A to Z of banking reforms since the financial crisis

a to z

The 2008 financial crisis, arguably the most influential event in recent history, has ushered in an era of unprecedented regulatory reform. But what are the new rules and initiatives? And what do they actually do?

To aid the industry in this brave new world of acronyms, Practice Insight has created an A-Z guide to the major post-crash reforms that have come into force in US and EU jurisdictions.

Generally speaking, the new rules and initiatives tackle either systemic risk or market abuse – or both. An overarching theme is a push towards more transparency in all areas of the market.

Is something essential missing? Let the author know: thomas.helm@legalmediagroup.com


Alternative Investment Fund Managers Directive (AIFMD)

Region: EU

Scope: Market abuse, systemic risk

The EU's transparency crusade – the drive to make previously opaque markets visible – is particularly evident in the AIFMD, a piece of regulation that covers a previously unlit part of the market: hedge funds, private equity funds, and real estate funds.

The regulation aims to enforce stricter compliance around information disclosures, to reveal potential conflict of interests, liquidity profiles and independent asset valuations.

It also helps regulators monitor for systemic risk. In a recent conversation with Practice Insight, the European Securities and Markets Authority (ESMA) revealed that a build-up of risk in the alternative investment space had been located and successfully dealt with, thanks to AIFMD.

The full story will be available in the first part of our upcoming feature: What's happened since the crash?  In this ground-breaking five-part article series, due for publication on September 12, Practice Insight evaluates the impact and effectiveness of all new rules since the crash.


Bail-in (not bailout)

Region: Global

Scope: Systemic risk

During the financial crisis, governments were forced to decide between rescuing failing financial firms by injecting public funds into them, or losing depositors’ assets and risking a run on credit institutions.

The consequence was a massive bailout regime, coordinated in the wake of the collapse of Lehman Brothers. The US Federal Reserve not only provided $700 billion to US banks but also covertly lent money to foreign central banks and financial firms. The alternative was collapse.

The US has actually managed not only to win back all the money it lent, it has even turned a profit. Other governments, notably in the EU, are still owed huge amounts of money 11 years down the line. There are doubts as to whether this money will ever be paid back.

For this reason, bailing out financial institutions is generally considered politically toxic. Politicians would much prefer that banks have the means to save themselves rather than reach for the public purse.

Bail-in regimes, developed in the wake of the crash, provide relief to financial firms by requiring the cancellation of debts owed to creditors and depositors.

Notable examples of bail-in instruments include alternative tier 1 (AT1) or CoCo (contingent convertible) bonds. One hybrid capital banker recently told Practice Insight that these instruments were "more equity-like than equity" because of their absolute subordination in the debt hierarchy.

These instruments can be written down or converted into ordinary shares if capital ratios fall below required levels or authorities determine that an issuer has reached the point-of-non-viability (PONV).

Santander recently made a controversial decision not to call an AT1 bond (technically the instrument’s maturity is perpetual), a move which scared markets but delighted regulators, who were eager for markets to learn the true nature of the phrase.

The EU's Bank Recovery and Resolution Directive consolidates the EU-wide bail-in regime. It was used famously to resolve failing Banco Popular.


Basel III

Region: Global

Scope: Systemic risk

The idea of Basel III is to provide a global minimum standard for capital and liquidity requirements, leverage ratios and risk management. The requirements are technically voluntary, but banks that decide to ignore them risk serious reputational damage.

Basel III supersedes Basel II, a regime that central banker Paul Tucker recently blasted as "one of the most abject failures of the modern international liberal order".

The financial crisis exposed serious problems with Basel II, as trouble in a relatively small niche – subprime US mortgage debt – almost precipitated the collapse of the entire international banking system.

The Bank for International Settlements – the institution behind the Basel Committee – recently stated that big banks are, on average, now holding twice as much capital as they did before the crisis.

As with all new rules, there have been unintended consequences. Practice Insight recently revealed that Basel III was fuelling reg cap trades in Europe's synthetic securitisation market. Sources said that the revival of the "nasty" synthetic CDO market was in fact based in large part on these risk mitigation reg cap trades.

The EU has introduced the Capital Requirements Directive (CRD) to create a supervisory framework to reflect Basel II and Basel III rules on capital measurement and capital standards.


Benchmark reform

Region: Global

Scope: Market abuse

Once a jewel in the City of London's crown, the London interbank offered rate (Libor) fell from grace when a series of rigging scandals exposed serious flaws in its calculation methodology. To make matters worse, the rate is now considered anachronistic because of a scarcity of underlying transactions.

This double blow has led central bankers to push markets to adopt alternative risk-free-rates, such as the US's secured overnight financing rate (SOFR) and the UK's sterling overnight index average (Sonia).

The main problem with overnight rates is that they are backward-looking, where ibors are forward-looking. This poses all kinds of operational difficulties for firms used to dealing with term rates that have a built-in credit risk component.

Then there is the gargantuan task of transitioning legacy contracts onto the new rates; a change that carries diverse risks, including arbitrage risks, litigation risks, operational risks, and reputational risks.

Regulators have hawks’ eyes on this issue.

Read Practice Insight's groundbreaking survey for more information on current trends in the SOFR space.


Benchmarks regulation

Region: EU

Scope: Market abuse

The EU's benchmarks regulation builds on concerns about the accuracy and integrity of indices used as benchmarks in financial markets.

The rule affects those who provide data to benchmarks.

Last year Practice Insight revealed that it could limit the growth of global markets by severely restricting the reference rates available to EU investors, with many administrators considering opting out of the EU market altogether.


Dodd-Frank Act

Region: US

Scope: Investor protection and systemic risk

The US' Dodd-Frank covers almost everything. It is widely considered a lighter touch than its EU counterparts. Unlike European Market Infrastructure Regulation (Emir), for example, its reporting regime is single-sided.

The Volcker Rule, which is currently under revision by the White House, aims to prevent commercial banks from taking part in speculative activities.

The Consumer Financial Protection Bureau (CFPB), established under the act, regulates consumer finance markets. Unsurprising, considering the role of US subprime mortgage debt in the 2007/8 financial crisis.

The Securities and Exchange Commission’s (SEC) Office of Credit Ratings tackles the credit rating agencies. The idea is to make their ratings more reliable.  Again, unsurprising, considering the amount of triple-A rated junk passed on to investors in the run-up to the crisis.

Dodd-Frank's whistleblower programme provides generous incentives for insiders to speak out: from 10 to 30% of the proceeds of a litigation settlement. Employees have 180 days to voice their complaints after a violation is discovered. It is significant that no equivalent regime exists in the EU.


Emir [European Market Infrastructure Regulation]

Region: EU

Scope: Systemic risk in derivatives markets

Large banks, securities firms, and insurance companies often face significant exposure to one another through their over-the-counter (OTC) derivatives portfolios.

In the last crisis, regulators and firms were blind. When Lehman Brothers collapsed, for example, it would take some time before firms could actually unravel their exposures.

Introduced in the aftermath of the financial crash, Emir aims to increase visibility in this previously opaque space.

As a double-sided reporting regime, it requires both sides of a trade to report on the transaction. This has led to mismatches, leading critics to bemoan data quality and wastage – though perhaps lack of consistency is a more pertinent criticism.

Practice Insight recently revealed that regulators were experimenting with AI systems to connect datasets produced by Emir with others, such as those produced by AIFMD.

After years of reporting errors, trade repository and regulatory sources claim that the quality has started to improve.


FRTB [Fundamental Review of the Trading Book]

Region: EU

Scope: Market abuse

Phase three of the Basel III reforms, FRTB, aims to create clearer risk modelling and increase capital requirements. Practice Insight recently reported that big banks were leading implementation efforts. Unsurprising, considering their weightier compliance budgets.


MAR [Market Abuse Regulation]

Region: EU

Scope: Market abuse

An extension of the directive that preceded it, MAR tackles insider dealing, unlawful disclosure of inside information and market manipulation.

According to banks, its market sounding framework has had an impact on high yield deals, making it more difficult for the sellside to gather feedback.


Margin Requirements

Region: Global

Scope: Systemic risk

In September 2013, the Basel Committee on Banking Supervision and the International Organisation of Securities Commissions (BCBS-Iosco) released their finalised framework on Margin Requirements for Non-centrally Cleared Derivatives. The framework, which established a set of international standards covering the over-the-counter (OTC) derivatives markets, came about at the prompting of the G20 following the global financial crisis of 2008-2009.

The guidelines had two stated objectives: firstly, to minimise systemic risk, and relatedly, to promote centralised clearing. Global regulators adopted and implemented the BCBS-Iosco framework into a set of rules dubbed the uncleared margin rules (UMR).

The rules directly address the G20’s call for non-centrally cleared contracts to be subject to higher capital requirements. By raising the amount of collateral required to trade uncleared derivatives, UMR increase the cost of funding for trading bilaterally; counterparties are incentivised to shift their trading to the cleared space, where collateral requirements are lower.

Some sources say that technicalities in UMR could cause disputes between global players


Mifid II [Markets in Financial Instruments Directive]

Region: EU, but some parts have gone global

Scope: Investor protection and systemic risk

More transparency means less market abuse and less systemic risk. This simple logic underlies the EU's epic piece of regulation: 1.4 million paragraphs, or 30,000 pages long, it is the single largest piece of financial regulation in the history of humanity.

Markets are being restructured because of Mifid II. Staying ahead of the regulatory curve is a perennial mantra.

Its more notable innovations include: research unbundling, double volume caps in dark pool trading, the Financial Instruments Reference Data System (FIRDS), best execution reports, consolidated tape (or lack thereof), to name but a few.

Because research unbundling has proven so influential, some global firms, such as BlackRock, have even decided to unbundle globally, in order to harmonise operations: much to the chagrin of local regulators in other parts of the world, many of whom do not wish to see European rules imposed upon their markets.


Mifir [Markets in Financial Instruments Regulation]

Region: EU

Scope: Investor protection and systemic risk

Mifir is all about trade and transaction reporting. Technically a separate piece of legislation, it is often related to Mifid II – and certainly arises out of the same mindset.


Missing in action

Region: Global

Scope: Everything

In Crashed: How a Decade of Financial Crashes Changed the World, Adam Tooze writes that in the years leading up to 2008, policymakers were so focused on the prospect of China reducing its huge holdings of US Treasury bills, and thereby crashing the value of the dollar, that they ignored the more pertinent danger of subprime mortgage debt.

It is theory that dictates where we look. New rules, however well-intentioned, do not ensure that regulators are looking in the right places.

Meanwhile the Lucas critique argues that it is naïve for policy makers to attempt to predict future trends using historical data. Market participants frequently relay this concern with the following question: to what extent are regulators simply cleaning up after the last crisis?

When presented with this argument, regulators speaking to Practice Insight usually argue that this time, no stone is left unturned. The Basel Committee, for example, devotes considerable time and resource to cyber risks, a potential source of future crisis. It is clear that regulators are trying to be holistic in their macro-risk analyses.

Are there any blind spots? Rules missing in action, so to speak? It might take another crisis to find out.


Priips [Packaged retail and insurance-linked investment products]

Region: EU

Scope: Retail investor protection

Priips aims to protect retail investors from packaged debt products. The word packaged is deliberately broad and ambiguous, and has been interpreted to mean any kind of product that contains a structured element.

The unintended consequence of Priips is that issuers have taken an overly conservative stance and refrained from raising capital through retail, causing the retail bond market to contract.

The irony is that the European Commission actually wants the retail market to grow.

Priips obliges issuers to prepare a Key Information Document (KID) to highlight risks to retail investors.

In effect since January 2018, it’s continuing to cause headaches across the industry – particularly surrounding how it interacts with other pieces of legislation, such as Mifid II.


Prospectus Rules

Region: EU

Scope: Investor protection

Prospectus Rules aim to bolster investor protection and market efficiency by harmonising requirements for the drawing up, approval and distribution of prospectuses for securities offered to the public or admitted to trading on a regulated market.



Region: Global

Scope: Retail investor protection

Ringfencing requires banks to separate their everyday banking businesses from investment banking. The idea is to protect retail clients from the riskier, more complex activities of investment banking.

If other parts of the bank become insolvent, depositors' assets would remain protected. In theory, this means that a bank could be unwound without triggering a bank run or systemic crisis.

Crises are both material and psychological. It is often the scare factor – the panicked rush to recall debt, combined with a reluctance to lend – that causes the worst damage. Like Basel III, ringfencing initiatives are aimed at bolstering investor confidence in the system.

Legislatures in major financial jurisdictions, such as the US, France, Germany, and the UK, have all enacted ringfencing measures in the wake of the crash.

Bailout regimes have become politically toxic: no politician can expect to hand over wads of public cash to a failed banking sector and not face repercussions.


Senior Managers Certification Regime (SMCR)

Region: UK/EU

Scope: Market abuse

The Senior Managers and Certification Regime (SMCR) aims ‘to reduce harm to consumers and strengthen market integrity by making individuals more accountable for their conduct and competence’, according to the UK's Financial Conduct Authority.

The regime aspires to end so-called golden parachutes: schemes that provide senior managers with generous retirement schemes, even as the financial institution they mismanaged falls apart behind them.

The UK regulators felt helpless, for example, when failed chief executive Sir Fred Goodwin received a £16 million ($23.4 million) pension pot amid the smoking rubble of RBS.

The SMCR addresses that sense of helplessness by making senior executives personally accountable for problems by attacking bonus and pension schemes if things go wrong.

So far, however, the regime has only been loosely enforced with tame penalties, according to sources. This is possibly because the UK's scheme is much more draconian than its EU counterparts. Unilateral regulation risks creating regulatory arbitrage opportunities.

practIt is significant that no similar scheme exists in the US.


SFTR [Securities Financing Transactions Regulation]

Region: EU

Scope: Systemic risk

Often heralded as the last piece in the EU's reporting puzzle, SFTR is an Emir-like reporting regime that seeks to illuminate one last blind spot in European markets: rehypothecation (the practice of using collateral provided by borrowers to supply value to other transactions) and shadow banking.

When Lehman Brothers went down in 2008, many borrowers found themselves unable to recall the collateral they had provided to the bankrupt firm.

To increase transparency, SFTR obliges firms to report on repurchase transactions, securities or commodities lending and securities or commodities borrowing, buy-sell back or sell-buy back transactions, and margin lending transactions.

Like Emir, SFTR requires that securities financing transactions (SFTs) are reported to registered trade repositories.

Practice Insight recently reported the rule will create complications for US-based firms looking to enter into collateralised transactions like repurchase agreements (repos), margin loans and total risk return swaps in the European Union.

Practice Insight has also conducted an in-depth survey into how well the industry is adapting to the rule.


Securitisation Regulation

Region: EU

Scope: Market abuse

In 2008, close to 30% of all high-risk US mortgage securities were held by foreign investors. Many of those investors were unaware of the risks.

Securitisations, often described as the engine of the American Dream, diversify risk by pooling debt. The idea used to be that not everybody will default at the same time, and that risky debt – subprime mortgages, say – could become solid and safe if enough of them were bundled together.

History has clearly had other views on the subject.

The idea behind the European regime is to make sure that investors can clearly model the underlying risks in the securitisation products they are purchasing.

The key words here are: simple, transparent and standardised (STS). Homogeneity requirements, for example, strictly enforce the kinds of debt allowed to enter the pool. A car loan securitisation, for example, shouldn't contain buy-to-let mortgages. Nor should owner-occupied mortgage securitisations for that matter, because the associated risks are so different.

Practice Insight recently reported that the European markets, despite initial concern, found the homogeneity requirements "workable".

Interest in STS securitisations is growing, despite frustration.


Stress testing

Region: Global

Scope: Systemic risk

Stress testing assesses a bank's ability to survive a severe economic shock. The idea is to catch problems before they arise, with more onerous requirements for the largest banks.

Each year the scenarios change.

The Bank of England’s 2019 test, for example, test the resilience of UK banks to deep simultaneous recessions in the UK and global economies, a financial market stress, and an independent stress of misconduct costs.

Stress testing practices vary from jurisdiction to jurisdiction. Unsurprising, because different jurisdictions carry different kinds of risks.


Too big to fail

Region: Global

Scope: Systemic risk

Regulators once hoped to end too-big-to-fail (financial firms so large that they could not fail without destabilising the entire banking systems).

In practice, some banks are even larger than they were prior to 2008, while the industry-wide trend towards consolidation does not look as though it will stop anytime soon. In 2007, for example, there were 8,534 Federal-Deposit-Insurance-Corporation-covered banks; 11 years later, in 2018, this number had dropped to 5,406.

Admittedly, the trend towards consolidation has slowed since the crisis. But a world of fewer and bigger banks – and therefore more concentrated risk – is the opposite of what regulators want.