around the early 1980s. At the same time, he would also note a major increase in financial crises, especially banking crises, with serious macroeconomic consequences, in both advanced and emerging market economies. Reading the contemporary economic texts to understand the intellectual backdrop, he would surely find it ironic that the view prevailing at the time had regarded price stability as a guarantee of macroeconomic stability. And that, in much of the West during the early 2000s, there had even been talk of a so-called Great Moderation: a golden age of stable output and low inflation. This conviction had hardly been dented by the banking crises that had hit emerging market economies and even some advanced ones during the 1980s and 1990s, not least the N ordic countries and Japan.
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To paraphrase Reinhart and Rogoff, what seemed to be at work was not just the this-time-is-different syndrome but the no less insidious we-are-different syndrome.
It had taken the Great Financial Crisis, as contemporaries had quickly called it, which had erupted in 2007 to shake this complacency. The historian would also note that the experience of those years had been by no means unique. Similar economic fluctuations, where low inflation had coexisted with occasional banking crises, had been quite common in the Gold Standard days, when countries had pegged their currencies to gold. Indeed, a long economic boom with low and stable inflation had ushered in that other defining moment in economic history the Great Depression in the United States in the early 1930s. Then, just as later on, there had been talk of permanent prosperity, of an end to the tyranny of the business cycle. Our historian would then go one level deeper. He would ask: Are banking crises, like Tolstoys famous unhappy families, all different?Or are they more like his happy ones, which are all alike? It is all too easy, he would note, to spot the idiosyncratic features of a crisis. Structured products, for instance, had not existed in the early 1930s.
Or, to take just another example, the crises in Japan and Nordic countries had caused havoc in bank-based financial systems; by contrast, the subsequent Great Financial Crisis had originated in the United States, with its securitisation-intensive, capital markets-based financial system.
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Or, again, the crisis in Finland had followed the collapse of its main trading partner, the Soviet Union; but no obvious external shock had been at work in 2007.
And he could go on. Yet, he would quickly realise that focusing on idiosyncrasies would mean falling victim to the we-are-different syndrome in another guise. A fuller understanding of crises requires a focus on what they have in common, not on how they differ. Only then can one find reliable remedies. After all, had not the Japanese bank-based financial system been hailed as superior ahead of the countrys banking crisis? And had not much the same been said of the US market-based financial system ahead of its own meltdown? Our historian would then look for common patterns. Soon enough, an obvious one would leap out at him: crises tend to be preceded by major financial booms and followed by protracted busts that leave deep scars in the economic tissue. In other words, they are closely associated with peaks in the financial cycle. The joint behaviour of credit and asset prices, in particular property prices, capture these cycles remarkably well.
And since banking crises are rare events in any given country, it is natural for these cycles to be very long.
Their order of magnitude is between 15 and 20 years.
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As he read further, our historian would realise that the close association between crises and financial booms and busts had, in fact, been recognised early on in the economics profession, as far back as the 19th century.
During the post-war period, economists such as Kindleberger and Minsky had kept the concept alive at the margins of the field. Their work had inspired policy-oriented research ahead of the Great Financial Crisis.
But it had gone largely unheeded, drowned in the contagious enthusiasm for the Great Moderation.
Memories are short; hubris long. But our historians intellectual curiosity could not stop there. H e has established that financial cycles foment banking crises, with damaging macroeconomic consequences. He has also noted that financial cycles were a common feature both of the gold standard era and of the period running from the mid-1980s to our present day. Could the two periods have yet more in common? Yes, would be our historians answer. And this conclusion would refer to the tectonic plates of the global economy to the institutions that embody its economic regimes. The two eras had seen the coexistence of monetary policy frameworks that delivered reasonable price stability with liberalised financial markets and highly integrated markets for goods, capital and labour. In fact, they had come to be known as the first and second waves of globalisation.
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The successful fight against inflation dated back to the early 1980s, and had gradually spread across the world thereafter.
By the mid-1980s policymakers had largely liberalised domestic financial markets, and by the end of that decade, in the words of Padoa-Schioppa and Saccomanni, the global financial system had turned from government-led to market-led. The integration of goods and factor markets had started much earlier in the post-war period, but it had taken a quantum leap in the 1990s, when the former communist countries had entered the capitalist production system. As Thomas Friedman had put it, the world had become flat once again, he should have added.
Stylised facts: an interpretation

Is this similarity between deep structures and economic outcomes just a coincidence?
I would suggest not.

But now it is best to part company with our economic historian, as we move further away from the realm of stylised facts to that of (we hope) informed conjectures and their policy implications. It stands to reason that the three powerful forces have interacted so as to deeply shape economic fluctuations. Their conjunction has made economies more vulnerable to large and prolonged financial booms and busts financial cycles that can inflict severe damage on the economy. During the boom financial imbalances develop: (private sector) balance sheets become overextended on the back of aggressive risk-taking.
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The imbalances sow the seeds of their own destruction, and hence of economic weakness, unwelcome disinflation and financial strains down the road.
The boom can turn to bust either because incipient inflation eventually does emerge, forcing the central bank to tighten or, more often, because the imbalances collapse under their own weight. One may call this property of the economy excess elasticity. The analogy is with an elastic band, which one can stretch further and further until at some point it snaps. These financial booms and busts necessarily take a long time to unfold. As they emerge, they slow down economic time relative to calendar time. How might the tectonic forces interact to produce this outcome? First, financial liberalisation makes it more likely for financial factors in general, and booms and busts in credit and asset prices in particular, to drive economic fluctuations. Rather than being tightly bound by cash flow constraints, the economy is propelled by loosely anchored perceptions of asset values and risks, critically supported by easier credit availability. Indeed, the link between financial liberalisations and subsequent credit and asset price booms is well documented. Second, the establishment of regimes yielding low and stable inflation, underpinned by central bank credibility, can make it less likely for signs of unsustainable economic expansion to show up first in rising inflation and more likely for them to emerge first as unsustainable increases in credit and asset prices (the paradox of credibility).
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After all, stable expectations make prices and wages less sensitive to economic slack: this is precisely what policymakers and economists have expected all along.
Finally, the globalisation of the real economy has given a major boost to global potential growth what economists would call a sequence of pervasive positive supply shocks or an outward shift in the global economys production possibility frontier. Think of the huge boost to production capacity as China and other former communist countries joined the world trading system. By the same token, however, it has surely helped to keep inflation down and provided fertile ground for credit and asset price booms.
Policy and horizons: pre-crisis role

So much for the big picture the tectonic plates, so to speak. But what about the role of decisions made by the policymakers who were confronted with these forces?
With hindsight at least, it has become clear that policymakers inadvertently added fuel to the fire ahead of the Great Financial Crisis.
They put too much faith in markets ability to self-correct. They failed to fully understand that the changing landscape called for adjustments in policy frameworks. And, even when they did understand, they found it too hard to change course: too much reputational capital was at stake and, anyway, why fix what aint broken? Consider, in turn, prudential, monetary and fiscal authorities. Prudential authorities converged on frameworks that concentrated too much on the safety and soundness of individual institutions and too little
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on that of the system as a whole frameworks in which the macroeconomy and the financial cycle hardly figured.
They focused too much on individual trees and too little on the wood. I n current jargon, they had too much of a microprudential focus, as opposed to a macroprudential one. Monetary authorities, still burnt by the Great I nflation experience, focused narrowly on stabilising near-term inflation.
They could not justify raising interest rates if inflation was low and stable, let alone falling, even if financial imbalances were building up.
As a result, the imbalances proceeded to grow unchecked. And fiscal authorities failed to realise that financial booms were hugely flattering the fiscal accounts and that the busts would at some point present them with a huge bill a burden over and above the better known, but just as intractable, one resulting from ageing populations. Underlying these failings was a natural tendency to overestimate sustainable output and growth. The notion that inflation was the sole harbinger of unsustainability was especially insidious. Financial factors, again, did not figure in this picture. That was the relentless message of the prevailing intellectual macroeconomic paradigm, both a reflection of the Zeitgeist and a contributor to it. Short policy horizons played a key role in all this. Much of macroeconomic policy centres on the notion of the business cycle.
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As conceived and measured, the business cycle has a duration of eight years at most.
And yet we have seen that the financial cycle lasts at least twice as long. Since the financial cycles booms and busts have major consequences for economic activity, not taking them into account can create serious biases in policymaking. It is as if, on the open sea, sailors successfully rode out the smaller waves but remained blissfully unaware of the tsunami rolling beneath them a wave that would surge and crash only once it reached the shore. To illustrate this, consider the experience of several advanced economies in the mid-1980s to early 1990s and in the period 200107. In both episodes, policymakers reacted strongly to collapses in equity prices the global stock market crashes of 1987 and 2001 that ushered in economic slowdowns or actual recessions. They cut policy rates and, to a varying and smaller degree, loosened the fiscal reins. In both episodes, however, credit and property prices the most relevant indicators of the financial cycle continued to increase, as if getting their second wind. Financial imbalances built up further. And a few years later, the credit and property price booms collapsed, in turn, causing serious financial damage and dragging down the economy with them. This is what happened to Japan in the first episode and to the United States and United Kingdom in both.
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From a medium-term perspective, consistent with the length of the financial cycle, the slowdowns or contractions in 1987 and 2001 can thus be regarded as unfinished recessions.
The initial over-reaction to short-term macro-economic developments, followed by an under-reaction to the further build-up of financial imbalances, caused more serious problems down the road. But short horizons are not just an issue for policymakers. They are an even bigger one for the private sector, especially for financial market participants. Here, traders horizons may be as short as a day, or minutes or even microseconds. More generally, horizons rarely extend beyond one year, constrained by the rhythm of financial reporting conventions. Moreover, they have, if anything, been shrinking: technology has been surging ahead; the spread of fair value accounting has telescoped the indefinite future into the ephemeral present; tighter monitoring has come to mean more frequent monitoring. These short horizons are embedded in risk measurement tools, such as value-at-risk, in common trading strategies, such as momentum trading, and in credit techniques, such as securitisation. For instance, risk models rely on extraordinarily short data histories, hardly ever extending beyond a few years, and they project outcomes over a very short future, mostly days and at the very most one year. Short horizons are probably best captured by the famous words of Chuck Prince, then CEO of Citigroup, to the effect that as long as the music is playing, you have to get up and dance. This was just before the crisis broke. The end result is that market participants expectations, once embedded in market prices, appear highly extrapolative: they follow the trend until it is too late.
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Hence what one might call the parad ox of fin an cial in st ab ilit y: th e financial system looks strongest precisely when it is most vulnerable.
Credit growth and asset prices are unusually strong, leverage measured at market prices is artificially low, and risk premia and volatilities sag to rock-bottom levels precisely when risk is at its highest. What looks like low risk is, in fact, a sign of aggressive risk-taking. The recent crisis has simply confirmed this all over again. A vicious cycle has set in. The interaction between market participants instincts, the relentless 24/7 media razzmatazz and the response of policymakers becomes ever stronger; as a result, horizons become ever shorter. So, the search for the culprits for the Great Financial Crisis brings very much to mind Agatha Christies famous thriller, Murder on the Orient Express. Who was the murderer then?As it turns out, all the passengers on the train were. Who is the culprit now? As it turns out, we all are.
I I . Post-crisis challenges The legacy of the crisis: a balance sheet recession

The foregoing analysis casts light on the recession that followed the financial crisis. Not all recessions are born equal. stop rising inflation a balance oftriggered payments crunch. The typical postwar or recession was by tighter monetary policy to
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By contrast, a post-financial crisis recession is a balance sheet recession, linked to a financial bust against the backdrop of low and stable inflation.
This means that the preceding expansion is much longer, the subsequent debt and sectoral capital stock overhangs much larger, and the damage to the financial sector much greater. It also means that the policy room for manoeuvre is very limited: unless policy has actively leaned against the financial boom, policy buffers will be depleted. The capital and liquidity cushions of financial institutions will rupture; gaping holes will open up in the fiscal accounts; and policy interest rates will sag to near zero. Think of Japan in the 1990s. A growing body of evidence suggests that balance sheet recessions are particularly costly. They tend to be deeper, to give way to weaker recoveries, and to result in permanent output losses: output may return to its previous long-term growth rate but not to its previous growth path. Several factors are no doubt at work here: the overestimation of both potential output and growth during the boom; the misallocation of resources, notably the capital stock but also labour, during that phase; the oppressive effect of the debt and capital overhangs during the bust; and the disruptions to financial intermediation once financial strains emerge. A full five years after the beginning of the financial crisis, the symptoms of a balance sheet recession are all too evident. Banks in Europe and, to a lesser extent, the United States remain weak although in the United States it is Government Sponsored Enterprises (GSEs) that are more exposed to the mortgage market. To be sure, banks have significantly beefed up their capital ratios.
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But their credit default swaps, gauges of perceived creditworthiness, have returned to levels that are not that far away from those that prevailed when Lehman Brothers collapsed.
Meanwhile, their shares have lost ground against the rest of the stock market, and they have incurred downgrades across the board in both standalone and all-in ratings. Private sector debt-to-GDP ratios, a measure of aggregate leverage, are still very high. Sovereign debt has ballooned and sovereigns have been downgraded. The policy rates of leading economies languish at their effective zero lower bound while the balance sheets of their central banks have swelled enormously. Globally, though, there are significant differences between countries. Those that have experienced domestic financial booms and busts have faced serious strains in both non-financial sector and bank balance sheets; to varying degrees, they are seeing deleveraging in both sectors. Clear examples are the United States, the United Kingdom, Spain and Ireland. Those whose financial institutions were exposed to financial booms elsewhere have also seen serious strains in their banks, but their non-financial private-sector debt-to-GDP ratios have typically risen further on the back of credit expansion. Notable examples are Germany, France and Switzerland.
Indeed, in Switzerland a strong and possibly unsustainable housing boom is under way, despite rather weak economic growth.
Those whose banks were not directly exposed to the financial busts in mature economies, after a brief slowdown, have proved very resilient;
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many of them have continued to see financial booms, sometimes eerily reminiscent of the pre-crisis ones in mature economies.
These include several emerging market economies and some commodity-based advanced countries, among others. The situation is particularly worrying in the euro area. It is there that the perverse feedback loop between the weaknesses in the balance sheets of banks and sovereigns has been most intense.
An obviously incomplete economic and monetary union has brought it into the open and exacerbated it.
That said, one should not confuse the symptoms with the disease. Markets can and do lull policymakers into a false sense of security. They are far too slow to react and, when they do, they react violently. There are other major countries whose underlying fiscal positions are hardly more sustainable than those in the euro area. And yet bond markets seem to be oblivious, at least for now.
The immediate policy challenge: returning to self-sustaining and sustainable growth

The immediate global policy challenge is to return to self-sustaining and sustainable growth. Seen through the lens of the financial cycle, this raises different issues across countries, depending on their specific situation. At one end, for those largely spared by the crisis, and that have been seeing signs of unsustainable financial booms, the challenge is to contain these excesses and to avoid overestimating the strength of fiscal positions.
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Where the cycle might have turned already, it is to contain the damage. At the other end, for those that were at the epicentre of the crisis and have experienced a domestic financial boom and bust, the challenge is to deal with twin weaknesses in the financial and non-financial sector balance sheets. Somewhere in between, for those whose banks have suffered from losses on exposures to financial busts elsewhere, the challenge is to solve the banks problems, even as the non-financial sector may be in the process of leveraging up further. For all, the challenge is to ensure that the sovereign remains creditworthy or regains its lost creditworthiness. In what follows, I will leave it to the reader to draw implications for specific countries. Instead, I will focus on the general challenges that balance sheet recessions raise, ie on how to address financial busts. I will then discuss how to address booms in the following sub-section, which considers the longer-term challenge of how to adjust policy frameworks: how to address booms is by now better understood and requires less elaboration. The main policy challenge in a balance sheet recession is to prevent a stock problem from morphing into a long-lasting flow problem, weighing down on income, output and expenditures. It is therefore critical to distinguish two phases, crisis management and crisis resolution, which differ in terms of their priorities. In crisis management, the priority is to prevent the implosion of the financial system, so as to ward off the threat of a self-reinforcing downward spiral in economic activity. Restoring confidence is essential.
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If there is scope to do so, policies should be deployed aggressively.

This is the phase historically linked to central banks lender-of-last resort function; together with interest rate cuts, such a course of action can be especially helpful in boosting confidence. In crisis resolution, by contrast, the priority is balance sheet repair, so as to lay the basis for a self-sustaining recovery. Here it is essential to tackle the debt overhang head-on. And policies need to be adjusted accordingly. Consider, sequentially, the roles of prudential, fiscal and monetary policy in this phase. The priority for regulation and supervision should be to induce the thorough repair of banks balance sheets and to support banks return to sustainable profitability. This means: Enforcing full recognition of losses (writedowns); Recapitalising institutions (subject to tough tests), including possibly via temporary public ownership; Sorting institutions according to their viability; Dealing with bad assets (including through disposal); Reducing excess capacity in the financial system; and promoting operational efficiencies. This is precisely what the Nordic countries did when they faced their banking crises in the early 1990s; and it is what Japan failed to do around the same time.
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This difference was no doubt a key factor behind their divergent economic performance subsequently.
Before the recent crisis, the response of the Nordic countries to their crisis was universally regarded as the right way to go. Such a policy would have several benefits. It would restore confidence in the banking system. At present, for instance, market-to-book values are well below 1 and there is little uncollateralised funding on offer to banks, especially for European ones. Such a policy would also unblock interbank markets and relieve pressure on central banks just think of the Eurosystems extraordinary long-term unconditional liquidity support to banks. And it would restore incentives for allocating credit properly and avoiding inappropriate risk-taking. It is hardly a coincidence that volatile trading profits have been the main source of income since the crisis and that one global bank has recently made sizeable trading losses on its credit portfolio. Unless losses are fully recognised, viable institutions are recapitalised and unviable ones induced to exit, the incentives will stay in place for banks to take on the wrong risks at the expense of the good ones, and to overcharge healthy borrowers to the benefit of unhealthy ones. When the level of debt in an economy is too high and must be cut back to set the scene for a self-sustaining recovery, the allocation of credit is more important than its overall amount. The priority for fiscal policy should be to create the scope for using the public sector balance sheet to support the repair of private sector balance sheets.
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This applies to the balance sheets of financial institutions, through injections of public sector money (capital) subject to strict conditionality on loss recognition and possibly through temporary public ownership.
But it applies also to the balance sheets of the non-financial sectors, such as households, including through various forms of debt relief. Such a prescription contrasts sharply with a widespread view among macroeconomists, who would regard pump-priming (increases in expenditures or tax cuts) as more effective during slumps.
That view, however, assumes that people wish to borrow and cannot.
But if they have already taken on too much debt, they are more likely to wish to cut that burden. Debt repayment would take priority over more spending. If so, even the short-term effect of untargeted fiscal expansion (the so-called fiscal multiplier) is likely to be small. Rather than jump-starting the economy, it could end up building bridges to nowhere, as the Japanese experience suggests. By contrast, the targeted use of the fiscal room for manoeuvre to support the balance sheet repair of the financial and non-financial sectors, as needed, could remove a key obstacle to a self-sustaining recovery. Moreover, as an owner or co-owner, the sovereign could actually make capital gains in the longer term, as was the case in some Nordic countries. Importantly, this is not a passive strategy, but a very active one. It inevitably substitutes public sector debt for private sector debt.
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It requires a forceful approach to addressing the conflicts of interests between borrowers and lenders, between managers, shareholders and debt holders, and so on.
And it raises tricky distributional questions. It is not pure fiscal policy in the traditional macroeconomic sense: it calls for a broader set of measures, including legal adjustments, supported by the public purse. But what if the country is already facing a sovereign crisis? My sense is that, even where immediate fiscal consolidation is necessary, this use of public money is critical. The Nordic countries did it, even as they cut elsewhere. One way of alleviating the trade-offs is to obtain targeted external support. There is a clear potential for that option in the euro area, especially as part of a well sequenced and comprehensive shift towards a more complete economic union. And even as short-term steps are taken, a long-term horizon is essential. The evidence indicates that any contractionary effects of fiscal policy dissipate over time. And restoring the creditworthiness of the sovereign is paramount. The sovereign is the ultimate backstop for the financial system and the economy. There cannot be lasting financial and macroeconomic stability if public finances remain on an unsustainable path. What about monetary policy?
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The priority is to recognise its limitations and to avoid overburdening it. Monetary policy is likely to be less effective in a balance sheet recession. This applies as much to changes in short-term interest rates and guidance about future rates (interest rate policy) as it does to an aggressive use of the central bank balance sheet, such as through large-scale asset purchases and liquidity support (balance sheet policy). Overly indebted agents unwilling to borrow and a banking system unable to function blunt the impact of such policies on expenditure. As a result, as policymakers press harder on the gas pedal, the engine revs up without traction. And this exacerbates any side effects that policy may have in the crisis resolution stage. Several possible side effects may arise from a long period of extraordinarily accommodative monetary policy. First, easing can mask underlying balance sheet weaknesses. It makes it easier to underestimate the private and public sectors ability to repay in more normal conditions and delays the recognition of losses (eg evergreening). Second, it can blur incentives to reduce excess capacity in the financial sector and even encourage betting for resurrection. Third, it can undermine the earnings capacity of financial intermediaries, by compressing banks interest margins and sapping the strength of insurance companies and pension funds. This, in turn, weakens the balance sheets of non-financial corporations, households and the sovereign.
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It is no coincidence that Japans insurance companies came under serious strain a few years after its banks did.
Fourth, it can atrophy markets and mask market signals, as central banks take over financial intermediation functions. Interbank markets tend to shrink and risk premia become unusually compressed as policymakers become large-scale asset buyers. Fifth, while it can help repair balance sheets by weakening the currency, this may be unwelcome elsewhere, as it may be seen as having a beggar-thy-neighbour character a point to which I will return later. Finally, over time it may compromise the operational autonomy of the central bank, as political economy considerations loom ever larger. This is especially important for central banks balance sheet policy, because of its quasi-fiscal nature. The key risk is that central banks become overburdened and a vicious circle develops. Monetary policy can gain time, but it can also make it easier to waste time, because of the incentives it generates. As the policy fails to produce the desired effects and adjustment is delayed, central banks come under growing pressure to do more. An expectations gap yawns open, between what central banks are expected to deliver and what they can deliver. All this makes the eventual exit more difficult and may ultimately threaten the central banks credibility. One may wonder whether some of these forces have not been at play in Japan, a country where the central bank has not yet been able to exit.
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Recent evidence squares broadly with the view that macroeconomic policies are less effective in balance sheet recessions.
BIS colleagues find that, when considering recessions and the subsequent recoveries, monetary policy has a smaller impact on output if recessions are linked to financial crises. Moreover, in normal recessions, a more accommodative monetary policy in the downturn is followed by a stronger recovery, but this relationship is no longer apparent if a financial crisis occurs. In addition, the same study finds that in balance sheet recessions a faster pace of debt reduction ushers in a stronger recovery. And it concludes that, when used to alleviate a balance sheet recession, fiscal policy has limitations that are similar to those of monetary policy.
The longer-term policy challenge: adjusting frameworks

The longer-term policy challenge is to adjust frameworks to fully reflect the implications of the financial cycle. The financial cycle unfolds over a much longer horizon than the one that normally underpins policy decisions concerning output and inflation. Addressing its implications, therefore, requires lengthening the horizon and shifting the focus from period-by-period flows to their cumulative crystallisation in stocks. Lets first consider national policy frameworks and then broaden the view to the global context. The overall strategy for national policy frameworks would be to ensure the build-up of buffers in the boom phase of the financial cycle so as to draw them down in the bust phase. The buffers would make the economy more resilient to a downturn.
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And by acting as a kind of dragging anchor they could also curb the booms intensity.
Put differently, the strategy would make policy less procyclical by making it less asymmetric with respect to the boom and bust phases of the financial cycle. For prudential policy, it would mean strengthening the systemic or macroprudential orientation of the frameworks, by adjusting instruments, such as capital standards or loan to value ratios, to reduce procyclicality. For monetary policy , it would mean providing for the option to tighten even if near-term inflation appears under control whenever financial imbalances show signs of building up. And for fiscal policy, it would mean extra caution when assessing fiscal strength during financial booms and taking remedial action. Post-crisis, policies have indeed moved in this direction, but to varying degrees.
Prudential policy is furthest ahead.

Basel I I I, in particular, has introduced a countercyclical capital buffer for banks as part of a broader trend to put in place macroprudential safeguards. Monetary policy has shifted somewhat. It is now generally recognised that price stability is no guarantee of financial stability, and a number of central banks have been adjusting their frameworks to incorporate the option of tightening during booms. A key element has been to lengthen policy horizons. That said, no consensus exists as yet on the desirability of such adjustments.
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And the side effects of prolonged and aggressive easing after the bust remain controversial.
Fiscal policy is probably furthest behind. There is so far little recognition of the need to incorporate the impact of the financial cycle in assessments of fiscal sustainability or to explore the limitations of expansionary fiscal policy in balance sheet recessions. The main risk is that policies that fail to recognise the financial cycle will be too asymmetric, thus generating a serious bias over time. Failing to tighten policy in a financial boom but strong, if not overwhelming, incentives to loosen it during the bust would erode both the economys defences and the authorities room for manoeuvre. In the end, policymakers would be left with a much bigger problem on their hands and without the ammunition to deal with it. This is what economists call a time inconsistency problem. The root cause here is horizons that are too short and a failure to appreciate the cumulative impact of flows on stocks. This would entrench instability in the system. There are all-too-evident symptoms that this has been happening. Banks pre-crisis capital and liquidity buffers have proved woefully inadequate; post-crisis, there have been calls not to raise them and to delay the implementation of the new regulatory standards.
Sovereign debt levels have reached record peace-time highs; the crisis and countermeasures have left a gaping hole in fiscal positions, which were already gradually deteriorating.
No less worrying, most of the costs arising from ageing populations still loom ahead of us.
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And monetary policy has been far from immune.

In many advanced economies interest rates are now effectively at zero; in both advanced and emerging market economies, central banks balance sheets have expanded to record highs. At the global level, policy rates, even adjusted for inflation, have been trending down for decades, even as the trend growth of the world economy a common yardstick to gauge their appropriate level has picked up.
Likewise, more refined yardsticks that seek to take into account output and inflation so-called Taylor rules indicate that policy rates are globally unusually low.
And partly as a result of purchases at the long end of the yield curve and foreign exchange intervention, bond yields have never been as low as they are now. This brings us to the global implications of national policies. In a highly integrated world, any tendencies in national policies can easily spread worldwide through a variety of channels, including other countries responses. In the case of monetary policy, exchange rates are a critical channel. Precrisis, easy monetary policy in the mature economies, notably in the United States, spread elsewhere, especially to emerging market economies such as China, partly through resistance to exchange rate appreciation. These other countries kept interest rates low or else intervened in the foreign exchange market and invested the proceeds in the countries with international currencies, in turn putting further downward pressure on yields there. Post-crisis, if anything, the same process has intensified.
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This raises tough issues.

Economically, the risk is that monetary conditions for the world as a whole end up being too loose. Signs that financial imbalances have been building up, especially in several emerging market economies, are a source of concern, particularly when large mature economies have not yet returned to self-sustaining growth. The world remains unbalanced. Politically, one obvious risk is that countries might revert to the modern-day equivalent of the competitive devaluations of the interwar years, which proved so divisive. Worryingly, post-crisis the term currency wars has been all too often on policymakers lips. But the bigger risk is that yet another epoch-defining shift in the global economys tectonic plates might take place. As historians such as Niall Ferguson and H arold James keep reminding us, such shifts often occur quite abruptly and when least expected. So far, institutional setups have proved remarkably resilient to the huge shock of the Great Financial Crisis and its tumultuous aftermath. But there are also troubling signs that globalisation may be in retreat, as states struggle to come to grips with the de facto loss of sovereignty. This is true both globally and regionally. It is simply most visible in Europe, where a more ambitious historical experiment with greater integration has reached a watershed. Meanwhile, the consensus on the merits of price stability is fraying at the edges.
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As memories of the costs of inflation fade, the temptation to get rid of the huge debt burdens through a combination of inflation and financial repression grows.
Taking all these hard-won gains for granted is the surest way of losing them. The future is not pre-determined; far from it. But we should not underestimate the challenges ahead.
Conclusion
A cyclist has made a strong start to the race. But, as it happens, he has overestimated his strength. After a while, he has to pedal harder just to avoid falling over. His energies are flagging and he is on the point of collapsing from exhaustion.
His mistake was to treat a long-distance race as a series of ever-shortening sprints.

His horizon was too short; the cumulative effort is finally catching up. And yet, he struggles on. The global economy is not so different from this sportsman. It gained new force from a powerful wave of globalisation and the suppression of inflation. But the resurgence of the financial cycle made it feel, for a while, stronger than it really was. Market participants and policymakers did not see through this illusion.
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And, every time that a financial boom turned to bust, they would simply try harder, re-applying the same old nostrums.
Their horizons were too short; and the cumulative impact of their efforts is catching up with them: stocks of private and sovereign debt have been growing beyond sustainable levels and the policy room for manoeuvre has been shrinking dramatically. Maybe it is time to change course. Maybe it is time to recognise the need to address underlying weaknesses head-on, to stop postponing adjustments to an ever-elusive better day, to stop calling for illusory monetary policy fixes for what are deeper balance sheet and structural problems. This would mean incurring some costs in the short run, but the alternative would risk creating much bigger costs further down the road. As the French say: reculer pour mieux sauter. It would be a mistake, as some have noted, to believe in the confidence fairy, but it would be an even bigger mistake to believe in the free-lunch fairy. Some signs are encouraging, others less so. Navigating the tricky waters ahead will require a balance between Gramscian pessimism of the intellect and optimism of the will: pessimism to assess the challenges ruthlessly, never underestimating them; optimism to overcome them. And, as the late Tommaso Padoa Schioppa stressed, it will require a long-term view. Keynes once famously said: in the long run, we are all dead. But, one would hope, the next generation will be very much alive.
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What is at stake is nothing less than the legacy of the current generation to the next.
This is as true at the global level as it is in Europe.
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PCAOB Regulatory Initiatives James R. Doty, Chairman

Practising Law I nstitute, New York, NY Thank you for inviting me back to the Securities Regulation Institute. It is great to be before a group that cares so much about good financial reporting. I came to the PCAOB with that objective. I am here today to talk about the regulatory initiatives of the Public Company Accounting Oversight Board. The PCAOB is deeply engaged in examining ways to enhance the relevance, credibility and transparency of the audit to better serve investors. The auditing profession has developed a highly skilled body of experts capable of analyzing accounts in a way that draws out truths and insights and sheds light on confused or misleading claims. It plays an indispensable role in making our capital markets fair and strong. But I believe we are in a high risk period that merits more attention to the audit, not less. When companies make lay-offs, as we've seen recently, they often affect the internal audit and compliance staff the first line of defense for fraud and other corporate malfeasance. This should be a concern to the legal community. Although we have never needed it more, the audit too has, in the minds of some, become a commodity to be contained with other compliance costs.
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In the United States, large audit firms' revenues from consulting are growing 15 percent a year.
Audit fees have stagnated at, basically, the inflation rate. Thus audit practices have shrunk in comparison to audit firms' other client service lines. This can weaken the strength of the audit practice in the firm overall. The problem is compounded when audit firms turn their talents to other endeavors that may further damage public views on the relevance and value of audit. To be relevant, the auditor must speak to and for investors. Fair or not, that is in question today. I want to see a vibrant audit profession that competes on quality more than price. I want to see a profession that is revered for insight and clarity, not box-checking. I want to see a profession that attracts and retains top graduates who are and remain committed to excellence in public service.
I. The PCAOB's I nitiatives Aim to Help the Profession Realize Its Potential by Enhancing the Relevance, Credibility and Transparency of the Audit for the Sake of Investor Protection.
At John's invitation, I will focus my remarks on six policy initiatives that the PCAOB is pursuing to accomplish these goals, by enhancing the relevance, credibility and transparency of public company audits. This is not an exhaustive list of our initiatives.
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We have a robust standards-setting agenda developed through extensive outreach, including with the PCAOB's Standing Advisory Group as well as other standard-setters.
The SAG, as we call it, is comprised of numerous stakeholders, including auditors themselves, as well as preparers and their representatives, investors, and others. John is a member. We don't rewrite standards just for the sake of change. But through our consultation process we identify areas of auditing that deserve improvement, or updating in light of developments in practice. I also leave for another day a discussion about our international program, other than to say that we have now entered into bilateral cooperative agreements with regulators in 14 other jurisdictions to conduct inspections jointly with the local regulator. We've recently restarted or begun joint inspections in major financial centers throughout Europe, in the U.K., Germany, N etherlands, Spain, Norway, and Switzerland. We benefit greatly from local insights and can be significantly more effective together. In cooperation with foreign audit regulators, we are revolutionizing what it means to engage in cross-border audit regulatory cooperation and, in the process, overcoming legal and organizational impediments to sharing information. I am disappointed that we still face resistance from some countries where there are registered firms we are required to inspect. We are coming to a cross-roads where we will have to make some important decisions and may have more to report in the coming months.
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A. A New Auditing Standard and Additional Guidance H elp Audit Committees Oversee the Audit.
The first two initiatives I will cover focus on arming audit committees with more and better information about the audit, as well as more and better information about the auditor's strengths and weaknesses. Audit committees cannot make decisions about hiring and compensating auditors on the basis of quality without transparency and insight about quality.
1. Auditing Standard N o. 16 I mproves Auditor Communication with Audit Committees

The PCAOB has recently adopted a new auditing standard Auditing Standard No. 16 on what the auditor should communicate to audit committees in order to protect the public's interest in keeping audit committees informed of important audit matters. It has been submitted to the SEC for the necessary approval.
AS 16 will require, among other things, that the auditor communicate to the audit committee matters arising from the audit that are significant to the oversight of the company's financial reporting process, including complaints or concerns regarding accounting or auditing matters that have come to the auditor's attention.
AS 16 will also require the auditor to communicate any significant difficulties encountered during an audit, including delays by management, unavailability of company personnel, or an unwillingness by management to provide information needed for the auditor to perform his or her audit procedures. I would expect the best auditors to communicate this information already, and the best audit committees to demand it.
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Yet we see and many law firms have built a good business on situations where this was not the case.
2. The PCAOB H as Issued Guidance on What Audit Committees Can Learn from PCAOB I nspections.
The PCAOB has also recently issued guidance about how audit committees can learn more from their auditors about the results and implications of the PCAOB's inspection findings. Description in the public portion of the inspection report of failure to obtain sufficient evidence to support the firm's opinion means that the inspection staff has determined that the firm failed to fulfill its fundamental responsibility in the audit: the firm failed to obtain reasonable assurance about whether the financial statements are free of material misstatement. Firms' characterizations of inspection results can sometimes distort them. How an auditor approaches inspection results can tell an audit committee a lot about the firm's commitment to excellence. In addition, how an audit committee addresses these issues affects the tone of the audit. An audit committee that accepts weak arguments may inadvertently signal to the audit firm and audit team that the audit committee is not concerned with quality. An audit committee that, on the other hand, expresses explicit concern for how the auditor has resolved noted deficiencies tells the auditor that quality matters. As lawyers for corporate boards, you will want to be attuned to these nuances.
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B. The PCAOB Has Proposed N ew Standards on Related Party Transactions and Audit Transparency.
The PCAOB has also proposed two new standards. The first, on related party transactions, describes basic tools that good auditors have used for years to identify financial reporting risks. For example, it requires auditors to understand management's compensation as a way to understand management's motivations. Changes in performance metrics may well be an important clue to understand areas where management's financial story is weak. They offer the auditor and audit committee insights about management's incentives that may not be gleaned otherwise. In addition, the Board has proposed to require disclosure in the audit report of the name of the engagement partner as well as participating firms in the audit.
Auditing is more than ever a global endeavor.

Engagement partners supervise audits that span continents and oceans. But the reader of an audit report may not know how much of the actual work was done by the firm signing the report. Participating audit firms practice in markets that exhibit markedly different business cultures, with divergent patterns of transparency. We are currently evaluating comments on both the related party proposal and the transparency proposal, with a view to moving toward issuing final standards next year.
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C. The PCAOB Has I ssued Concept Releases to Commence Debate on More Broad-Ranging Topics.
The PCAOB standards-setting work also includes two rather more broad-ranging projects, commenced not with concrete proposals but with concept releases.
1.The Auditor's Reporting Model

One involves consideration of changes to the form and content of the standard audit report. The current model is boilerplate limited to three paragraphs. This project is intended to develop a better, more transparent reporting model that will impart the auditors' insights about key aspects of the financial statements and other matters they want to emphasize. The project is not about changing the nature or scope of the auditor's work. I t's about making the results of that work more relevant.
The profession (and various of you as their frequent counselors) generally support changing the report.
We are now engaged in deep analysis and development of some of the concepts mooted in our concept release.
2. Auditor I ndependence
In addition, in August 2011, the Board issued a Concept Release on Auditor Independence and Audit Firm Rotation. The concept release notes the importance of auditor independence to the viability of auditing as a profession and highlights the risk to independence arising from the "client-pays" model.
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Since 2003, the PCAOB has hired experienced auditors from the field, taken them out of client service, and within weeks sometimes even days redeployed them as PCAOB employees to inspect the quality of audits around the country, and now around the world.
Yet from our earliest days, inspectors have identified serious audit deficiencies of such a range that it is not possible to ascribe them to isolated technical weaknesses. These include instances where auditors did not approach some aspect of their audit work with the required independence, objectivity and professional skepticism. We consistently find strong technical auditing skills at all of the largest firms and many smaller firms, in both new and long-term engagements. Yet we also find explicit policies directing partners to price audits for new clients lower than the cost of auditing for the express purpose of establishing a long-term relationship. According to a compilation of inspection results from Canada, the U.S., the U.K. and Australia, prepared by the Canadian Public Accountability Board, "Insufficient Professional Skepticism . . . is undoubtedly the most common finding that auditors are too often accepting or attempting to validate management evidence and representations without sufficient challenge and independent corroboration." A number of other regulators have also recently issued insightful reports on auditor independence and professional skepticism, including the Netherlands, France, Germany and Switzerland. Against this background, the concept release seeks public comment on ways to enhance independence, objectivity and professional skepticism and counteract these practices and influences. The PCAOB has embarked on several public meetings to engage prominent and thoughtful commenters with various, often conflicting, viewpoints.
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They have included some of the most authoritative and experienced voices to address the subject of audit quality, auditor independence and the challenges to both.
They offered varied perspectives as investors, senior executives and audit committee chairs of major corporations, chief executive officers of audit firms, academicians, and former regulators. The European Union and its member states are engaged in their own inquiry and are considering their own term limits, possibly six-year terms.
I don't want to rush to decision here.

I do want to influence the debate worldwide, by broadening its scope and getting beneath the surface of generalities, coming to grips with the practical. It is not our way of doing things in this country to shy away from large issues and avoid discussion of big, bold ideas. The commercial world we are part of is wrestling with the challenges of independence in fact and in appearance. We have thoughtful scholars and skillful advocates on all aspects of that question, and they should be heard. Discussion leads to a more robust consideration of alternatives, refinement of the analysis, and in the long run, better solutions.
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Introductory statement
Mario Draghi, President of the ECB, Vtor Constncio, Vice-President of the ECB, Frankfurt am Main Ladies and gentlemen, the Vice-President and I are very pleased to welcome you to our press conference. We will now report on the outcome of todays meeting of the Governing Council. Based on our regular economic and monetary analyses, we decided to keep the key ECB interest rates unchanged. Owing to high energy prices and increases in indirect taxes in some euro area countries, inflation rates are likely to remain above 2% for the remainder of 2012. They are expected to fall below that level in the course of next year and to remain in line with price stability over the policy-relevant horizon. Consistent with this picture, the underlying pace of monetary expansion continues to be subdued. Inflation expectations for the euro area remain firmly anchored in line with our aim of maintaining inflation rates below, but close to, 2% over the medium term. Economic activity in the euro area is expected to remain weak, although it continues to be supported by our monetary policy stance and financial market confidence has visibly improved on the back of our decisions as regards Outright Monetary Transactions (OMTs).
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At the same time, the necessary process of balance sheet adjustment in large parts of the financial and non-financial sectors as well as high uncertainty continue to weigh on the economic outlook.
It is essential for governments to support confidence by forcefully implementing the necessary steps to reduce both fiscal and structural imbalances and to proceed with financial sector restructuring. The Governing Council remains firmly committed to preserving the singleness of its monetary policy and to ensuring the proper transmission of the policy stance to the real economy throughout the euro area. As we said before, we are ready to undertake OMTs, which will help to avoid extreme scenarios, thereby clearly reducing concerns about the materialisation of destructive forces. Let me now explain our assessment in greater detail, starting with the economic analysis. Euro area real GDP contracted by 0.2%, quarter on quarter, in the second quarter of 2012, following flat growth in the previous quarter. As regards the second half of 2012, the available indicators continue to signal weak activity. While industrial production data showed some resilience in July/August, most recent survey evidence for the economy as a whole, extending into the fourth quarter, does not signal improvements towards the end of the year. Looking ahead to next year, the growth momentum is expected to remain weak. It continues to be supported by our standard and non-standard monetary policy measures, but the necessary process of balance sheet adjustment in the financial and non-financial sectors and an uneven global recovery will continue to dampen the pace of recovery.
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The risks surrounding the economic outlook for the euro area remain on the downside.
Euro area annual H ICP inflation was 2.5% in October 2012, according to Eurostats flash estimate, compared with 2.6% in September and August. On the basis of current futures prices for oil, inflation rates could remain at elevated levels, before declining to below 2% again in the course of next year. Over the policy-relevant horizon, in an environment of modest growth in the euro area and well-anchored long-term inflation expectations, underlying price pressures should remain moderate. Current levels of inflation should thus remain transitory. We will continue to monitor closely further developments in costs, wages and prices. Risks to the outlook for price developments continue to be broadly balanced over the medium term. Upside risks pertain to further increases in indirect taxes owing to the need for fiscal consolidation. The main downside risks relate to the impact of weaker than expected growth in the euro area, in the event of a renewed intensification of financial market tensions, and its effects on the domestic components of inflation. Turning to the monetary analysis, the underlying pace of monetary expansion continues to be subdued. In September the annual growth rate of M3 decreased to 2.7%, from 2.8% in August. Monthly outflows from M3 reflected to some extent the reversal of portfolio shifts into the most liquid components of M3.
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Accordingly, the annual rate of growth of M1 declined to 5.0% in September, from 5.2% in August. At the same time, we have observed a strengthening in the deposit base of banks in some stressed countries, amid improvements in investors confidence in the euro area.
The annual growth rate of loans to the private sector (adjusted for loan sales and securitisation) declined further to -0.4% in September, from -0.2% in August. This development was mainly due to further net redemptions in loans to non-financial corporations, which led to an annual rate of decline in these loans of -1.2%, compared with -0.5% in August. The annual growth in MFI lending to households remained unchanged at 0.9% in September. To a large extent, subdued loan dynamics reflect the weak outlook for GDP, heightened risk aversion and the ongoing adjustment in the balance sheets of households and enterprises, all of which weigh on credit demand. At the same time, in a number of euro area countries, the segmentation of financial markets and capital constraints for banks restrict credit supply. The recent results of the bank lending survey for the third quarter of 2012 underpin this assessment. The soundness of banks balance sheets will be a key factor in facilitating both an appropriate provision of credit to the economy and the normalisation of all funding channels, thereby contributing to an adequate transmission of monetary policy to the financing conditions of the nonfinancial sectors in the individual countries of the euro area. I t is thus essential that the resilience of banks continues to be strengthened where needed. To sum up, the economic analysis indicates that price developments should remain in line with price stability over the medium term.
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A cross-check with the signals from the monetary analysis confirms this picture.
Other economic policy areas need to make substantial contributions to ensure a further stabilisation of financial markets and an improvement in the outlook for growth. Structural reforms are crucial to boost the growth potential of euro area countries and to enhance employment. Policy action is also necessary to increase the adjustment capacity of euro area economies in order to complete the ongoing process of unwinding existing imbalances. Visible progress is being made in the correction of unit labour costs and current account imbalances. However, further measures to enhance labour market flexibility and labour mobility across the euro area are warranted. Such structural measures would also complement and support fiscal consolidation and debt sustainability. As regards fiscal policies, there is clear evidence that consolidation efforts in euro area countries are bearing fruit. It is crucial that efforts are maintained to restore sound fiscal positions, in line with the commitments under the Stability and Growth Pact and the 2012 European Semester recommendations. Full compliance with the reinforced EU fiscal and governance framework, including the rapid implementation of the fiscal compact, will send a strong signal to markets and strengthen confidence in the soundness of public finances. The Governing Council takes note of the European Council conclusions on completing Economic and Monetary Union, adopted on 18 October 2012.
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In the context of measures to achieve an integrated financial framework, it welcomes in particular the objective of agreeing on the legislative framework for a Single Supervisory Mechanism (SSM) by 1 January 2013 with a view to the SSM becoming operational in the course of 2013.
We are now at your disposal for questions. Question: Given what you just said about the condition of the economy, and what you said in your speech yesterday, do you expect your projections for the economy to be revised downwards next month, and did you discuss a cut in interest rates? Also, considering the SME lending survey of last week, would you consider a further LTRO or possibly the purchase of corporate bonds or corporate ABS? Draghi: We will certainly monitor developments in the euro area economy and these developments will be taken into account in the December staff projections. Certainly the outlook is being revised; as you know, the European Commission has released its forecast, and there is a picture of a weaker economy, as I had the chance to say yesterday. So all this is bound to be taken into account in the staff projections in December. On interest rates, we always discuss all our instruments of monetary policy but, as I just said, the Governing Council decided to keep interest rates unchanged. We have not discussed what we are going to do next year in terms of monetary policy. Question: I s the ECB satisfied with the degree of relief that the mere announcement of the OMTs has already brought to the markets?And in the current environment would you then theoretically be happy to never buy a single bond, or do you think that the rest of the euro area would benefit from a Spanish bailout request by giving you the opportunity to
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show your resolve and thereby clear the impaired transmission mechanism?
My second question is on interest rates. I know you said you did not make a decision on the future main refinancing rate. Governing Council member Ewald Nowotny said that, for him, a negative deposit rate, should you decide to cut interest rates, doesnt appear to be a realistic prospect to him. I s that an assessment that is shared in the Governing Council? Thank you very much.
Draghi: We did not discuss matters related to your second question.

On the first question, we certainly take note that since the OMT announcement there has been a series of market improvements that I will just quickly list. First of all, we have a return of flows from the rest of the world, in particular from US money market funds, which was +16% in September, month on month, for the third consecutive month since the announcement.
So, even though overall it continues to be a small exposure with respect to euro area banks and with respect to what it was at the beginning of last year, it is going up.
Also, this form of lending has shifted considerably from secured to unsecured lending. Only 30% was secured, and this is the lowest figure since March. And this is a positive sign. Another positive sign is that there have been some limited renewed US dollar bond placements by euro area institutions. There has been a moderate pick-up in corporate issuance. As I had the opportunity to mention on other occasions, there have been a few issues of sovereign bonds by I reland and Portugal.
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The funding plans of two large sovereigns like I taly and Spain are quasi-completed if not completed.
And the share of foreign holdings of these bonds issued by Spain and I taly has gone up, which is also something that we had not seen for a while. Finally, the TARGET2 balances figure, which is another sign of how imbalances in the euro area are developing, has been stable now for two or three months, which is also another good sign. So all this is encouraging, and by itself this has certainly been equivalent to a further expansion of monetary policy , because financial market conditions are considerably easier now than they were two or three months ago. On the Spanish request, I will decline to make any comment. It is entirely in the hands of governments to decide about this. The conditions of the OMTs are clear and we stand ready to act. OMTs are, as you know, a fully effective backstop that is devised to remove the tail risk for the euro area, and we stand ready to act. Question: I do need to press you again on Spain, unfortunately, because Spanish bond yields have gone up again you are nodding the longer Mr Rajoy hesitates. Would you like Spain to ask for aid? And my second question is: Do you consider financing conditions appropriate across the euro area right now, or do the current I talian and Spanish spreads still contain a redenomination risk? Thank you. Draghi: Again, you keep on pressing, but I will keep on answering in the same way. It is entirely up to Spain, and to the Spanish Government, to take this decision. I t is not up to the ECB. As I have said many, many times, the ECB has produced the OMTs. The OMTs are a fully effective back-stop mechanism. They are a device to remove tail risk, while at the same time not removing incentives for fiscal discipline, and delivering price stability.
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That mechanism is in place. And the conditions for accessing that mechanism are also very, very clear.
Now, for the rest, the ball is now completely in the governments side of the court, not in that of the ECB. With respect to the financing conditions, I think that, rather than focusing on the levels of the spreads or interest rates, one should look more at the fragmentation of the euro area. So, when we talk about financing conditions, for example at financing for small and medium-sized enterprises (SMEs), as was asked in the preceding question, when we are asked whether we are satisfied with the financing conditions, the answer is: no, we are not satisfied at all. We are observing a fragmentation of the euro area, a re-nationalisation of the banking systems, differences in the cost of funding that go beyond the fundamentals. Therefore, our priority now is to repair the monetary policy transmission channels, so that our monetary policy will actually deliver, will be able to deliver price stability. Question : you have always said that you can only fix the transmission mechanism if the OMTs are activated without the Spanish request. Then Draghi: No. OMTs will help to fix the transmission mechanism, but there are many other reasons why the transmission mechanism is not working. First and foremost among them is the lack of appropriate economic policies that are now in the process of being fixed. But let us not forget how we came to find ourselves in this situation. We know that there was a situation marked by bad equilibrium, where until three months ago we had self-fulfilling expectations, self-feeding expectations. At the same time, the countries concerned found themselves in this bad equilibrium because of policy mistakes of the past, or because of the lack of policy altogether.
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So the origins of the fragmentation of financial markets in the euro area are basically to be found in policy mistakes, and these have to be corrected. Question : Mr Draghi, the Spanish Prime Minister, Mr Rajoy, has said that one of the reasons why he is taking his time with the request for a European bailout is because he wants assurance that the ECBs intervention will actually bring down his countrys borrowing costs. Can you give Mr Rajoy this assurance today?
Draghi: No. I think I have answered this question before. First, there is a general statement. The way the OMTs have been designed foresees, as we have discussed many times, that, as a necessary condition, the country should sign up with an ESM programme, and that a role for the I MF would be actively sought and would be welcome. But this is the necessary condition it is not also the sufficient condition. So, the Governing Council will take its final decision in total independence. And in so doing, it cannot give any assurance ex ante. Because we have to make our monetary policy assessment, we have to make an assessment of the actual state of fragmentation of the financial markets. So, I think there is not any automatic quid pro quo. We know that the mechanism is a fully effective back-stop, and it is in place. But it is up to the countries to take all the right steps to ensure that this mechanism can be activated. Question: My second question is on Greece. Last night, Greece managed to approve another austerity package. Is this enough and would the ECB now be willing to help make Greeces debt burden more sustainable, and if so, what could you do? Draghi: The ECB and the Governing Council certainly welcome the outcome of the vote yesterday. It is a very important step that the Greek government and the Greek citizens have undertaken.
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It really represents progress, especially if one compares the situation with what it was a few months ago.
Another vote is expected on the budget on Sunday. The governments will discuss the Greek situation at next weeks Eurogroup meeting. The ECB ensures price stability and wants to repair monetary policy transmission channels, but it cannot undertake monetary financing. Question: N ext week Greece will have to refinance 5 billion of Treasury bills and that is likely to be done again through emergency liquidity assistance. How much longer is the ECB going to tolerate that sort of behaviour and could you also please explain why emergency liquidity assistance is not a form of monetary financing? Second, do you see evidence that this sort of funding is being used increasingly elsewhere, for example in Cyprus? Are you worried about this, especially in the light of very tight fiscal policies? Draghi: We consider this type of financing to be temporary. We do not consider emergency liquidity assistance to be monetary financing; it is one of our instruments. We are keeping a close eye on developments in Cyprus, but it is ultimately up to the government to respond to this situation, not the ECB. Question: My first question is on inflation expectations. After OMTs were announced in September, we saw a very strong increase in gold prices, with 3 billion going into gold ETFs and ETCs just in that month. Is that a sign of speculation or of increased inflation expectations? My second question relates to unit labour costs. You said that there has been visible progress in the correction of unit labour costs. Most economists say that unit labour costs are not a good way to measure competitiveness because you have this unemployment productivity. They say that one should look at the GDP deflators because there we do not really see any great progress being made. Are they right or wrong?
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Draghi: The increase in gold prices is exactly that. Why this should depend on OMTs is a mystery to me.
We are constantly looking at inflation expectations over several horizons, and no matter what horizon we look at, we continue to see that they are solidly anchored. To ask whether the price of a specific asset forecasts an increase in the inflation rate is always a very risky question. You see asset prices going up and down, and to infer from an increase in the price of one asset that inflation will go up, and that inflation will go up because of OMTs, which havent created any liquidity yet, is really a very rash assumption. With regard to the improvement in labour costs, yes, there has been an improvement in unit labour costs in several countries. This may certainly be partly the consequence of an increase in productivity, which, as the economists you mentioned correctly say, could be cyclical. However, we also observe an improvement in the current account balances of these countries. You are also right when you say that, in spite of the changes in unit labour costs in some countries, we do not observe comparable changes in the GDP deflator, which may be due to other reasons. For example, in one country unit labour costs have fallen, but there has been no change in the GDP deflator or H ICP inflation rate because energy prices remain very high. The other reasons have more to do with the inertia that the components of value added show in adjusting to the new situation. Question: I have a completely different question concerning collateral framework rules.
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I just want to know how exactly you want to make sure that national central banks might not again bend the collateral framework rules according to their needs.
How do you want to make sure that the credibility of the ECB as a risk manager will not be hurt? Draghi: Let me first make a clarification, because there has been a lot of press on this point in the last week. The first clarification is purely factual: the nominal amount of collateral being posted was not EUR 80 billion, but EUR 10 billion. The second clarification is that all this had no impact at all on our lending. So nobody received more than they should have received because of this mistake because it was a mistake. The impact of this is zero, but we take this mistake very seriously. And so the Governing Council has mandated the Eurosystem Audit Committee, which is chaired by Governor Liikanen, to assess the implementation of the collateral framework in the Eurosystem and we will have an initial assessment of this at our next Governing Council meeting and then we will discuss whether further analysis or further action is needed and I will keep you posted on that. Question: I would like to go back to the economic outlook. You have mentioned recently that there are some deflationary risks in some European countries. You have talked about unemployment being deplorably high. Why arent you cutting rates, why arent you considering some kind of quantitative easing? Isnt that an appropriate role for monetary policy? And my second question, back to the Greece issue: You said you wont do anything that is monetary financing, but are there things you could do that would not cross that line? Specifically, could you sell your bonds at cost to Greece or to the ESM?
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Could you somehow redirect your profits back to Greece? Do you have options or are you just telling the governments that you have no role in this whatsoever?
Draghi: Well, let me first just point out that I never mentioned deflation. Deflation is a generalised fall in the price level across sectors and it is self-sustaining. And so far we have not seen signs of deflation, neither at the euro area level nor at country level.
We should also be very careful about not mixing up what is a normal price readjustment due to the restoration of competitiveness in some of these countries.
They will necessarily have to go through a re-adjustment of prices. We should not confuse this readjustment of prices, which is actually welcome, with deflation. Basically, we see price behaviour in line with our medium-term objectives.
So, we see price stability over the medium term.

Also consider that monetary policy is already very accommodative, consider the very low level of interest rates and that real interest rates are negative in a large part of the euro area, and consider how many measures we have taken in just one year: several cuts in interest rates, halving the reserve ratio, two LTROs for a gross amount of EUR 1 trillion and so on and so forth. We have gone through this together many times, so I will not repeat it. And then we had the OMT announcement, which by itself produced an easing of financial market conditions. But we will certainly continue monitoring economic activity and we stand ready to act.
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As I said before, we stand ready to act with the OMT once the prerequisites are in place, but we also stand ready to act with the rest of our standard monetary policy instruments.
On Greece, we certainly cannot do monetary financing. I repeat this. On the profits of the SMP holdings, we already decided this at the time of the first PSI because what happens is that these profits naturally accrue to the central banks that are members of the Eurosystem. And then the central banks, in their independence or according to their legislation, will transfer these profits to the governments and then it is up to the governments to decide whether they want to re-use these profits for Greece. And the governments actually committed themselves to do so at that time. Question: So youre done, the ECB is done on Greece? Draghi: The ECB is as you say, by and large, done. Question: A question still relating to SMP profits. I am just trying to make a fair estimate of the scale of this profit, assuming that you have 60 billion on your balance sheet, bought at 75% of its face value, and get interest income of 5% over five years; that would mean 30 billion profit. I s that a fair estimate of the profit of the SMP holding? Draghi: I am very sorry but I am not in a position to answer this question. I can provide you with an answer later. Question: Provided that it is being paid back in full. I s it a fair estimate? Draghi: I do not have an answer now. Question: Two questions. First of all, just again on inflation. You said today that the risks were balanced on the upside and the downside. I think when you were talking behind closed doors to German Members of Parliament, you said the other day, in the text of the speech that was released anyway, that there was, if anything, a downside risk. Could you just clarify, which is it? I s it balanced or is it a downside risk?
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The second question is on LTROs.

Your neighbours in the tower block just over there in Commerzbank said, this morning, that they plan to hand back their LTRO funding at the end of the year, as soon as they can, basically. This is essentially because they do not seem to be able to find anything useful to do with it; it costs them 0.75%; they are just parking it with the Eurosystem at 0%. Is that a worrying sign? Should these banks be finding companies to lend that money to, or are you relaxed about a sudden end to all these LTRO borrowings? Draghi: On inflation, I think I have always said, at least in the recent past, that risks are broadly balanced because, on the one hand, you have the downside risks that come from the weak level of economic activity and high unemployment. On the other hand, you have the upside risks that come from energy prices and the widespread use of indirect taxation, especially VAT, by countries that need to consolidate their budgets.
So, the two things, by and large, balance themselves and this is the assessment that I would still maintain today.
On the LTRO: no, it is not necessarily a matter of concern. Actually, in a sense, it is the best response to all those who were saying you are flooding the world with liquidity; now, you see that this is not happening. You see that, in fact, money is coming back, and the balance sheet of the ECB will shrink down correspondingly.
No consequences on inflation had followed since the time when we decided on the LTRO, way back in January/December last year.
Whether banks return LTRO because they do not lend it because of risk aversion or because credit demand is weak, I am not in a position to say today.
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But, certainly, these must be the two reasons: either they are fearful to lend and here we are talking about banks that do not have capital constraints of course so, assuming that they do not have any capital constraints, banks do not lend because either the risk aversion is too high or because there is no demand.
This could be a sign of either of the two factors. The important thing with the LTROs was that, again, we removed tail risks coming from the lack of funding that would have happened in the first quarter of this year. The objective has been achieved.
Question: Did you try to saddle the OMT horse from the other side? You said the OMT was there to avoid extreme scenarios, extreme risks.
Could you foresee a scenario, an extreme scenario, where the OMT would be triggered without the conditionality in place, or without parts of the conditionality in place, because, as I said, it might be too extreme a scenario? The other thing is, after yesterdays speech, and also after the statements today, the markets are taking the view that we are going to see a rate cut next time around. Would you say that the markets are grossly misguided? Draghi: Well, on the second question, as you know, I cannot comment. On the first question, you are asking me: could there be an OMT without conditionality? The answer is no. Question : Mr Draghi, I have a question concerning the euro zone and the United States, where we just had the elections. Under the pressure of the markets in Europe, the reform process started two years ago in Italy and in Spain. In the United States it is said that there the reforms could not start. We are all wondering whether they will start now.
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What do you think, in your eyes, is Europes potential to catch up with the United States? Do you think that Europe can have a comeback, a sort of comeback, in the near future?
Draghi: What I can say is that both the euro area as a whole and the individual countries forming the euro area and I would not have made this statement a year ago, by the way have a fundamental position, which is way more balanced than the United States, but also than other countries: Japan or the United Kingdom. The euro area has a current account balance which is basically in balance zero that, both as corporate debt and household debt, is relatively low all over the euro area; saving ratios are high; and as I was saying before, unit labour costs are on their way down. The fiscal consolidation that has taken place all over the euro area is amazing. When we look at the other parts of the world, it is not so amazing at all. So, deficit-to-GDP levels are on their way down everywhere, even in the countries which have the highest ones. So, all this basically poises the euro area for a recovery, which should be, or probably is going to be, slow, gradual but also solid, looking exactly at these fundamentals. So, what we have to overcome now is the sort of fragmentation; that is our major challenge ahead and I think we have made, collectively, significant progress on that route. Question: Mr Draghi, you said before that that the monetary policy stance is very accommodative at this time and you mentioned the bunch of measures taken in the past year. Is this the time, or is this absolutely not the time, to think about the point when you will abandon this strategy? Do you prepare for it, maybe in your mind, or is it not something you are thinking about at all at the moment? Secondly, through the supervisory mechanism that you welcome, the ECB will soon be giving a formal legal opinion, but could you give us your opinion now, if you have one, on the information that Paris and Berlin are in favour of a woman chairing this authority.
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Draghi: On the first question: we look at price stability and we will decide on our strategy and the timing of our exit depending on how we see price stability over the medium term.
So far, we see no reason to change our monetary policy, looking at price stability over the medium term. On the second point: gender considerations are close to our hearts and minds. That goes for both the Executive Board and me personally.
We understand that the European Parliament, with whom we have always had excellent relations, has valid concerns about this, and our hearts and minds are really open with respect to this.
This has to do with my answer to your point about the supervisory mechanism and who might chair it. Gender concerns are very important and, actually, the ECB has been quite active on this. Let me just go through some of the things we have done in order to show you how we all care about this. We have been very active as far as our recruitment success rate is concerned and we are doing fairly well at staff level. We are not doing well at management level, so we have to improve in that respect. However, we have launched a series of actions which I think will bear some fruit here. We know we have to improve at management level. Question: You said the original financial fragmentation was a policy mistake and that structural reforms are needed. Are you satisfied with the reform path and the reform speed you see in Spain and Italy, or would you expect more and faster reforms? Draghi: I think this is an important question.
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In answering it, I would ask you not to take a medium-term, but a short-term perspective.
Compare the situation today with how it was even less than a year ago and the conclusion is unavoidable: there has been substantial progress. Is the task finished? Not at all. There is a lot more to do, obviously on the fiscal consolidation path, but and this is more and more significant as time goes by also on the structural reforms. Question: But is it happening fast enough? Draghi: Again, it depends on your perspective, because if you compare the current speed of reform with the speed of reform in those countries in the previous five years, then you are bound to say that it is very fast. But if you are asking me whether it will ever be fast enough, I will put it this way: the faster it is; the sooner financial market conditions in Europe will return to normal. Question: I will take your perspective, because you said the main problem was the lack of structural reforms and that you cannot solve the problem it is up to the countries to do so. So, from your perspective, is the speed of reform fast enough for financial conditions to return to normal? Draghi: It does not matter what speed we would like to see, as it is ultimately for the citizens of these countries to decide on the speed. They should know that these structural reforms have to be made. They are unavoidable and necessary. Eventually, prosperity, growth and job creation will come out of them.
The actual pace of the reforms is a combination of many factors but, first and foremost, the political realities of these countries.
As I said, the sooner this process is brought forward, the quicker the euro area will get back to normal in the euro area because and let us not forget this the financial conditions in the euro area started to worsen
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after the financial crisis, but this was because very unsatisfactory policies were found to be in place in many countries.
Elisabeth Ardaillon-Porier, Director Communications, announces that the President will now make an announcement regarding the euro banknotes and afterwards a video will be shown. Draghi: But before I do, I just want to go through the partial answer I gave about gender diversity, because I think it is actually quite important that I do give some time to this. As I said, we are doing very well at staff level but we should improve at management level. In order to achieve this, we have launched a number of initiatives to encourage female staff to pursue management functions, and to support them in this. These initiatives include mentoring, the diversity task force, making use of external counsellors, enhancing diversity in recruitment panels, and child-minding facilities. As I said before, my impression is that these initiatives are bearing fruit.
Now, coming to the banknotes; let me read the statement.

I am pleased to be able to announce that the European Central Bank and the national central banks of the Eurosystem are to introduce a second series of euro banknotes. Called the Europa series, it will include a portrait of Europa a figure from Greek mythology and the origin of the name of our continent in the watermark and the hologram. The new banknotes will be introduced gradually over several years, starting with the 5 banknote in May 2013.
The Europa series has benefited from advances in banknote technology since the first series was introduced over ten years ago.
Its security features have been enhanced, which will help to make the banknotes even more secure.
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Three new features the portrait watermark, portrait hologram and emerald number have been unveiled today.
The first series will initially circulate alongside the new banknotes, but will gradually be withdrawn and eventually cease to be legal tender. The date when this occurs will be announced well in advance. However, the banknotes of the first series will retain their value indefinitely and can be exchanged at the Eurosystem national central banks at any time.
The ECB will be revealing the details of the new 5 euro banknote in two phases starting today with three of the new security features that it contains.
This will allow the public to start familiarising themselves with this three new security features. Also, in order to raise public awareness of this series, the Eurosystem will be conducting an information campaign across the euro area in 2013. I would also like to take this opportunity to thank all the Eurosystem staff who have been involved in the preparations for the new banknotes. And now I am pleased to present a short film that is showing three of the new security features embedded in the new five euro banknote. Question: President asks: What is the sense of this movie? Mr Vice-President, please answer the question. Constncio: I am just considering it like you are, because I just saw the film for the first time. In fact, the purpose is to show the three new security features that we decided to reveal today. I would like to take this opportunity to say that on 10 January 2013 the full new five euro banknote will be revealed at an event in the archaeological museum here in Frankfurt.
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We will also show the 2000-year-old Greek vase that belongs to the Muse du Louvre the vase from where the portrait of Europa was taken.
So, there will be an exhibition and all the other security features of the note will be revealed in full. Today, it is just three features, and thats what was shown in the film: the hologram; the watermark; and the number five changing colour.
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Steven Maijoor, ESMA Chair
Developments in European Financial Reporting Regulation and Enforcement

Meet the Experts, London
Ladies and Gentlemen, It is a pleasure to be here today at Meet the Experts. I am delighted to see that the organizers have attracted such a large group of speakers and participants with experience of financial reporting and I FRS. Today I will touch upon four financial reporting topics namely: (i)Consistent application and enforcement of IFRS in Europe; (ii) Forbearance in the banking sector and the need for transparency; (iii)Convergence with US GAAP; and, as I know there are many auditors in the audience today, I do not want to disappoint you and will say a few words on (iv)The audit proposals published by the European Commission last year.
But before I move on to the specific financial reporting topics, let me spend a few minutes on general ESMA issues to give you an impression of our activities in the past year, and which reflect our main objectives.
EU single rulebook
Since September 2011 we have developed 51 draft regulatory and implementing standards and six sets of guidelines in areas such as credit rating agencies, short selling, high frequency trading, and alternative investment funds.
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I specifically want to mention the 40 recently completed technical standards that were developed in order to meet the EU commitment to have rules in place for derivatives markets by January 2013.
In carrying out these tasks ESMA has ensured that all relevant stakeholders had the opportunity to pro-vide input into our policy development process through open public consultations, and interaction with various stakeholder associations representing both investors and market participants. To ensure the effective implementation of the single rule book, and avoid regulatory arbitrage, ESMA has supported supervisory convergence by for example issuing opinions, including one on the treatment of sovereign debt under IFRS.
Financial stability and crisis management

ESMAs work on financial stability is a mix of regular risk reporting and specific projects. We have com-pleted specific work on the risks associated with the current trend towards structured and complex retail products, the CDS market, and the shadow banking system in Europe. I would also like to highlight key aspects of ESMAs coordination activities in the context of adverse market developments. The Board of Supervisors of ESMA held several conference calls in early summer to discuss the significant worsening of financial market conditions in the EU. The objective of these calls was to exchange information on key financial market developments in the EU, planned responses to those developments by national competent authorities and to assess where, and what type of coordination, was needed.
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Investor protection
ESMA has reinforced the European framework for investor protection through a series of concrete initia-tives. In July 2012, ESMA published two sets of guidelines aimed at enhancing the protection of investors, and financial consumers more broadly. One set concerns the suitability of advice to financial consumers and the other set concerns investment firms requirements regarding the compliance function. Also in July, we published Guidelines on ETFs and other UCIT S issues which are aimed at strengthening investor protection and harmonising regulatory practices across this important EU fund sector, through increasing the level and the quality of information provided by UCITS investment funds to their investors. After the Summer we have published draft guidelines for consultation which address the alignment of remuneration with the overarching obligation on investment firms to act honestly, fairly and professional-ly in accordance with the best interests of its clients. Finally, ESMA has also exercised its power to issue warnings. We have issued a warning on the main risks involved in forex trading, and a warning on using the internet for investment purposes, following an observed rise in complaints reported by national authorities.
CRA supervision
This is the first year in which ESMA has exercised its supervisory powers regarding CRAs and currently 18 CRAs have been registered and ESMA continues to receive further applications for registration. In executing our supervisory responsibilities, ESMAs CRA Unit has undertaken two on-site inspections at the three largest registered entities.
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The first inspections were carried out in December 2011 and the find-ings were published last March, while a second round of on-site inspections has been completed after summer.
The March report identified several shortcomings and areas for improvement for CRAs. On the basis of the second round of inspections on bank rating methodologies we are now examining the evidence in preparation of our supervisory findings.
Euribor
Let me also mention that as a result of the LIBOR and Euribor cases, ESMA conducts various activities on reference rate issues. Together with the European Banking Authority (EBA), we conduct activities concerning, firstly, the facilitation of the national investigations regarding Euribor. Secondly, a review is conducted of the Euribor system, covering the rate setting system and the submission process. Thirdly, guidance is developed for benchmark providers and market participants focussing on transparency, con-flicts of interest and controls. This work complements and contributes to the forthcoming European Commission work in this area.
The ESMA organization

In addition to focusing on its role in policy and supervision, ESMA has also devoted much of this year to developing its internal organisation so it can carry out its mandate while remaining sufficiently flexible to respond to any further responsibilities it may receive.
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We are growing from 45 staff in September 2011 to an expected 100 staff at the end of 2012, and I would like to stress that we are pleased with the calibre of our recruits.
Let me now move on to the specific financial reporting topics.
Consistent application of IFRS

Europe has been getting a lot of bad press lately. Some Member States have been criticised for endangering the euro, and the resulting debate is shedding new light on the economic governance of the euro area. The last months discussions have rightly focused on enhancing prudential supervision and consistency throughout the euro area, more particularly in the banking sector. Establishing a banking union will surely contribute to the stability of the European financial system. However, financial stability is not only a duty for banking regulators, but for all financial services regulators, including securities regulators whose actions have contributed to maintaining a level of financial stability since the outset of the financial crisis. As I have described earlier, ESMAs activities are driven both by the investor protection objective and the stability objective. We strongly believe that financial reporting with strong measurement principles along with entity-specific and relevant disclosures reflecting economic substance are important in underpinning market discipline. This contributes to investor protection and stability. Market discipline can only be achieved through the development and application of high quality accounting standards.
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This is where the International Accounting Standards Board (IASB) has an important role to play, by developing clear, auditable, enforceable and globally accepted standards.
The worldwide adoption of I FRS is a necessary but, on its own, an insufficient condition for global comparability. In order to achieve true global comparability the standards have to be enforced. Research has shown that the mandatory adoption of I FRS by a jurisdiction results in reduced capital costs in the immediate mandatory adoption period reflecting increased disclosure and enhanced information comparability however, this is only really the case in countries with strong legal enforcement1 frameworks. In the European Union, the supervision of financial statements and their subsequent enforcement falls within the competence of national supervisory authorities. However, benefits of strong enforcement could disappear within the EU if we do not aim to improve on the consistent application at the Union level, and enhance comparability within the single market and at the global level. Therefore, consistent application of I FRS needs pan-EU coordination, which is one of ESMAs primary objectives. I have spoken about how ESMA does this in practice during past speeches and will not repeat myself here. However, I would like to talk about common IFRS enforcement priorities in the EU, which we will publish today. This is the first time EU enforcers have agreed on common enforcement priorities highlighting the areas on which all EU enforcers will focus when reviewing 2012s financial statements.
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These areas are:

(a)Financial instruments; (b) Impairment of non-financial assets; (c)Defined benefit obligations; and (d)Provisions that fall within the scope of I AS 37 Provisions, Contingent Liabilities and Contingent Assets.
I would like to expand on each of these issues briefly:
Financial instruments:
Since the beginning of the financial crisis, transparency related to financial instruments is a top priority. Issuers should provide disaggregated and expanded disclosures on material exposures to all financial instruments not only sovereign debt exposures that are exposed to risk. We would expect relevant quantitative and qualitative disclosures reflecting the nature of the risk exposure, elements related to the valuation of the instruments as well as an analysis of the concentration of exposure to relevant risks. - In addition, there should be due assessment at the end of the reporting period as to whether there is evidence that a financial asset is impaired. ESMA believes that issuers should be more transparent on how they assess the event or events triggering impairment. - A last point on financial instruments: significant or prolonged: a significant or prolonged decline in fair value triggers the recognition of an impairment loss for equity instruments held in the available-for-sale portfolio.
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EU enforcers have observed diverging practices in the application of the relevant criteria and think investors would benefit from more transparency.
So please tell them and us what is considered to be a significant or prolonged decline in value.
Impairment of non-financial assets:

The current economic situation increases the likelihood that the carrying amounts of assets might be higher than their recoverable amounts. The market value of many listed companies has fallen below their book value, a situation potentially indicating impairment and thus the need for an impairment test. ESMA considers that particular attention has to be paid to the valuation of goodwill and intangible assets with indefinite life spans, whenever significant amounts are recognised in the financial statements. ESMA emphasises the need to use assumptions that represent realistic future expectations and would expect issuers to provide entity specific information related to assumptions used, when preparing discounting cash flows (such as growth rates, discount rate and consistency of such rates with past experience) and sensitivity analyses.
Defined benefit obligations:

I n some countries there is no, or no longer, a deep market in high quality corporate bonds whilst discounted post-employment benefit obligations should be determined with reference to such market.
The crisis and economic downturn resulted in significant swings in market yields for some sovereign and corporate debt.
The question could arise whether entities should change their approach when determining discount rates for their post-employment benefit obligations.
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ESMA would expect issuers to disclose the yields used and provide a description of how they determined them.
Provisions within the scope of I AS 37

The measurement of provisions involves significant management judgment and could in the current market circumstances be subject to more uncertainty. The strong link between provisions and the risks an issuer is subject to, makes a case for high-quality disclosures. Nevertheless, European enforcers often find that only aggregated and boilerplate information is provided. Issuers should disclose for each class of provision the nature of the obligation, the expected timing of the outflows of economic benefits, uncertainties related to the amount and timing of those outflows as well as, if relevant, major assumptions regarding future events. In summarising our enforcement priorities I have highlighted the need for improved disclosures. That is not because ESMA believes that disclosures could replace the recognition or measurement principles, but rather that it allows issuers to provide investors with high-quality information within a principles-based environment. We think that the I ASB should set objective-based I FRSs (such as is currently the case with I FRS 7 Financial I nstruments) allowing a companys management to align it as best as possible to its own situation. However, a principles-based environment can only survive if clear and entity-specific disclosures, re-assessed at the end of each reporting period, bring useful decision-making information to investors.
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If not, detailed prescriptive requirements would need to be developed and we all know that what is important today will not necessarily be so in the next financial year.
The only way to avoid this is to stop providing boilerplate information directly mimicking the standards. Here I would like to specifically address the auditors in the audience, and ask them for their support in achieving this. We deliberately issued the European common enforcement priorities before the year-end so that companies and their auditors could and should take due consideration of them when preparing and auditing the IFRS financial statements for the year ending December 2012. Auditors have an important role to play in assuring investors about a companys financial position and performance, which is more important than ever for all companies, and especially financial institutions.
Forbearance
To introduce my next topic, I would like to highlight two developments affecting the European banking sector.
First, while there have been some improvements in recent years, bank leverage is still high and a very important issue of concern. Thin equity buffers make banks vulnerable to shocks in performance and the economy. Second, many holders of bank loans are impacted by the difficult economic situation in the EU and are struggling to meet their obligations. Today, there is a practice resulting from these two developments, on which I would like to go into more detail: the practice of forbearance.
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This concerns the situation where a borrower is in financial difficulties and does not pay on time, and the lender decides to wait and see, perhaps he even renegotiates the arrangement on more favourable terms.
If a number of borrowers and banks have problems at the same time, the issue has not only a micro but also an important macro-prudential dimension. We are thus working, even more closely than usual, with the EBA and the European Systemic Risk Board in this area.
The latters Advisory Scientific Committee issued an interesting report on forbearance and bank resolution in July 2012.
Under the practice of forbearance, the lender hopes to get his money back, waiting to see whether the borrower will eventually pay up which me an s t akin g a risk regardin g th e b orrowers ab ility or willin gn ess t o p ay . While forbearance can in some cases be justified and economically rational, it can also become a waste of additional resources if the banks continue to lend to their old debtors rather than to new clients. Continuing to lend to old debtors may be a way of kicking the can down the road, so to speak, avoiding a credit event that would have to be entered into the books. Continuing to lend to old debtors may then become a case of throwing good money after bad. From the perspective of the overall economy, such a use, or misuse, of funds is an impediment to economic growth. Even if the old borrowers do not receive any new funds, banks with weak balance sheets may reduce new lending in order to make their balance sheets appear stronger, rather than by writing off old loans and recapitalising.
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Personally, I think that Europe can learn a lot from the Japanese experience of the 1990s, which demonstrates some of the perils of forbearance.
When the Japanese banking crisis began in 1992, it was known, or it should have been known, that many loans in the banks books were worthless. However, fears of write-offs inducing open insolvencies motivated forbearance by banks towards borrowers and of supervisors towards banks. The avoidance of write-offs and the failure to acknowledge insolvencies had large economic and social costs. As banks continued to lend to problem borrowers, lending to new firms fell and growth slowed or stopped completely. Today there seems to be a consensus in the academic community that the strategy of denial, deferral and opaqueness was one of the main reasons why the Japanese crisis lasted for more than a decade, during which it stifled economic and social development. For this reason, I believe that it is important for lenders to clearly reflect in their financial statements the credit risk they are exposed to in relation to forbearance. They should do this by providing clear disclosures (including both qualitative and quantitative information) that help investors to understand the extent of the forbearance practices when the exposure is material and to evaluate the need for potential impairments.
US IFRS adoption
Let me now turn to an issue which is less technical but that has many technical implications and affects financial markets all over the globe and the competitiveness of Europe: the US SEC non-decision on IFRS.
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The publication of the SEC staff report last July represents an important milestone for the SEC in its evaluation of I FRS.
Let me remind you that the SEC report was aimed to provide the SEC commissioners with the relevant information needed to decide whether, and if so, how, IFRS should be applied in the US. Today we understand that the SEC staff will provide a recommendation to the Commission on I FRS, but that no timetable for completing such work has been communicated. Although fully understanding the domestic economic and political constraints of the US SEC, I am personally disappointed with the lack of ambition regarding IFRS on the other side of the Atlantic. Patience has been a real virtue for us over the last few years and there have been a number of efforts to facilitate the adoption of I FRS in the United States. To name just two: the I ASB /FASB memorandum of understanding, and the monthly joint Board meetings. Some of the efforts to facilitate US IFRS adoption were difficult topics for the I ASBs constituents to accept, especially in Europe, but they were willing to pay the price to get the US on board. Today I cannot avoid the feeling that all these efforts do not seem to be enough which suggests that it will never be enough. I believe many people feel as I do, which is disappointment that there is no progress or clear sign of political will to keep I FRS adoption high on the agenda in the US. We have made so many far-reaching mutual decisions over the last years that it would be a shame to miss the opportunity by walking away from IFRS.
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In any case, we should not accept that the lack of an American timetable for a decision and clear support for IFRS is further slowing down the IASBs technical agenda.
We urgently need to finalise the post-crisis agenda with projects like impairment of financial assets and insurance contracts. On the fact that the I ASB and FASB are not able to come up with joint proposals on the impairment of financial assets, I can only say that I truly believe that where there is a will, there is a way.
We cannot continue with the current US influence over the international standard-setter.
Convergence can no longer drive the IASBs agenda and it is time that the Foundation and the IASB focus their resources on developing high quality accounting standards and the important challenge it faces to achieve consistent application. This should not only be the case for the Foundation and the Board but for all actors including the Monitoring Board (MB). In 2009 a Monitoring Board was set up to enhance the organisations public accountability by establishing a link to a MB of public authorities. Three years later I think it is legitimate to assess the tangible results the Monitoring Board has achieved. True, public accountability is often about creating trust and cannot be easily measured. However, it is important to assess how the MB has ensured the public interest perspective in I FRS standard setting.
Audit
At the beginning of my speech I promised to say a few words on the proposals for audit published by the European Commission last year.
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Like many other parties, auditors play an important role in fighting the current crisis. Some of you might not like to hear this, but we have to admit that there have been serious shortcomings in the performance of the auditing sector during the crisis and that we have to learn from that. Prior to joining ESMA, as you may know, I was active in the regulation and supervision of auditors. During my time as chair of the International Forum of Independent Audit Regulators (IFIAR), I was extensively involved in the exchange of experiences about national inspections regarding audits of issuers hit by the financial crisis. One result of this work that struck me was that many of the shortcomings identified do not relate to auditors being unable to handle complex issues, rather they relate to quite basic auditing issues. These include a failure to give sufficient attention to issues whether in terms of time, or a failure to escalate them to a sufficiently senior level within the audit firm. As regulators we also saw that it took quite some time before the valuation of, and disclosure on, complex financial instruments traded in illiquid markets improved and met the right standards. I am personally convinced that if auditors had done a better job, investors would have had higher quality information on these financial instruments at an earlier stage and could have acted accordingly. Today there are still areas where issuers and their auditors should improve further. We have published some of these as part of our common enforcement priorities, as outlined earlier.
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We expect auditors to challenge issuers appropriately on these (and other) issues.

Many improvements in audit can be initiated by auditors themselves. However, I think it is important to support this with improvements in the regulation and supervision of auditors. Following the introduction of audit supervision in 2006, the European Commission now proposes to strengthen supervision, and to further improve the single market with harmonised standards, by for example requiring ESMA to issue guidance on issues like conducting audit quality assurance reviews. In the current European Commission proposals, ESMA is not going to supervise auditors directly; the competence for supervision remains with national oversight bodies who have a close understanding of the local market and its drivers. The knowledge and the good practices developed by some national regulators are an important cornerstone to build a stronger and harmonised European supervisory framework. When preparing this speech I was thinking back to a speech I gave as IFIAR Chair at a conference organised by the European Commission about two years ago. My message then was simple: we need to be much more ambitious regarding international cooperation in audit oversight. At present there is a large gap between the level of cooperation and integration of auditing regulators compared with that of the international networks of audit firms that regulators need to oversee. A failure to increase the level of international cooperation is a substantial risk for the effectiveness of auditing oversight. I have not changed my opinion since then.
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In the audit sector the group of largest networks is nearly identical in every country and continent, with day-to-day national auditing practices being strongly influenced by the regional and worldwide management of the international audit firms.
Serious extra-territorial issues are inherent in the oversight of internationally active audit firms. Therefore, there is a need for a more consistent European approach to overseeing the sector.
This particularly holds for the larger international audit firm networks, some of which have established legal entities covering their activities in more than one Member State.
The Commission proposals are now debated with the Council and the European Parliament. Whatever direction the European negotiations will take, we have to make sure that whichever system of oversight develops, it should be able to cope with audit firms practices: more international, more co-operative, more European. Ladies and gentlemen, thank you very much for your attention.
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Speech by the Chancellor of the Exchequer, Rt Hon George Osborne MP, to the Royal Society
It is a great privilege for me to address the Royal Society for the first time. You are testament to the continuing excellence of British science. You combine 350 years of history with support for cutting-edge research today. The manuscript of Newtons Principia Mathematica is in your Library and you host a seminar this month on energy transduction and genome function. Later this month you will be hosting a celebration of the Nobel Prize just awarded to your Fellow, Professor Sir John Gurdon, the 277th in your history. His research on cloning lies behind the development of stem-cells which is already transforming medicine. The sheer quality and range of scientific enquiry, as vigorous today as in the days of Ernest Rutherford and Dorothy Hodgkin , is one of our nations greatest achievements in which we can take real pride. I am glad to say that one of my predecessors has some small place in your Hall of Fame. Charles Montagu, whose portrait is on display here today, was President of the Royal Society in the late 17th century, and at the same time as Chancellor of the Exchequer.
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He made his mark as Chancellor, founding the Bank of England and so saving the country from bankruptcy after racking up debts after war with the French.
But I m afraid to report he was a rather unremarkable Royal Society President. He only got the job because his illustrious friend, Sir I ssac Newton owed him a favour because he had given Newton the then rather lucrative role of Master of the Mint.
Charles Montagu did, however, get something right.

Newton was one of the greatest Masters of the Mint, rebasing the discredited mediaeval coinage with the same rigour and precision he brought to his scientific enquiry. As Chancellor, it s my job too t o focu s on th e economic ben efit s of scientific excellence. But I understand that scientific enquiry cant be reduced to simple utilitarian calculation even though improving the human condition is a pretty good justification for any human endeavour. Intellectual inquiry is worthwhile in itself. The flourishing of communication about science in the media is evidence that this hunger to understand the world is more intense and more widespread than ever. You do not necessarily become a scientist to boost GDP even though it is a very welcome consequence of much of what you do. We must leave room for original research and abstract intellectual inquiry. For even when it is abstract and theoretical it does not flourish in isolation.
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David Hume put it very well in his great essay, Of Refinement in the Arts:
The same age which produces great philosophers and politicians, renowned generals and poets, usually abounds with skilful weavers and ship-carpenters. We cannot reasonably expect that a piece of woollen cloth will be wrought to perfection in a nation which is ignorant of astronomy. In the long run it is technical change which determines our economic growth we become more productive not by more back-breaking labour but by working with more knowledge in our heads and more equipment in our hands. That knowledge and that equipment are achieved through scientific and technological advance. A recent CBI study found that the quality of our scientific research base is one of the most significant factors encouraging international companies to bring high-value investment here. Innovation is not a sausage machine. You dont get it by a plan imposed by government and you cant measure it just by counting patents or even just spend on R&D. It is all about creative interactions between science and business. You get innovation when great universities, leading-edge science, world-class companies and entrepreneurial start-ups come together. Where they cluster together you get some of the most exciting places on the planet. That is where you find the creative ferment which drives a modern dynamic economy. And this coalition government is backing them because that is how we in
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Great Britain are going to pay our way in a tough competitive world. That is why we will continue to support science.
Indeed I am up for the challenge set by Brian Cox and others of making Britain the best place in the world to do science. Our decisions on tax and spending show we are serious about this. Even in these austere times, we have cut taxes for business who innovate, with greater R&D tax credits and the introduction of a corporate tax discount for patents. And we have protected cash spending on science and research with a 4.6billion ring-fenced budget. For first time this ring fence covers the whole range of current research activity financed both from the Research Councils and from the Higher Education Funding Council. We understand that cutting edge science requires cutting edge facilities and equipment. And in successive Budgets and Autumn Statements I have given priority to additional investment in capital for science, adding 500million of extra spending. It helps that our excellent research institutions have projects that are well-managed and ready to roll. A new building with labs and offices at the Babraham Institute was built, fitted-out, and occupied by new spin-out companies all within twelve months of the funding being announced in the 2011 Budget. That is the kind of flexibility we all like. But we recognise that you cant always be quite so nimble. Big science projects need long lead times.
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Take the Crick I nstitute which we are financing alongside the Wellcome Trust, Cancer Research UK, UCL, I mperial and Kings. I congratulate Paul Nurse, your President here at Royal Society, on the vision and leadership he has brought to his projects over many years. Giving this long cherished I nstitute the go ahead was one of my first acts in this office. As we take these decisions on science capital, we have been guided by the science communitys assessment of priorities. In Autumn 2010 the Research Councils set out its key capital projects to which they gave highest priority. In the following two years we have given the go-ahead to all but one of those. After successfully delivering so much, the Research Councils have been assessing further the long-term capital we need to carry on doing world-class science and research in the UK. They are publishing their report today. It is an important long-term programme for investing in British science. And it is matched by our commitment to sustained long-term support for capital investment as well as current spending on our science base.
This report today is evidence of our continuing strategy for science.

No one doubts the world-class nature of British science. But there has long been anxiety about our ability to turn scientific research into successful commercialisation. The idea that our science community do not bridge theory and practice,
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science and technology is just plain wrong.

We could not have world-class science without world-class technology creating new instruments. The Cavendish Lab at Cambridge proudly preserves the equipment which made their early experiments possible. They say they would not have won those Nobel Prizes nearly a century ago but for the skill of their glass-blowers who created the best cloud chambers. The Large Hadron Collider is a miracle of modern engineering. I have heard it said, there was a time when more welders were working there than on any other construction project in Europe. Modern astronomy depends on extraordinarily sophisticated satellite systems. In his excellent Reith Lectures, Martin Rees, the previous President of the Royal Society, explored the creative interaction of science and technology. Scientific curiosity creates a need for new equipment which makes new science possible. That creates new knowledge which in turn makes more new technology possible. Market opportunities are opened up too.
I think of the British small business which has a developed a device for drilling into surface of Mars which responds to the density of the material it encounters.
It is now being used for improving the performance of the machines
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stamping out aluminium cans.

The advanced materials developed at Culham for enclosing the extremely hot plasma in nuclear fusion can also improve performance of conventional nuclear power stations. The economic crisis has accelerated a change that was already happening in our world. Prosperity and the power it brings are shifting to new corners of the globe, to countries like China, I ndia and Brazil. So as the Prime Minister has said, countries like ours are in a global race. That we face a choice: Sink or swim, Do or decline. The starting point is dealing with our debts and confronting problems we face. And we are on the right track: weve cut the deficit by a quarter in the past two years. But its also about making the structural reforms to make economy more competitive - and harnessing our scientific ingenuity and translating it into growth and jobs is core part of that. I am clear about the role of government. It is not government who creates the scientific innovation, or translates into growth. But we can back those who do. And as a government and as a scientific community we need to be willing to identify Britains strengths and reinforce them. We do not claim to be able to predict them with 100% accuracy.
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But we need some sort of assessment.

Today I want to begin a debate about eight future technologies where we believe we can be the best where we already have an edge, but we could be world-leading. The list put together by my colleague David Willetts draws on the advice of science community, the research councils and the Technology Strategy Board and I would like Government to work with you to build a consensus that these are the right goals.
Let me take each area in turn.

First, the Big Data Revolution and energy-efficient computing. The next generation of scientific discovery will be data-driven discovery, as previously unrecognised patterns are discovered by analysing massive data sets. The world already creates 2.5 quintillion bytes of data equivalent to 150,000 full iPads every single day. We need to make sure we capture value from this mass of data both for economic growth and for social advances, such as better health. This requires a transformation in data management. The UK is well placed for the big data revolution. We have 25 of the worlds 500 most powerful computers. But crude computing power is not the be all and end all. We have a comparative advantage in I T because of three distinctive strengths. First, we are good at the algorithms needed to handle these large data sets.
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The key role of British scientists in research projects which generate very large data-sets, such as the search for the H iggs boson at CERN, has led to the UK sustaining our world-leading strengths in the software development and algorithms needed to make sense of these massive datasets. Secondly, we have some of the worlds best and most complete data-sets in healthcare, demographics, environmental change and food. One of the best places in the world to study medical risks from nuclear power stations is the University of Central Lancashire, which links data from Windscale / Sellafield with long-term reliable health records for the local population. Thirdly, these strengths are complemented by our strong life sciences sector. The future is linking dry computer sciences and wet biological sciences. The worlds key DN A sequencing technologies all come from British research labs. We can be a world leader in harnessing genetic data. There are major commercial opportunities here. We have a particular opportunity in energy efficient computing. IT is an increasingly heavy user of energy the typical visit to Facebook uses as much energy as boiling a kettle.
Energy-use is driven by the number of calculations, so smart algorithms which get to a result with less effort need less energy.
At the large scale, this means the UK is well placed to solve the challenges posed by clusters like the City of London which are close to reaching their
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energy and computing capacity.

At the smaller scale, this means UK research leads the way in developing longer-life mobile communications such as mobile phones and tablet computers. Business says we must out-compute to out-compete. Last year, I announced an investment of well over 100 million in high performance computing.
This has enhanced the UKs national capability and attracted important global businesses into partnership with the Research Base.
We are seeing the benefits already with I ntel putting five different investments into the UK this year. We have also created the open Data I nstitute in the East of London in Tech City, to bring together study of all the data from our whole environment. And as a government we are making more and more of that data available. Business will invest more as they see us invest more in computational infrastructure to capture and analyse data flows released by the open data revolution. The second future technology we should support is Synthetic Biology. Synthetic biology is the design and engineering of biologically based parts, novel devices and systems and processes for new uses. It can redesign existing naturally occurring genes and engineer new genes and hence organisms from them. These organisms can be designed to meet a particular need: they say that synthetic biology will heal us, heat and feed us.
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The value of the global synthetic biology market is predicted to grow to 11 billion by 2016.
In the longer term, synthetic biology has the potential to create new markets in response to emerging future needs. Our comparative advantage derives from our long-established global lead in the biological sciences from solving the structure of DNA in the 1950s to sequencing the human genome in the 1990s. We are now one of the leaders in applying engineering techniques to genetics. The aim is to use engineering principles to achieve reliable and reproducible biological products. One spin-off company using techniques first developed with the support of the UKs Biotechnology and Biological Sciences Research Council (BBSRC) and collaborating with I mperial is a good example of the potential of this technology. TMO Renewables outside Guildford has biologically engineered an organism that consumes household waste and converts it into bio-ethanol. It has secured a contract worth up to $500m to create up to 15 centres across the US, though it now needs development finance to scale up its successful proof of principle the technology. The UKs Synthetic Biology roadmap was recently published. I t highlights where we need to address gaps and improve access to cutting-edge infrastructure to maximise benefit to the UK economy. Today, we endorse their work and are publishing our response I can therefore announce that BBSRC is investing 20 million into leading universities and researchers in the UK to use synthetic biology to benefit the UK economy by addressing major global challenges, such as producing low-carbon fuel and reducing the cost of industrial raw
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materials.
The third technology I d like to highlight is Regenerative Medicine. Regenerative medicine is set to transform current clinical approaches to replacing or regenerating damaged human organs or tissue. Drawing on research strengths in engineering, material and physical sciences as well as medicine, tissue engineering is the generation outside the body of a renewable source of transplantable tissue.
The UK retains a leading position in the science and commercial translation of regenerative medicine.
This comes from our cross-disciplinary research strengths and our well-balanced legislative and regulatory framework, which has been essential to building comparative advantage in this area, and attracting researchers from countries seen to have more restrictive regulations. We have world-class research in centres such as Edinburgh (where Dolly the sheep was first cloned), Cambridge, Leeds, and London. I recently opened the new 73 million Centre for Translational and Experimental Medicine on I mperials Hammersmith Campus. This will house 450 scientists focusing on the translation of new discoveries into novel ways of preventing, diagnosing and treating diseases. We can grow new tissue and then remove distinctive features that cause rejection by the host so patients avoid having to spend the rest of their life time on drugs to combat tissue rejection. Current estimates of the global regenerative medicine industry value it at just over 500 million, with forecast generating revenues of over 5 billion by 2021. Last December, the Prime Minister launched the Governments life
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sciences strategy, a detailed plan which is designed to ensure the UK continues to attract the worlds best academics and companies in all areas of the life sciences.
The Government has committed 40 million to deliver the Strategy for UK Regenerative Medicine. Regenerative medicine is a priority area and we will have more to say next month. There is the technology of Agri-Science. The UN forecasts that global food production will need to increase by over 40% by 2030, and 70% by 2050. Yet water is becoming scarcer, and there is increasing competition for land, putting added pressure on production. Our aim is sustainable intensification raising the productivity of agriculture, protecting diversity of land-use, and avoiding high energy costs or eroding the quality of soil. We did not just have the I ndustrial Revolution we had the Agricultural revolution too. Ever since we have had a strong lead in agricultural research. We need capital investment to exploit and maintain this capability. Our historic collections of data and samples are a crucial research asset. The Broadbalk Winter Wheat experiment began at Rothamsted in 1843 is the worlds longest-running agricultural experiment and still produces important results about yields of wheat grain and changes in husbandry. It has had long-term funding from the Research Councils. In addition the John I nnes Centre in Norfolk, the I nstitute for Animal
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Health in Surrey and the Roslin Institute in Edinburgh are global leaders in agri science.
We can design better seeds and more productive farm animals. Wheat provides a fifth of all human calorie consumption but improvements in wheat yields have been slowing down and fertiliser intensity is growing. Heat stress is a growing problem threatening yields.
It is a research priority to harness our world lead in wheat research to improve wheat yields.
This raises UK wheat production, generates exports as new wheat strains are exported, and contributes to international development as for example we create new strains of drought-resistant wheat. We now get on average about 9 tonnes of wheat per hectare from a British farm (about 1 tonne this wet summer from organic farms that do not use fungicide). Rothamsteds 20:20 wheat programme aims to deliver wheat yields of 20 tonnes in 20 years. Such a doubling of wheat yield in the UK would generate 1.5 billion at the farm gate. It has strong industry representation to increase business investment and we have recently issued a public call for evidence to ensure our priorities are those of the sector.
And the Government is spending around 400 million a year on investing in the UK agri-food sector.
A fifth technology is Energy Storage for the Nation: Stockpiling Electricity.
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We need better ways to store electricity. This is true at three levels. First there are the batteries in all our personal electronic devices. These use lithium ion batteries working on a chemical reaction developed at Oxford in the early 1980s. Thirty years on that basic technology is still central.
Second there is the development of battery-powered vehicles.

One reason Nissan decided to produce their new all electric LEAF car here in the UK in Sunderland was the continuing support for research on innovative batteries for cars. Third there is the challenge of storing more electricity for the Grid. Electricity demand peaks at around 60 Giga Watts, whilst we have a grid capacity of around 80 Giga Watts but storage capacity of around just 3 Giga Watts. Greater capability to store electricity is crucial for these power sources to be viable. It promises savings on UK energy spend of up to 10 billion a year by 2050 as extra capacity for peak load is less necessary. The Research Councils energy programme is investing over 500 million over this Spending Review period in energy research, including energy storage. However, urgent action is needed to accelerate translation of research into new technologies and products so that global market opportunities are realised by UK companies and ensure the UK is established as an international focus for energy storage research and innovation.
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Research projects are delivering but the UK currently lacks the test-bed demonstrator capacity and dedicated R&D facilities to take the next step in developing and testing new grid-scale energy storage technologies.
We need to create them. We are funding the Energy Technologies I nstitute jointly with industry partners including BP, Caterpillar, EDF Energy, E.ON, Rolls Royce and Shell to accelerate new technologies for producing clean, reliable and affordable energy.
And we are now investing 800 million with industry to maximise the funding of low carbon energy technology innovation.
A sixth technology is centred on Advanced Materials and Nano-technology. The UK has a long-established reputation for excellent materials science, as well as industrial strengths in advanced materials. Wedgwood and Pilkington are two of the many companies to gain competitive advantage from the application of materials research. One example of advanced materials, meta-materials, are materials which are built from the atom up and designed to have characteristics not found in nature. Materials innovation is crucial for sectors such as aerospace and the automotive sector. Formula One racing teams in the UK, especially McLaren which is one of our most research intensive companies, push rapid innovation in advanced materials. The future of construction is to incorporate more functions into structural materials rather than adding them as extras. Scientists at Imperial have created a cement which absorbs CO2 as it sets.
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It brings us closer to the carbon neutral building.

The new Baglan Bay I nnovation and Knowledge Centre, which was opened by Vince Cable last month, will develop and prototype novel technologies and functional coatings for energy storage and release. In the future, this could turn buildings into small power stations and potentially revolutionise the construction sector. And clothing is increasingly likely to incorporate advanced materials with smart functions such as health monitoring. They have already developed in Spain a sports vest for footballers which enables the coach to monitor every players heart beat during a match. We need that development in the UK. And new advanced materials are needed for next generation nuclear fission and for nuclear fusion as well. These are being developed at Culham in Oxfordshire to enable ultra-hot plasma to be held in stable conditions. After the Fukushima disaster, part of the market is looking for a nuclear fuel rod that does not heat so much: we may be able to develop this, using high performance computing to model the new materials we need. We are determined to act fast to seize the moment. Take the new material graphene for example. International competition was intense after the award of the Nobel Prize to the inventors of Graphene, Andre Geim and Konstantin N ovoselov of Manchester University and so we moved without delay to invest in major new research capabilities there and in other universities - 50 million in all committed to ensure an invention made in Britain was developed in Britain.
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The Engineering and Physical Sciences Research Council will be announcing 22m worth of funding to leading research groups across the UK in graphene engineering later this month, focusing particularly on manufacturing processes and technologies linked to graphene.
Graphene is just one of the many new exciting advanced materials we should exploit. And we should work on Robotics and Autonomous Systems a seventh critical technology.
Robots acting independently of human control which can learn, adapt and take decisions will revolutionise our economy and society over the next 20 years.
Our wider manufacturing industry has so far been a slow adopter of industrial robotics the UK has 25 robots per 10,000 employees in non-automotive sectors; whilst Japan leads the world with 235 robots per 10,000 employees. Our researchers have some distinctive leads which we can exploit.
NASAs Mars Rover vehicle is largely controlled from Earth with a 7 minute delay as instructions travel to Mars. The European Mars Rover vehicle, due to land in 2018, is more autonomous and is mainly British technology.
In the Bristol Robotics Laboratory they are developing self-powering robots which collect dead flies and other detritus and place it in a back pack container of bacteria which converts this into electric power. The UK can lead in developing these technologies for sectors as diverse as defence, healthcare, manufacturing, transport, entertainment and education. Here are some examples. One of the worlds first fully autonomous cars has been developed at Oxford with close involvement of the car industry.
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At the University of Hertfordshire they are making breakthroughs in helping profoundly autistic children who find it easier to interact with a humanoid robot than a human.
The market for medical robotics is growing around 50% annually worldwide. The UK has a strong track record in pioneering medical and surgical robotics. They can enable operations to be done remotely. They can replace hands and arms. Exo-skeletons give movement for severely disabled people with controls linked directly to the brain. The Engineering and Physical Sciences Research Council funds some of this research. It is also a key strand of the Technology Strategy Boards support for advanced manufacturing. There is a small budget to encourage SMEs to shift to robotic manufacturing techniques but they need to be able to try out these techniques at demonstration facilities. David Willetts has convened a series of meetings so academia and industry and government can develop a strategy for future investment decisions. Finally there are the opportunities to be a world leader in satellites and commercial applications of Space.
The UK space sector, including such companies as Astrium, I nmarsat and Avanti, already generates 9 billion a year for the economy, and has grown at over 8 per cent per year through the recent difficult economic times.
Our ambition is to have a 30 billion industry by 2030.
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We are now at a watershed where space is transitioning from a celebration of science endeavour into a capability that impacts on our everyday lives. Live transmissions of news and sports are driven by satellite telecommunications, and satellites are bringing broadband to rural communities across the UK, while providing enormous export opportunities.
The new generation European navigation programme brings very precise location capabilities opening up new markets.
Because space involves substantial investment, much of it is better done through international collaboration. In particular, the UK gains great scientific and industrial benefits through being a strong but selective partner in the European Space Agency. We engage particular strongly in a number of areas of high added value including telecoms, earth observation and meteorological satellites. The European Space Agency is holding its four-yearly Ministerial meeting later this month, where commitments for the period to 2017/ 18 will be made. I can now announce that, subject to negotiation with our European partners, the UK is willing to commit an average of 240 million per year over the next five years through ESA to high value scientific and industrial programmes which will benefit the UK.
Subject to satisfactory negotiations, substantial benefits to the UK will flow from this investment, and the private sector itself has already identified projects to the value of 1 billion that will flow from this investment.
I am delighted also to announce that ESA has agreed, to site its telecoms satellite headquarters in H arwell, Oxfordshire.
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This will crystallise a major space hub at H arwell and create 100 new high-tech jobs there.
So there are eight technologies I challenge the scientific community of Britain to lead the world in, with our support;
The Big Data Revolution and energy efficient computing; Synthetic Biology;
Regenerative Medicine;
Agri-Science; Energy Storage; Advanced Materials; Robotics and Autonomous Systems; Satellites and commercial applications of Space.
The Royal Society is testament to our proud past and a symbol of our future scientific potential. It is right that, even at times of fiscal restraint, we find the resources to enable new scientific breakthroughs, to bridge the gap between discovery and commercialisation and to spread the economic and social benefits of scientific research. The prize is not just our future wealth but our health and quality of life, and our commitment to intellectual enquiry. No one can know what the future holds.
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But we can discern those areas where we have particular strengths and which scientists themselves believe have the most potential.
Let us identify what Britain is best at and back it. Today, I have also published the Research Councils new roadmap, announced the next stage in the development of our strategy for synthetic biology and explained how we will put the UK at the heart of the Euopean space programme. We have great science in Britain. We are backing it. And we will do more.
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The Challenges of Understanding Labor Market Trends

Dennis Lockhart President and Chief Executive Officer Federal Reserve Bank of Atlanta
Introduction
I'm happy to be back in Chattanooga. Chattanooga stands out among mid-sized cities in the Southeast and, indeed, nationally as a place that has mustered the civic leadership and popular support to change the trajectory of its economic destiny. You have seized economic development opportunities, generated new jobs to replace those that were disappearing, and made investments in workforce development that should pay dividends for many years. I have frequently cited Chattanooga as a city where interesting and impressive things are happening. I'm sure many who are responsible for the inspiring story of Chattanooga are in this room. Your city's resurgence cannot, I suspect, be attributed to a single strategic decision or program of action. But to highlight one thingyou have done something about employment.
Today I want to talk about the challenges of understanding employment trends and prospects at the national level, particularly as they are linked to recent decisions by the Federal Open Market Committee (FOMC) as regards monetary policy.
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I'll begin with a brief summary of the country's economic situation and outlook.
I'll then review the current posture of Fed policy and draw attention to what is now a defining aspect of our policythat is, a focus on improving employment outcomes. And, finally, I'll share some work-in-progress thinking on how to assess the "substantial improvement" in labor markets that we will need to see before discontinuing the bond-buying program popularly known as QE3.
All the views I will express are my personal views.

My colleagues on the FOMC and in the Federal Reserve System may not agree.
Summary of current economic situation and outlook

Let me try to summarize in a few words the current state of the economy and the medium-term outlook.
The advance estimate of real GDP growth in the second quarter was posted a week ago. I t came in at 2 percent.
The number is subject to revision in the weeks ahead and could be revised either lower or higher, but I doubt revisions will be so substantial that the basic narrative will change. In my view, the economy has been operating at a pace of growth of around 2 percent since recovery began 40 months ago. There have been quarters of faster growth and certainly quarters that clocked in below 2 percent, but the summary trend rate approximates 2 percent. The economy is stuck in a slow-growth mode.
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The slow and halting progress in bringing down unemployment is mostly attributable to the slow pace of growth.
In the prerecession period, the national unemployment rate reached a low of 4.4 percent in May 2007. Unemployment peaked at 10 percent in October 2009. And, as you know, the unemployment rate was 7.8 percent in September of this year. We will get another reading on unemployment tomorrow.
Inflation has been well-behaved for the better part of two decades, and that trend has continued over the past few years. Headline inflation has spiked in some quarters because of volatile energy and, to a lesser extent, food commodity prices.
But the underlying trend looking back, and I would add looking forward, is close to the FOMC's official target of 2 percent. I nflation expectationswhich are a very important factor in determining realized inflationremain stable. A mix of positive and negative elements is at work in the economy at this juncture. The housing sector is showing definite signs of improvement as indicated by sales, building activity, and rising house prices. Rising house prices affect consumer confidence, which contributes to growth in consumer spending. Consumer activity has continued to grow at a modest pace in spite of a still-weak economic picture overall.
In contrast, business investment has slowed in recent quarters.

I hear a lot of anecdotal support for the view that many decisions are on hold pending the election results and the hoped-for resolution of the fiscal cliff problem. Europe is also top of mind.
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At the moment, we are in a bubble of uncertainty that is restraining the economy.

As to the outlook beyond these immediate concerns, I think the most plausible forecast is continued modest growth with gradual employment gains. Around this more-of-the-same forecast are downside risks of economic shocks as well as chances of somewhat better economic performance if certain risk elements are eliminated or attenuated.
Current stance of monetary policy

One aim of the current set of monetary policies, in my view, is to construct a floor of support under a still-vulnerable economy. To this end, monetary policy continues to be very accommodative. Let me detail its components. The policy interest rate remains at effectively zero. When the policy rate cannot go any lower, central banks resort to so-called balance sheet policies to add further stimulus. In the United States, the Federal Reserve has implemented such programs by purchasing Treasury securities and mortgage-backed securities issued by government-sponsored enterprises. This has the effect of increasing the scale of the Federal Reserve's balance sheet.
The FOMC recently initiated its fourth round of policy initiatives using the balance sheet as the delivery vehicle of stimulus.
On September 13, the Committee announced a new program of bond buying concentrated in agency mortgage-backed securities.
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This action supplements what the public knows as "Operation Twist," due to end in December.
Operation Twist is the Fed's simultaneous purchase of long-term Treasury securities and sale of short-term Treasuries designed to put pressure on longer-term rates. The short-term sales have the effect of neutralizing the potential balance sheet scale effects. In addition, since September 2011, the Fed has been reinvesting proceeds of maturing Treasuries and mortgage-backed securities to avoid any semblance of tightening. What distinguishes the newest round of bond purchases from earlier ones is the open-ended nature of the commitment. In its post-meeting statement on September 13 , the FOMC said, "If the outlook for the labor market does not improve substantially, the Committee will continue its purchases of agency mortgage-backed securities, undertake additional asset purchases, and employ its other policy tools as appropriate until such improvement is achieved in a context of price stability." So what is meant by substantial improvement in the outlook for labor markets? I want to devote the remainder of my time to that question. Arriving at an answer is not so straightforward.
Complexity and dynamism: Many moving parts of employment market reality

The U.S. labor market is complex with many moving parts. I won't do justice to its complexity and dynamism in my few minutes here today, but let me highlight five important aspects of the employment environment in the United States.
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First, there is a huge amount of movement within the labor pool.

An estimated 17 million people change their employment status each month. That is more than 1 1 percent of the total labor force. What I 'm calling "movement" includes people finding jobs; people separating from jobs because they quit, are fired, or are laid off; people entering or reentering the labor market to look for a job; and people leaving the labor market for some other activity. Second, being employed takes different formsfull time, part time, temporary, contract worker. Approximately 1 15 million people currently hold full-time jobs. That's 7 million fewer than before the recession. There are about 28 million people with part-time jobs. That's 3 million more than before the recession. Some part-time workers are satisfied with their status, while some are working part time but really want a full-time job. There are considerably more in this underemployed categorycalled "part time for economic reasons"than before the recession. A third aspect is the decline in the rate of participation. Participation in the labor force has been falling since the early 2000s. Some of the decline is attributable to factors that are independent of the current economic situation. One ongoing participation trend relates to young adults. This cohort is pursuing postsecondary education and not entering the work force as early as in the past.
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The largest such factor is demographican aging population.

An obvious point: older people are more likely to exit the labor market into retirement. The first group of baby boomers is now reaching traditional retirement age. Partially offsetting what would seem to be an inevitable trend is a tendency of older workers to remain attached to the labor market longer than earlier cohorts. The participation rate of older workers in fact has been rising steadily over the last two decades. This reflects factors such as improved health and the need to build, or restore, retirement savings. So, there is a trend within a trend, so to speak. The trend is not one direction only.
While some of the drop in participation reflects longer-term trends, some of it is certainly attributable to recent economic conditions.
For example, just over 1 million more individuals than before the recession indicate that they are willing and able to work but are not actively searching. If you are not looking, you are not part of the unemployment calculation. It is likely a large share of these individuals considered "marginally attached" to the labor force will return to the labor market when conditions improve. This discussion highlights that movements in labor force participation can occur for benign reasons, like population aging, and not-so-benign reasons, like a rise in the number of marginally attached workers.
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Labor force participation can move the unemployment rate both up and down. It is sometimes difficult to interpret changes in the unemployment rate as unambiguously good or bad.
Fourth, there are meaningful variations in the performance of labor markets across regions and sub-markets within regions. It's important, I believe, to consider whether weak employment conditions are widespread or concentrated in a few regional labor markets reflecting idiosyncratic local circumstances.
Neither North Dakota nor Michigan is representative of the nation overall.

A fifth aspect of the employment picture relates to generating new jobs. Job creation and job destruction are occurring continuously and, to an extent, go hand in hand. Research shows that new and early-stage businesses account for a significant share of jobs created. At the same time, a high fraction of early-stage businesses do not survive beyond five years. When we think about job creation in our society, we should think, at least in part, of impermanent jobs that disappear due to business failure and that are replaced by jobs in other, often newer, entrepreneurial ventures, many of which also fail in time. The reality is one of continuous churn.
We would like to have more and better information on the formation of new businesses and the jobs they create.
The statistical tools in this area leave something to be desired.
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We do, however, have good and reasonably current information on job openings and job postings of a broad cross-section of businesses including both mature and early-stage firms.
I hope this commentary gives you a sense of how complex and dynamic the country's employment market truly is. There is much we don't know about the labor market. Not all important trends are captured well in the data.
The data are prone to normal measurement error and revision. I n my view, reliance on a single statistic to judge the health of the labor market may not be sufficient.
In support of this opinion, let me contrast recent official job growth numbers with the official unemployment rate. Total monthly employment gains at the national level in the first quarter of this year averaged 225,000. That pace slowed in the second quarter to a monthly average of 67,000. Although job growth moved higher in the third quarter, the month-to-month progression from July to September showed a decline. Job growth has hardly begun to build positive momentum. Meanwhile, the unemployment numbers are showing a somewhat different picture. Nationally, the unemployment rate changed little during the first half of 2012. From January through July, the unemployment rate hovered between 8.1 percent and 8.3 percent. By September, the rate had fallen half a percentage point from 8.3 percent as of July to 7.8 percent a month ago.
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For policy purposes, I think it's appropriate to be cautious about relying on a single indicator of labor market trendsfor example, the unemployment rateto determine whether the condition of "substantial improvement" has been met.
The official national unemployment rate published by the Bureau of Labor Statistics is the most prominent statistic in the mind of the general public. As a policymaker, I want to have confidence that a decline of this headline number is reinforced by other indicators and evidence of broad labor market improvement in its many dimensions. The challenge my FOMC colleagues and I will face is communicating in simple and trackable terms what this phrase "substantial improvement" means while respecting the complex reality of many moving parts.
A working concept of "substantial improvement"

Remember that at the beginning of my remarks I characterized my thinking on the meaning of "substantial improvement" as a work in progress. In that spirit, let me share a qualitative framework for defining "substantial improvement." The starting point certainly should be the headline unemployment rate and the payroll jobs number. The interpretation of movements in these two statistics would be enriched and reinforced by a review of additional data elements.
Here are examples of what I would look for:

First, I would look for lower unemployment rates that are driven by increased flows of job seekers into employment.
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I would not interpret discouraged workers dropping out of the labor force as a sign of improvement, even if the unemployment rate falls as a consequence.
Conversely, I 'd like to see growing public confidence in the labor market as measured by increased movement of people from out-of-the labor-force status into the labor forcethat is, growing labor force participation. I would interpret a reduction in the number of marginally attached workers as a sign of improvement, even if the unemployment rate goes temporarily higher. Third, I'd look for employment gains that are associated with reductions in underemployment. I would interpret a pickup in job growth less positively if it is associated with increases in part-time jobs for people who seek full-time work. Finally, I'd like to see signs that improvements in all these indicators are gaining momentum and are sustainable. A framework for assessing labor market conditions needs to include forward indicators of labor market health, such as falling claims for unemployment insurance.
Close
To sum up, the FOMC continues to marshal an aggressive attack on the serious employment challenges that beset the nation. The Committee has conditioned any further monetary stimulus on improvementsubstantial improvementin labor market prospects. In my view, it's desirable to put more definition around the term "substantial improvement" since so much rides on the Committee's assessment of that economic milestone.
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In closing, I again want to express my admiration for what's been accomplished here in Chattanooga.
Back in 1969, CBS news anchor Walter Cronkite called Chattanooga the dirtiest city around. Today you are aptly known as the "scenic city." While achieving this visible transformation, you have transformed the economy of the city in so many fundamental ways. This afternoon, I'm taking a tour of the Volkswagen plant to see firsthand evidence of what you have done.
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Large Exposure Regime Groups of Connected Clients and Connected Counterparties

Interesting parts
Background
We published a Consultation Paper in January 2012 to propose rule changes to our handbook definition of connected counterparties and the basis for aggregating exposures to connected counterparties when applying large exposure (LE) limits. We also proposed new guidance on the treatment of LE to structured finance vehicles, building on the Committee of European Banking Supervisors (CEBS) guidelines on the implementation of the revised LE regime published in December 2009. Finally we proposed a change to the handbook guidance in BIPRU 10.6.33G on the institutional exemption.
Who should read this Policy Statement?

The LE regime applies to all banks, building societies and all BIPRU firms, and will be of particular interest to these firms and their advisers.
Next steps
In the Consultation Paper we stated that we expect the final rule changes to come into immediate effect without the use of transitional arrangements when we publish the Policy Statement. This is because the rule changes reflected in this statement will effectively be a relaxation of existing rules.
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However, we do understand that firms might need to discuss practical matters about the guidance on the treatment of LE to structured finance vehicles and we encourage firms to engage with their supervisory relationship managers to discuss reasonable timeframes to full compliance.
Guidance on application of the group of connected clients definition to structured finance vehicles A. Group of connected client considerations
A revised large exposures regime is included in the amended Capital Requirements Directive (CRD 2). To ensure harmonised implementation of the revised regime, CEBS published guidelines which focus on the CRD 2 definition of group of connected clients (GCC) and, in particular, on what constitutes control and economic interconnection for the purposes of that definition. The CRD 2 definition of a GCC and the CEBS guidelines refer to interconnections arising from control and economic dependency between two or more entities to which a reporting firm has exposures. The purpose behind consideration of such interconnections is to determine if it is appropriate to aggregate the exposures to two or more entities because these entities constitute a single risk. This guidance considers application of both the control limb and the economic interconnection limb of the GCC definition to structured finance vehicles.
Control
The CEBS guidelines consider what constitutes control for the purposes of the definition of GCC.
Where a control relationship exists, there is a presumption of single risk. The CEBS guidelines note that firms must rely on the CRD definition of control, which is taken from the accounting definition.
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The relevant indicators of control for accounting purposes, in the context of structured finance vehicles may include SIC 12 (International accounting standards) or FRS 5 (UK GAAP).
Concepts that are relevant in assessing accounting control in the context of structured finance vehicles (e.g. auto-pilot execution of actions in accordance with a prescribed and documented procedure) focus primarily on the retention of risks and benefits by the sponsor firm and do not specifically address if the sponsor and the structured finance vehicle constitute a single risk. Firms should therefore use this guidance in their assessment of single risk with structured finance vehicles. While the guidance that follows typically refers to firms acting in a capacity as sponsor of a structured finance vehicle, the considerations raised are equally applicable where firms act either as sponsor or as originator of such transactions, and the usage of sponsor and sponsoring below is intended to capture both types of involvement in structured finance vehicles. Firms may challenge the presumption of single risk that arises as a result of a relationship of control through a sufficiently justified analysis that situations exist where one of the two entities would survive while the other experiences existence threatening difficulties.
Economic interconnectedness
The economic interconnectedness limb of the GCC definition refers to single risk as a result of funding or repayment difficulties being experienced by one entity resulting in the other(s) being likely to encounter similar difficulties. Once again the aim behind this assessment is to establish if the entities constitute a single risk.
Single risk
The CEBS guidelines focus on the strong presumption of single risk between entities arising from either a control or economic interconnection relationship.
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Firms may demonstrate, with sufficient justification, why a single risk does not exist for the specific vehicle(s) being considered.
The primary focus of this guidance is the treatment of different structured finance vehicle(s) in the GCC context, building on specific discussion of certain such vehicles in the CEBS guidelines. The CEBS guidelines highlight the need to distinguish between issues related to a single funding market and those relating to the interaction between a vehicle and a sponsor, such that sponsored vehicles should not be aggregated as a GCC simply because of common funding from a single investor base, e.g. ABCP or ABS investors.
Direction of causality of financial distress

In the context of economic interconnection, the CEBS guidelines highlight that the GCC definition is appropriate for use with entities that may be connected: 1) Between themselves but not to the reporting firm; and 2) To the reporting firm itself.
The CEBS guidelines highlight that an economic interconnection may exist as a result of either a one-way or two-way economic dependency.
Firms should therefore identify the direction of causality of financial distress (i.e. vehicle to firm, firm to vehicle or vehicle to vehicle (via the firm)) as part of their GCC assessment. This assessment of different directions of contagion transmission will help determine the type of connection for the purposes of identifying a GCC.
B. Connected Client status of firm own sponsored structured finance special purpose entities (SPEs)
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GCC considerations in the CEBS guidelines focus on connections between entities that are not necessarily connected with the reporting institution.
As the focus of this guidance is specifically on exposures that firms have to sponsored SPEs, firms should first assess whether such a vehicle is a connected client of the firm and then should consider if this connected client constitutes a single risk with other counterparties. If so, the vehicle should be grouped with those other counterparties and deemed a GCC. In assessing single risk firms need to consider the direction of causality of financial distress. This means that firm needs to assess whether financial contagion occurs in one direction or two.
As outlined in the CEBS guidelines, firms should have in place established processes to determine when exposures to different entities represent a single risk. We expects firms to be able to use analysis already carried out as part of the internal approvals process to identify scenarios in which individual vehicles face funding difficulties and to what degree these overlap with scenarios where:
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1)The firm itself would face financial difficulties (in determining a connected client relationship); and
2)Any other vehicles would also face financial difficulties (in determining a GCC relationship).
Scenarios of financial distress

In addition to other considerations, we would anticipate that firms would consider scenarios for vehicles that include:
- the credit performance of the assets and asset-liability mismatch/ liquidity considerations in the underlying portfolio of a vehicle;
- the tenor of outstanding debt and related frequency of debt refinancing needs; - the reliance on successful debt refinancing, including the provision of contingent support (credit, liquidity or otherwise) from another entity (including the sponsor, originator or any other third party; this could include consideration of factors affecting the rating of the vehicle or bonds issued by it); - any deterioration in market sentiment in, or the performance of, any part of the portfolio of assets funded by the vehicle which could ultimately result in unavailability of replacement funding; - the structural features of the vehicles constitution which may exacerbate deterioration in investor appetite for replacement debt; and - operational failures, e.g. servicer failure, collections fraud, etc. Having compiled a set of scenarios for each individual vehicle, firms should seek to assess the degree of overlap that occurs between these different sets. As the CEBS guidelines clarify that common concentrations of industrial sector, geography or funding base should not result in counterparties
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being connected, firms may exclude these factors from their assessment of common scenarios.
Establishing single risk

Firms should seek to ensure that commonality of other factors is considered. These should include the: 1)Commonality of borrowers and/ or sellers (i.e. exposures to a particular borrower or seller of assets, in a vehicle where the firm also has exposures to the same or related borrower/seller on its own balance sheet); and 2)Consequences of common ratings triggers related to the provision of ancillary support facilities within the structured finance market, which may also occur within the provision of similar ancillary support facilities being provided by the firm to other non-sponsored structured finance SPE or to any other third parties.
C.Process for aggregation of exposures to Connected Client that are structured finance vehicles
When it comes to capturing scenarios where the firm experiences financial distress, it is appropriate to consider only those scenarios which result in one or more vehicles also encountering financial difficulties, along with the firm. This should allow firms to focus on the commonality of scenarios where both or more than two sponsored vehicles encounter financial distress as a result of constituting single risk with the firm.
D. Vehicle-type specific conclusions

The conclusions reached in this section are based on typical features within common structures.
Where a firm has an exposure to a structure that has atypical features, firms are encouraged to engage with their supervisory relationship managers.
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D1. ABCP Conduits Structural features

There are a number of primary features of an ABCP conduit that lead us to conclude that they are connected: - a variety of liquidity support mechanisms including, but not exhaustively: liquidity facilities; - liquidity asset purchase agreement (LAPA); - asset repurchase agreements; - total return swaps; - letters of credit; and - desk commitments to purchase ABCP issued
Behavioural interactions
During the recent crisis period 2007 to 2010, firms provided non-contractual support to their sponsored conduits.
Firms committed to repurchase assets from the conduits where investors objected to the inclusion of those assets, even though those assets did not necessarily affect the view of the Credit Rating Agencies (CRAs) on the rating of the ABCP issued. More recent history showed investor sentiment against the securitization / ABS market, where any element of ABS held in conduits (or even the inability of the sponsor to demonstrate what proportion of the assets was represented by ABS) resulted in the swift deterioration of investor appetite. As demonstrated during the last two to three years, conduits which had some liquidity support mechanisms provided by the sponsor firm, were
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likely to partially draw on these when they experienced financial difficulties.

Therefore the presumption is that these vehicles are likely to be a connected client. In the case of third-party asset conduits it may be possible that firms can demonstrate that any exercise of liquidity to purchase the assets of a particular seller/contributor to a multi-seller conduit was offset by the seller/contributor either providing funding to the sponsor firm or having purchased the assets from the sponsor firm for them to be refinanced elsewhere. In the case that reliance is placed on the ability of a seller/contributor to provide replacement funding for assets within a third-party asset conduit, as referred to above, firms should be satisfied with a high degree of confidence that all (and not only some) of the assets may be refinanced and that a sufficient tangible incentive (contractual or economic) exists for the seller/ originator to engage in the event of the vehicle sponsor having to provide liquidity support.
Conclusion
ABCP conduit structures are to be considered a connected client with the sponsor firm and, for the purposes of GCC reporting, all conduits will be presumed to fall within a single GCC unless firms are able to demonstrate with sufficient justification why certain conduits may not represent single risk with other conduits.
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AIMA ANN OUN CES AIFMD IMPLEMENTATION PROJECT

The Alternative Investment Management Association (AIMA), the global hedge fund association, has announced its AIFMD Implementation Project ahead of the release of the final implementation text of the Alternative I nvestment Fund Managers Directive (AIFMD) by the European Commission. AIM As AIFMD I mplementation Project will aim to provide guidance to the industry on complying with the Directive, create a forum for discussion within the industry on the practicability of the new requirements, and generate feedback on practical implementation issues that will be passed to policymakers. AIMA will work in partnership with PwC, the corporate audit, tax and consulting firm, on the creation of an online operational guide that will assist hedge fund firms in preparing for and tracking their compliance readiness as they approach the Directives July 2013 transposition deadline. It is expected that the guide will be published by the end of the year. AIMA will also publish a handbook on the Directive that will aim to provide guidance regarding the AIFMD s requirements in areas of uncertainty. It will appear later than the operational guide in order to take account of issues highlighted by the process of implementing the Directive at an EU member state level. AIMA also intends to host seminars on the Directive around the world. Andrew Baker, AIM As CEO, said: We expect the AIFMD s implementing measures to be published shortly, and when that day finally comes, the global industry will have only a few months to comply
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with probably the most extensive set of regulatory reforms in its history. We are under no illusions as to the size of the task facing the industry, but AIMA is determined to play a leading role in these efforts.
I would like to thank the leaders of the working groups and all of the AIMA member firms who are involved in the project for volunteering their time and expertise. Their contributions have been invaluable during the AIFMD negotiations and will be even more so during the implementation phase.
Notes for Editors

Different sections of the handbook will be produced by different AIMA working groups, headed by I ain Cullen of Simmons & Simmons LLP, Gus Black of Dechert LLP, Lucy Frew of Gide Loyrette Nouel LLP, Imogen Garner of N orton Rose LLP, Chris H ilditch of Schulte Roth & Zabel LLP and Jane Tuckley of Travers Smith LLP.
About AIMA
As the global hedge fund association, the Alternative I nvestment Management Association (AIMA) has over 1,300 corporate members (with over 6,000 individual contacts) worldwide, based in over 50 countries.
Members include hedge fund managers, fund of hedge funds managers, prime brokers, legal and accounting firms, investors, fund administrators and independent fund directors.
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Certified Risk and Compliance Management Professional (CRCMP) distance learning and online certification program.
Companies like IBM, Accenture etc. consider the CRCMP a preferred certificate. You may find more if you search (CRCMP preferred certificate) using any search engine. The all-inclusive cost is $297. What is included in the price:
A. The official presentations we use in our instructor-led classes (3285 slides)

The 2309 slides are needed for the exam, as all the questions are based on these slides. The remaining 976 slides are for reference. You can find the course synopsis at: www.risk-compliance-association.com/Certified_Risk_Compliance_ Training.htm
B. Up to 3 Online Exams
You have to pass one exam.
If you fail, you must study the official presentations and try again, but you do not need to spend money. Up to 3 exams are included in the price. To learn more you may visit: www.risk-compliance-association.com/Questions_About_The_Certif ication_And_The_Exams_1.pdf www.risk-compliance-association.com/CRCMP_Certification_Steps_ 1.pdf
C. Personalized Certificate printed in full color

Processing, printing, packing and posting to your office or home.
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D. The Dodd Frank Act and the new Risk Management Standards (976 slides, included in the 3285 slides)
The US Dodd-Frank Wall Street Reform and Consumer Protection Act is the most significant piece of legislation concerning the financial services industry in about 80 years. What does it mean for risk and compliance management professionals? It means new challenges, new jobs, new careers, and new opportunities. The bill establishes new risk management and corporate governance principles, sets up an early warning system to protect the economy from future threats, and brings more transparency and accountability. It also amends important sections of the Sarbanes Oxley Act. For example, it significantly expands whistleblower protections under the Sarbanes Oxley Act and creates additional anti-retaliation requirements. You will find more information at: www.risk-compliance-association.com/Distance_Learning_and_Cert ification.htm

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International Association of Risk and Compliance Professionals (IARCP)

I nternational Association of Risk and Compliance Professionals (I ARCP) www.risk-compliance-association.com

You must read it!!!

I nternational Association of Risk and Compliance Professionals (I ARCP) www.risk-compliance-association.com

Agencies Provide Guidance on Regulatory Capital Rulemakings

A full version of the Group of 20 communique:

On time, stocks and flows: Understanding the global macroeconomic challenges

I nternational Association of Risk and Compliance Professionals (I ARCP) www.risk-compliance-association.com

PCAOB Regulatory Initiatives

Steven Maijoor, ESMA Chair

Developments in European Financial Reporting Regulation and Enforcement

Speech by the Chancellor of the Exchequer, Rt H on George Osborne MP

I nternational Association of Risk and Compliance Professionals (I ARCP) www.risk-compliance-association.com

The Challenges of Understanding Labor Market Trends

Large Exposure Regime Groups of Connected Clients and Connected Counterparties

AIMA ANN OUN CES AIFMD IMPLEMENTATION PROJECT

I nternational Association of Risk and Compliance Professionals (I ARCP) www.risk-compliance-association.com

Agencies Provide Guidance on Regulatory Capital Rulemakings

I nternational Association of Risk and Compliance Professionals (I ARCP) www.risk-compliance-association.com

I nternational Association of Risk and Compliance Professionals (I ARCP) www.risk-compliance-association.com

I nternational Association of Risk and Compliance Professionals (I ARCP) www.risk-compliance-association.com

I nternational Association of Risk and Compliance Professionals (I ARCP) www.risk-compliance-association.com

The following is a full version of the Group of 20 communique:

I nternational Association of Risk and Compliance Professionals (I ARCP) www.risk-compliance-association.com

I nternational Association of Risk and Compliance Professionals (I ARCP) www.risk-compliance-association.com

I nternational Association of Risk and Compliance Professionals (I ARCP) www.risk-compliance-association.com

We will deepen work on these issues under Russias Presidency.

I nternational Association of Risk and Compliance Professionals (I ARCP) www.risk-compliance-association.com

I nternational Association of Risk and Compliance Professionals (I ARCP) www.risk-compliance-association.com

I nternational Association of Risk and Compliance Professionals (I ARCP) www.risk-compliance-association.com

I nternational Association of Risk and Compliance Professionals (I ARCP) www.risk-compliance-association.com

The Finance Track

I nternational Association of Risk and Compliance Professionals (I ARCP) www.risk-compliance-association.com

On time, stocks and flows: Understanding the global macroeconomic challenges

I nternational Association of Risk and Compliance Professionals (I ARCP) www.risk-compliance-association.com

These are hard questions.

All of them together are worth having and fighting for.

I nternational Association of Risk and Compliance Professionals (I ARCP) www.risk-compliance-association.com

This is true of both private and public debt.

Much of my discussion will seek to make these guidelines more concrete.

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I. The broad canvas Stylised facts: an economic historians perspective

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I nternational Association of Risk and Compliance Professionals (I ARCP) www.risk-compliance-association.com

Stylised facts: an interpretation

I would suggest not.

I nternational Association of Risk and Compliance Professionals (I ARCP) www.risk-compliance-association.com

Policy and horizons: pre-crisis role

I nternational Association of Risk and Compliance Professionals (I ARCP) www.risk-compliance-association.com

I nternational Association of Risk and Compliance Professionals (I ARCP) www.risk-compliance-association.com

I I . Post-crisis challenges The legacy of the crisis: a balance sheet recession

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The immediate policy challenge: returning to self-sustaining and sustainable growth

I nternational Association of Risk and Compliance Professionals (I ARCP) www.risk-compliance-association.com

If there is scope to do so, policies should be deployed aggressively.

I nternational Association of Risk and Compliance Professionals (I ARCP) www.risk-compliance-association.com

I nternational Association of Risk and Compliance Professionals (I ARCP) www.risk-compliance-association.com

I nternational Association of Risk and Compliance Professionals (I ARCP) www.risk-compliance-association.com

I nternational Association of Risk and Compliance Professionals (I ARCP) www.risk-compliance-association.com

I nternational Association of Risk and Compliance Professionals (I ARCP) www.risk-compliance-association.com

I nternational Association of Risk and Compliance Professionals (I ARCP) www.risk-compliance-association.com

The longer-term policy challenge: adjusting frameworks

Prudential policy is furthest ahead.