Understanding Risk Management and Compliance, January 2012

8/3/2019 Understanding Risk Management and Compliance, January 2012

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_____________________________________________________________International Association of Risk and Compliance Professionals (IARCP)

www.risk-compliance-association.com

International Association of Risk and ComplianceProfessionals (IARCP)

1200 G Street NW Suite 800 Washington, DC 20005-6705 USATel: 202-449-9750www.risk-compliance-association.com

The January 2012 edition of the International Association of Riskand Compliance Professionals (IARCP) newsletter

Dear Member,

On December 2, 2011, we had the 10-year anniversary of Enron filing forChapter 11 bankruptcy.

This bankruptcy, whichwas at the time the largest in corporate history,

led to the creation of new laws and regulations, including the SarbanesOxley Act.

The Sarbanes-Oxley act was enacted on July 30, 2002, less than a yearafter Enron filed for Chapter 11.

Today Sarbanes Oxley is as important as it has been all these years.Amended by the Dodd Frank Act, the Sarbanes Oxley rules continue toapply and change the lives of hundreds of thousands of professionals

around the world.

Today we will remember what has been said about the role ofprofessionals and the board of directors during one of the mostinteresting investigations.We will also see that, although we had so manylaws and regulations, many of the problems we had in Enron, continue tohaunt boards, corporate officers and shareholders.

Enrons board of directors was criticized for being asleep at the wheelafter the firm collapsed.Today we will read the interesting opinion of one

of these directors, a very good and very experienced one.
http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/http://www.risk-compliance-association.com/


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THE ROLE OF THE BOARD OF DIRECTORS INENRONS COLLAPSEHEARING BEFORE THE PERMANENT SUBCOMMITTEE OFINVESTIGATIONS OF THE COMMITTEE ON GOVERNMENTAL AFFAIRS,UNITED STATES SENATE, MAY 7, 2002

Senator Levin:On December 2, 2001, the seventh largest corporation in Americacollapsed.

Its stock, having plummeted from $80 a share to practically nothing inless than 10 months, the reins of what was once a high-flying company of$100 billion in gross revenues and 20,000 employees were handed over to a

Federal bankruptcy judge.

That collapse has rolled like a tidal wave across the corporate boardroomsof America, across Wall Street, and across the entire investing community,

which now includes over half of U.S. households.

With this tidal wave, we are all asking two questions: What happened atEnron, and could it happen again?

Today,we hope to help answer the first question in order to ensure that

the answer to the second question will become no.

One of the key players responsible for overseeing the operations of ourpublicly held corporations is the Board of Directors.

Directors are charged by law to be the fiduciaries, the trustees whoprotect the interests of the corporate shareholders.

In that capacity, they are supposed to exercise their best businessjudgment on behalf of those shareholders.


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They are supposed to be independent.

And while they are not expected to be detectives, they are expected to asktough questions of management, to probe opaque answers, and to displaysufficient skill and fortitude to say no to transactions that do not lookright.

Along with management and the auditors, the Board shares theresponsibility to provide to the companys shareholders a financialstatement that is a fair representation of the financial position of thecompany.

As the Second Circuit Court of Appeals held in a widely quoted opinion,technical compliance with Generally Accepted Accounting Principles

may be evidence of acting in good faith, but it is not necessarilyconclusive:

The critical test, the court said, is whether the financial statements asa whole fairly present the financial position of a company.

Enrons financial statementsdid not, and the Boards role in that failure isbefore us.

Today, we have five key members from the Enron Board of Directors to

tell us what they knew about the financial condition of Enron, when theyknew it, and what they did about it.

In other words,what role did the Board play in these events?

The Subcommittee issued over 50 subpoenas for documents to Enron,Arthur Andersen, members of the Enron Board, and officers of Enron.Staff has reviewed about 300 boxes of documents to date, and conductedinterviews with 13 current and past Board members.


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Each Board member complied with the document subpoenas andwillingly appeared for interviews.

We appreciate their cooperation and their voluntary appearance today.

We have found that when you pare down the hundreds of incrediblycomplex financial transactions that were the hallmark of Enron, yourealize that many were nothing more than smoke-and mirrorsbookkeeping tricks, designed to artificially inflate earnings rather thanachieve economic objectives, to hide losses rather than disclose businessfailures to the public, to deceive more than inform.

The decisions to engage in these accounting gimmicks and deceptivetransactions were fueled by the very human but unadmirable emotions of

greed and arrogance.

Putting a growth gloss on the balance sheet pumped up the stock price,and the rise in stock price, regardless of the underlying true value of thecompany, was, for many, the measure in the 1990s for judging corporatesuccess.

The Board that was supposed to be the check on the greed and thearrogance, in fact, was not.

Here is how it happened.

Enron was in transition from an old-line energy company, with pipelinesand power plants, to a high-tech global enterprise engaged in energytrading and international investment.

It experienced large fluctuations from quarter to quarter in its earnings.Those large fluctuations affected the credit rating Enron received, and thecredit rating affected Enrons ability to obtain low-cost financing,attract investment, and increase its stock price.


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In order to smooth out its earnings and avoid the natural dips, Enronengaged in a variety of complicated transactions that relied on structuredfinance, derivatives, and other arrangements that, while legal if done right,are nonetheless designed to massage a companys financial statement tomake its financial condition look better than it really is.

While it is not uncommon for a company to use these devices, they arealso used somewhat sparingly.

Enron, however, made them a high art form and used them aggressively,and in some cases, improperly.

When used extensively and when they become dominant, when theyinvolve billions of dollars, $27 billion in assets at Enrons peak, the real

impact of these complex transactions on a financial statement is to coverup reality with a glitzy coat of paint.

The financial statement becomes a fiction, and that is what happened atEnron.

Step by step, Enron shifted a larger percentage of its assets into thesestructured finance arrangements, not for any real business purpose, but inorder to make Enron look more profitable than it really was.

Funds flow and the appearance of funds flow became the Enron mantrain order to keep Enrons credit rating up and its stock price climbing, andthe Board of Directors went along with it.

In many actions starting in 1997, when the Board first approvedWhitewing, through the summer of 2001, just before things fell apartpublicly, the Board of Directors went along with managements wishes.

The Board relinquished its role of questioner and adopted the role offacilitator.


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It succumbed to the Enron ether of invincibility, superiority, andgamesmanship in manipulating Enrons financial statement to keep theEnron stock price soaring.

This is a company, we are told, that had televisions in its elevators inorder for employees to monitor Enrons stock price at all times.

The financial transactions that the Board approved were used to makedebt look like equity, to make loans look like sales, to make poorly

performing assets look like money makers, and to make Enron controlledentities look like legitimate third parties.

By the time of the collapse, Enron held almost 50 percent of its assets offits books, and what started as a useful tool to address specific business

problems had become a way of life.

As long as Enrons stock was rising, these elaborate financial structuresdid what they were designed to do, make Enrons financial condition lookbetter than it was.

But once Enron stock started falling, these financial structures collapsedon themselves like a house of cards, revealing at the end that there was nothere there.

These transactions involved a number of deceptions that pushed the limitof accepted accounting practices and, at times, exceeded them.

And parenthetically, if it turns out that Generally Accepted AccountingPrinciples allow such deceptions, then those accounting principles needto be changed.

One type of deception that Enron used was to report on the companysfinancial statements the sale of an asset despite an understanding thatEnron would buy it back after the financial statement was filed, or despite


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a hidden guarantee that the entity buying the asset would receive acertain rate of return.

Five of the seven assets sold this way to the LJM partnership at the end ofthe last two quarters of 1999 were bought backby Enron, sometimes

within 6 months time.

But those guarantees did not show on Enrons books as a liability. Onlythe sales showed as funds flow.

Another type of deception made what was essentially a loan look like asale, so the companys financial statement reflected the transaction asincome or cash flow instead of debt.

A third type of deception inflated thevalue of the assets that Enron heldfor sale.

For example, Enron would buy a power plant on day one for $30 million,and within a month or so would begin carrying it on Enrons books as anasset worth $45 million.

Two weeks ago, Enron filed a statement with the SEC declaring that it isgoing to write down its assets by another $14 to $24 billion, a staggeringsum, due to overvaluationson the books and accounting errors or

irregularities.

Another type of deception, the Raptors, used Enron stock to backstop arisk that the LJM partnership and its investors were supposed to beassuming for Enron, and the risk retained by Enron was not disclosed onthe companys financial statements in a meaningful way.

As these structured financial transactions grew in number, size, andfrequency, and as 50 percent of Enrons assets were moved off Enronsbooks, no one on the Enron Board said that their fiduciary duty required


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them to blow the whistle and prevent a deceptivepicture of Enronsfinancial situation from being presented to the public.

During the 13 interviews, the Board members told us that they had notbeen aware of the depth of Enrons problems or the extent of thesestructured transactions and accounting gimmicks, and most said theyhad no inkling that Enron was in troubled waters until mid-October 2001.

But look at this chart that the Subcommittee staff has put together,identifying numerous red flags presented to the Board of Directors fromFebruary 1999 on, that signaled the risks Enron was taking, and thatshould have alerted the Board to probe and then to change course.

The staff has identified well over a dozen of these red flags, but I am just

going to highlight a few.

In February 1999, the Boards Audit Committee was told by ArthurAndersen directly that Enrons accounting practices were high risk andpushed limits.

In June 1999, the Board approved at a special meeting and without priorFinance Committee consideration the creation of the LJM partnership,and waived the conflict of interest provision of the Enron code of conduct.

The Enron Chief Financial Officer, Andy Fastow, served as the managingpartner of LJM, something no Board member had ever approved or heardof prior to this.

The Board was to approve a code of conduct waiver for Fastow threetimes over the next 16 months.

In September 1999, the Board approved moving off the Enron balancesheet a $1.5 billion joint venture calledWhitewing, which was establishedby the Board in December 1997 to get a loan that looked like equity, and


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then used from 1999 on to purchase assets that Enron wanted to move offits books.

In May 2000, the Board approved the first Raptor transaction, a vehicledesigned to hedge Enron investments by using Enron stock to backstopthe hedge, which amounted to Enron hedging with itself.

By October 2000, the Board knew that Enron had $27 billion in assets,almost half of its assets, off its balance sheet.

InApril 2001, the Enron Board knew that 64 percent of Enrons assetswere troubled or not performing and that 45 million shares of Enron stockwere at risk in Raptors and Whitewing.

Starting with the creation of Whitewing in 1997 and with itsdeconsolidation in 1999, the Board started to wade into dangerous waters.

With the establishment of the LJM partnership and the waiver of the codeof conduct, they were up to their necks, and with the Boards approval ofthe Raptors, the Board was swimming way over their heads.

In the end, Enron drowned in its own debt.

The Board had ample knowledge of the dangerous waters in which Enron

was swimming and it did not do anything about it.

The Board told the Subcommittee staff that because each ofEnronstransactions was approved by Enron management,whom they saw assome of the most creative and talented people in the business, andbecause the transactions had been approved byArthur Andersen, a topauditing firm, and by Enrons lawyers and private law firms like Vinsonand Elkins, by the credit rating agencies, or by investment bankers whohad a significant stake in a lot of these transactions, the Board assumedthat the transactions were OK.


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Now, I can see why you might rely on a company auditor or an outsideattorney, but the Board must exercise independent judgment.

The Board is not supposed to be a rubber stamp for auditors or attorneys.

Also, the people that the Board relied on were conflicted in their rolesinvolving Enron, and the Board knew it.

First, the Board knew that Enrons management handed out bonuses likecandy at Halloween.

Employees were given huge bonuses for closing deals, and many of thesedeals proved damaging to Enron.

For instance, two executives closed a deal on a power project in India,which is now a financial disaster, and got bonuses in the range of $50million.

The head of one Enron division who was moved out of the companywalked away with more than $250 million in the year that he was shownthe door.

The temptation to self-enrichment at Enron was overwhelming.

Arthur Andersen was conflicted, because it served Enron as both anauditor and a consultant, and, for 2 years, it also served as Enronsinternal auditor, essentially auditing its own work.

Enronwas Andersens largest client, and in 2000, Andersen earned over$50 million in fees from the company.

Employees of Andersen routinely crossed over to work for Enron, and anAndersen employee who actually questioned Enron practices whileserving on the audit team was promptly reassigned to another client at

Enrons urging.


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Relying on outsiders, conflicted or not, does not relieve the Board fromthe ultimate responsibility to make sure that at the end of the day, Enron

was operating properly and Enrons financial statement was a fairrepresentation of Enrons financial condition.

The Board failed in that responsibility.

The structured debt and guarantees overwhelmed Enrons ability to pay,and that meant bankruptcy for the corporation, huge pension losses foremployees, investment losses for stockholders, and business losses forhundreds of small companies that did business with Enron, while theofficers of the corporation walked away with fortunes.

OPENING STATEMENT OF SENATOR COLLINS

Today is the first in a series of hearings to be held by the PermanentSubcommittee on Investigations into the events that led to thebankruptcy of the Enron Corporation.

As a result of the companys downward spiral and ultimate bankruptcy,shareholders, both large and small, individual and institutional, lost anestimated $60 billion.

This includes more than 15,000 Enron employees and retirees who had a

significant proportion of their pension funds invested in the companysstock.

They lost an astounding $1.3 billion.

The collapse of Enron caused thousands of Americans to lose their jobs,to lose savings, and to lose confidence in corporate America.

Unraveling the complexities of what happened, determining who isresponsible, and prosecuting those individuals will take the Department


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of Justice, the Labor Department, and the Securities and ExchangeCommission many months and possibly years.

The Subcommittees job is not to duplicate those efforts, but rather toexamine the actions taken by all of the players who contributed toEnrons demise in order to illuminate the public policy issues.

By doing so, the Subcommittee can help focus the debate in Congress, inState legislatures, and in corporate board rooms across the Nation on

what measures should be taken and by whom to minimize the chances ofanother Enron-like debacle.

In this first hearing, the Subcommittee will examine the role played byEnrons Board of Directors in the companys bankruptcy.

I want to acknowledge the Boards full cooperation with thisinvestigation.

I also want to take a moment to praise Senator Levin and the dedicatedboth Majority and Minority Subcommittee staff who have been tireless intheir efforts to unravel a very tangled web of conflicts of interest, unusualtransactions, and lax oversight.

Corporate boards play an essential role in the American economy.

They are the single most important guardians of a companysshareholders, and as such, they have a fiduciary duty to promote theinterests of the corporation, to act in good faith, and to exercise their bestjudgment.

When Korn/Ferry, a major corporate recruiter, polled corporate directorsin 2001 to determine the outstanding capabilities of board members, itidentified one single trait that stood significantly above all the others.


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That trait is a willingness to challenge management decisions whennecessary.

There is no question that directors generally should be able to rely on therepresentation of management and independent experts.

But directors have an obligation to do more than simply accept what theyare told, occasionally ask whether there are any problems, and inquire

whether the accountants agree on the propriety of actions presented fortheir approval.

Prudent directors retain their objectivity and to some degree, a healthyskepticism.

They must be willing to ask the tough questions of management,recognize those situations where independent expert advice should besought, and exercise heightened diligence when a company is pursuingunfamiliar or new territory.

Enron was a company that prided itself on its innovation.

CEOJeffrey Skilling often boasted of Enrons pioneering efforts as ittransformed itself from a traditional energy company to a globalenterprise creating new markets and businesses.

In contrast, it appears that the Board of Directors continued to perform itsduties as if Enron were still an old-line, conservative energy company, at atime when it appears they should have been far more probing, givenEnrons metamorphosis into an energy trading company.

Serving as a director for a corporation as complicated as Enron obviouslyis not an easy task.

Enron was one of Americas largest corporations. It had thousands of

partnerships, joint ventures, and other special purpose entities, many of


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which were engaging in transactions that can only, and barely even then,be followed with the aid of complex diagrams.

In fact, the Board members interviewed by the staff appear to have beenunaware that Enron has some 3,000 related entities, including 600 usingthe same post office boxin the Cayman Islands.

I would argue that should have been another red flag.

The complexity of the responsibility is precisely why Enrons Directorswere paid hundreds of thousands of dollars per year in cash, stock, andoptions.

While the exact amount of compensation can be difficult to determine,

depending on how one calculates the value of stock options, there is noquestion that Enrons Board members were among the most highlycompensated in the world.

Today, we will ask five Enron Directors what they did to protectshareholders and why they believe that they failed in doing so.

We will also hear an evaluation of their efforts from some of the leadingexperts on corporate governance.

I am particularly interested to learn more about the Boards response tothe large stock salesengaged in by Enrons management, its reaction tothe departure of a CEO who left after only 6 months on the job, and itsdecision to approve a waiver of Enrons code of conduct to allow the ChiefFinancial Officer to engage in business deals with the company.

This latter decision is the Board action that I find among the mostinexplicable.


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During the investigation, the Subcommittee spoke with many experts oncorporate governance, and not a single one had ever heard of a publiccompany ratifying a similar proposal.

I want to understand also the Boards view of what now appears to be theobvious conflicts of interestthat contributed to Enrons collapse and toexplore whether the Board, and its Audit Committee in particular,believed that they acted prudently in monitoring the outside auditor,

Andersen.

Actually, Andersen, as we know, was more than the outside auditor,which is another issue in and of itself.

The Board, with Andersens endorsement, approved many of the

transactions described by Senator Levin that enabled the company topaint a false picture of its financial health and Enron employees to enrichthemselves at the expense of the corporation, its shareholders, andultimately its creditors.

We are still working to unravel the complexities of these transactions,which has proven to be a monumental task.

It is troubling to me that in staff interviews, Board members haveprovided little insight into major transactions.

For example, not one Board member could explain or recall a $2.2 billionBoard resolution that approved the issuance of preferred Enron stock toan outside investor.

Now, I certainly do not expect the Board members to have perfect recallof every deal that they approved, but I would hope that transactions thatrise to the threshold of multiple billions of dollars would be memorable toat least someone on the Board.


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In addition, we will discuss some of the alleged conflicts of interestcreated by some of the Board members other relationships with Enron.

Was the Boards vigilance dulled by large consulting fees, corporatecontributions to their favorite charities, and other business relationships?

Every corporate governance expert with whom we spoke was critical, forexample, of any Board member having a consultant contract with Enron.

At a minimum, such relationships do not foster the appearance ofpropriety and financial independence of Board members.

Mr. Chairman, the Enron case is uncannily similar to another businessfailure that occurred some 70 years ago.

In the early 1930s, an electric holding company called Middle WestUtilities collapsed under the weight of stock fraud and cooked books.

Middle West was comprised of so many interlocking boards that it tookthe Federal Trade Commission 7 years to fully comprehend its structure,

which involved 284 affiliates.

Underneath its incredibly complex structure lay an immense amount ofdebt taken on as it expanded in the 1920s.

Ironically, Middle Wests auditor was a relatively new firm named ArthurAndersen.

There is, however, one significant difference between MiddleWests andEnrons executives.

The Middle West CEOs considerable fortune of around $150 million wastied up in Middle West holdings and disappeared with the company.


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In contrast, many ofEnrons managers were making tens and, at least inone case, hundreds of millions of dollars by dumping their Enron stockbefore the corporations collapse.

Although imperfect, it is important to remember that today, our systemsof accounting and financial regulation are the best in the world.

That makes the Enron case all the more troubling, because it simplyshould not have happened.It represents a colossal failure of virtually every mechanism that issupposed to provide the checks and balances on which the integrity of ourcapital markets depend.

And in that system, the Board of Directors is supposed to provide the first

line of defense by overseeing the conduct of management.

There are already encouraging signs that many directors in the wake ofEnrons collapse are taking their roles much more seriously.

As we seek answers in the Enron case, we should be careful not to actprecipitously without understanding the true nature and extent of theproblems underlying the corporations bankruptcy.

The testimony we will hear this morning about the role of the Board of

Directors should provide some answers.

It should also yield valuable lessons for strengthening our free enterprisesystem, restoring public confidence in our capital markets, and ensuringthat small investors, in particular, have access to complete and accurateinformation to guide their investment decisions.


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TESTIMONY OF JOHN H. DUNCAN, FORMER EXECUTIVECOMMITTEE CHAIR, BOARD OF DIRECTORS, ENRONCORPORATION, HOUSTON, TEXAS

Chairman Levin, Senator Collins, and Members of the Subcommittee,good morning and thank you for the opportunity to address thisSubcommittee.

My name is John Duncan. From 1967 to 1985, I was a Director of Enronspredecessor company, Houston Natural Gas, and I was there whenEnron began in 1985.

I have served as the Chairman of the Executive Committee since 1986.

Thus, I am the Enron Director who has served the longest period of time.

Until the Fall of 2001, I considered Enron one of the great companies ofthis country, and I was proud to be one of its directors.

I resigned from the Board in March 2002.

After receiving my bachelors degree in business administration at theUniversity of Texas, I set out to become a businessman, to start and runmy own company.

With the exception of the first job, in a family business, and a stint in theU.S. Air Force during the Korean War, I have not drawn a paycheck froma company of which I was not either the founder or the co-founder.

As co-founder and President of Gulf and Western and founder of GulfConsolidated Services, both companies had small beginnings and

wonderful success stories.During the course of my career, I have served on the board of seven New

York Stock Exchange Companies, and, Senator Durbin, not all at one

time.


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I have also served and chaired the boards of several important Texasinstitutions, including the Chancellors Council of the University of TexasSystem, Southwestern University in Georgetown, Texas, the Board of

Visitors at M.D. Andersen Cancer Center, and all the metropolitanHouston YMCAs.

I provide that background to the Subcommittee to respectfully suggestthat I have had substantial experience and exposure to the workings andto the role and to the duties of a board of directors.

I also know a boards limitations.

That is what I want to talk about today.

In particular, I want to focus on what I believe are the elements of aneffective board and why I believe the tragic events of Enron occurred.

First, I believe the directors must be individuals whopossess integrityand intelligence.

They also should collectively bring a broad spectrum of knowledge andexperience in the areas of business and finance and in the particular fieldsthat the company is in.

People usually acquire this experience by having operated a companywith a significant budget or by having obtained unique experience fromother professions that are relevant to the companys mission.

The Directors of the Enron Board certainly possess, in my opinion, thesequalities.My colleagues are highly ethical and of good character.

As far as intelligence goes, I can simply say that if education is anymeasure, I believe I was one of only two directors who did not have a

masters degree or a doctorate degree.


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Our directors are experienced, successful businessmen and women,experts in areas of finance and accounting, and have had experience inleading large institutions.

Others, like our overseas directors, brought experience in certain areas ofthe world in which Enron saw great business potential.

Second, I believe the board must be dedicated and diligent in addressingthe matters that are presented to it.

The directors need to do their homework, analyze the issues, askpenetrating questions, and make decisions that are always in the bestinterest of the shareholders.

In my opinion, the Enron directors met this criteria.

We worked hard. We prepared for meetings.

We asked probing questions and imposed specific controls andprocedures that management and outside advisors were required tofollow.

I know that my colleagues here today will address those items in moredetail.

We were also willing to say no to management when we did not agreewith its recommendations.

A good example of exercising a boards responsibility and to actindependently in the companys best interest occurred only lastSeptember, when all the indicators that we had were still positive andbefore any of the outside directors was aware that Enron was in trouble.


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We were presented two transactions at the Executive Committee and theBoard; management requested to authorize the purchase of two pulp

paper mills at a price in excess of $300 million cash.

We did not approve these acquisitions because we were concerned abouta prior acquisition in the same field; we did not like the purchase price;and we wanted to preserve our financial flexibility in the light of theSeptember 11 tragedies.

We postponed our decision, but we now know that subsequent eventssoon overtook us and the company.

I did not sit on the Audit Committee or the Finance Committee, but I didsit in as a guest at a number of their meetings.

In my opinion, these committees and these members thoroughlyexecuted their duties.

Third, I think that a board cannot be successful unless it feelscomfortable relying on the intelligence and integrity of the management,as well as other advisors who present matters to the board.

With over 20,000 employees working at the company, with over 200lawyers writing contracts every day, and with over 400 accountants

posting the daily books, we, the directors, had to rely on the reports givento us by the officers of the company.

Frankly, there is no other way that we could direct effectively a companyof that size.

We felt confident relying on the senior management of the company, aswe truly believed we had hired some of the best and the brightest in theindustry.

National, independent publications lauded the Enron officers for their

intelligence, leadership, and creativity.


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Finally, I believe the management and other advisors reporting to theboard must tell the truth.

They must tell the complete truth, good or bad, in order for the board tomake informed decisions.

We now knowthis did not happen at Enron.

The Board had implemented mechanisms and controls to ensure, at thevery least, it obtained early warning signals of any impending problem.

Among other procedures, we created a risk management officer position,and we staffed that department with nearly 100 employees.

That officer and that department was responsible for reporting to theBoard the most significant concerns and credit issues that faced thecompany.

That did not happen.

It is now quite clear that significant information about related partytransactions was withheld from us.

We were not aware, for example, of the problems of Chewco.

They were withheld from us for years.

We were not informed about Raptor III.

We were not told about the $800 million recapitalization of the Raptors inlate 2000 and 2001.

We were not told that employees, in addition to Andy Fastow, wereparticipants in a number of partnerships, andwe were unaware of their

substantial windfall profits.


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As late as the August 14, 2001 Board meeting, the Board was briefed onthe financial condition of the company.

Your staff has that briefing. The report wasearnings were up, balancesheet was stable, except maybe a credit rating improvement in the year2002.

Various Power Point slides given at that same meeting indicated to theBoard that the companys good businesswas still improving as usual.

The Powers Report and the reports we now have read in the press indicatethat for many months, if not years, certain members of management andour outside auditors were well aware of the problems facing the company,and they did not tell us.

In sum, I do not believe that Enrons fall would have been avoided hadthe Board asked more questions, implemented more controls, or avoidedcertain financing projects, because they were too complicated or risky.

Rather, I believe if management had implemented the Boards controls,as they assured us they had, if just one of the Boards officers oremployees had fulfilled his or her corporate duty to reveal these problemsor to any one director, or if the outside auditors had executed theirobligation to convey to us concerns they privately expressed and

documented amongst themselves, that I and we would not be here today.


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PCAOB Enters Into Cooperative Agreement with Dubai

The Public Company Accounting Oversight Board has announced that ithas entered into a cooperative arrangement with the Dubai FinancialServices Authority (DFSA) for the oversight of auditors that practice inthe regulators' respective jurisdictions.

The two regulators plan to hold a formal signing ceremony in January.

"For many years the DFSA has been a valued partner as the PCAOB hassought to ensure effective cross-border audit oversight," said PCAOBChairman James R. Doty.

"We are pleased that this agreement will allow us to exchange

confidential information, which will enhance the strong cooperativerelationship that already exists," he added.

This marks the second cooperative arrangement that the PCAOB hasconcluded in the Middle East.

The PCAOB recently signed a cooperative arrangement with the IsraeliSecurities Authority.

In addition, earlier this month, the PCAOB announced that it had entered

into a cooperative agreement with the Netherlands Authority for theFinancial Markets.

The PCAOB already conducts inspections in Dubai. The agreementauthorizes the PCAOB and the DFSA to exchange confidentialinformation, consistent with the provisions of the 2010 Dodd-Frank WallStreet Reform and Consumer Protection Act.

Those provisions amended the Sarbanes-Oxley Act of 2002 to permit thePCAOB to share confidential information with its non-U.S. counterpartsunder certain circumstances.


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"We are pleased to have concluded these arrangements with the DFSA,"said Rhonda Schnare, PCAOB Director of International Affairs.

"The PCAOB has long considered the DFSA's approach to cross-borderregulation to be a model of cooperation, which furthers the goal of

protecting investors."

The Sarbanes-Oxley Act directed the PCAOB to oversee and periodicallyinspect all accounting firms that regularly audit companies whosesecurities trade in U.S. markets.

More than 900 audit firms currently registered with the PCAOB arelocated outside the United States, spanning 88 jurisdictions.

There are eight registered firms located in Dubai.


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Basel III News

Dear Member,

Interesting!We have the first important Basel iii templates.

We will start with the Post 1 January 2018 disclosure template

From the BIS Consultative document, Definition of capital disclosurerequirements, Issued for comment by 17 February 2012, December 2011

Post 1 January 2018 disclosure template

The common template that the Basel Committee has developed is

designed to capture the capital positions of banks after the transitionperiod for the phasing-in of deductions ends on 1 January 2018

The Basel Committee proposes that banks should publish the completeddisclosure templatewith the same frequency as the publication of theirfinancial statements (typically quarterly or half yearly).

Furthermore, it is proposed that the completed disclosure templateshould either be included in the banks published financial reports or, at aminimum, these reports should provide a direct link to the completedtemplate on the banks website.

Banks should also make available on theirwebsites an archive of alltemplates relating to prior reporting periods.Certain rows are in italics. These rows would be deleted after all theineligible capital instruments have been fully phased out (from 1 January2022 onwards).

Regarding the shading (below):


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- Each dark grey row introduces a new section detailing a certaincomponent of regulatory capital.

- The light grey rows with no thick border represent the sum cells in therelevant section.

- The light grey rows with a thick border show the main components ofregulatory capital and the capital ratios.

Notes


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Notes


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Notes


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Notes


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Notes


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Notes


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Notes


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Notes


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Notes


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Notes


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Disclosure template during the transition phase

The proposed template for use during the transition phase is the same asthe steady state disclosure template set out in Section 1 except for thefollowing additions (all of which are highlighted in the template belowusing cells with dotted borders and capitalised text):

A new column has been added for banks to report the amount of eachregulatory adjustment that is subject to the existing national treatmentduring the transition phase (labelled as the pre-Basel III treatment).


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Example - Row 8: In 2014 banks will be required to make 20% of theregulatory adjustments in accordance with Basel III.

Consider a bank with Goodwill, netof related tax liability of $100 mnand assume that the bank is in a jurisdiction that does not currentlyrequire this to be deducted from common equity.

The bank would report $20 mn in the first of the two empty cells in row 8and report $80 mn in the second of the two cells.

The sum of the two cells will therefore equal the total Basel III regulatoryadjustment.

While the new column shows the amount of each regulatory adjustmentthat is subject to the existing national treatment, it is necessary to showhow this amount is included under existing national treatment in thecalculation of regulatory capital.


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Therefore, new rows have been added in each of the three sections onregulatory adjustments to allow each jurisdiction to set out their existingnational treatment.

Example - Between rows 26 and 27:Consider a jurisdiction that currently filters out unrealised gains andlosses on holdings of AFS debt securities and consider a bank in thatjurisdiction that has an unrealised loss of $50 mn.

The transitional arrangements require this bank to recognise 20% of thisloss (ie $10 mn) in 2014.

This means that 80% of this loss (ie $40 mn) is not recognised.

The jurisdiction would therefore include a rowbetween rows 26 and 27that allows banks to add back this unrealised loss.

The bank would then report $40 mn in this row as an addition to CommonEquity Tier 1.


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Example - Between rows 41 and 42:Assume that the bank described in the bullet point above is in ajurisdiction that currently requires goodwill to be deducted from Tier 1.

This jurisdiction would insert a new row in between rows 41 and 42, toindicate that during the transition phase some goodwill will continue tobe deducted from Tier 1 (in effect Additional Tier 1).

The $80 mn that the bank had reported in the last cell of row 8, would thenneed to be reported in this new row inserted between rows 41 and 42.


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ExampleRow 60:To take account of the fact that the existing national treatment of a BaselIII regulatory adjustment may be to apply a risk weighting, jurisdictions

would also be able to add new rows immediately prior to the row on riskweighted assets (row 60).

These rows would need to be defined by each jurisdiction to list the BaselIII regulatory adjustments that are currently risk weighted.


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Example: Consider a jurisdiction that currently risk weights definedbenefit pension fund net assets at 200% and in 2014 a bank has $50 mn ofthese assets.

The transitional arrangements require this bank to deduct 20% of theassets in 2014.

This means that the bankwill report $10 mn in the first empty cell in row15 and $40 mn in the second empty cell (the total of the two cells thereforeequals the total Basel III regulatory adjustment).

The jurisdiction would disclose in one of the inserted rows between row59 and 60 that such assets are risk weighted at 200% during thetransitional phase.

The bank would then report a figure of $80 mn ($40 mn * 200%) in thatrow.


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Financial stability and risk disclosureKeynote address by Mr Jaime Caruana, General Manager of the BIS, to

the FSB Roundtable on risk disclosure, Basel, 9 December 2011.

Abstract

High-quality risk disclosure is good for markets, because it helpsinvestors make more informed decisions.

It is good for prudential supervisors, because it makes banks moreaccountable to both supervisors and investors.

And it is good for financial stability, because it reduces the chance thatunexpected events will disrupt the system.

To be effective in promoting market discipline, disclosure must becomplemented by strong incentives for counterparties to engage inmonitoring.

The public sector's role in promoting transparency arises from a numberof market failures, including the externalities to be gained from commonstandards, the "free rider" problems that may lead to too little investmentin producing and gathering financial information, and the tendency ofmarkets to overreact to bad news when the information environment is

clouded.

Guided by these considerations, the Financial Stability Board and theBasel Committee on Banking Supervision have long supportedimprovements in transparency, through their work on accounting,disclosure templates and aggregate market data.

At the same time, industry and investor representatives need to play a keyrole in developing disclosure standards.


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Accounting standards need to converge, standards for the discussion andanalysis that accompany financial statements need to be established, andexternal auditors need to insist on higher-quality risk disclosures.

Full speech

Good morning, and welcome to Basel. We are meeting at a time of greatturbulence and uncertainty in the global economy and financial system.

But although all of us are focused on immediate challenges and risks, it isimportant not to lose sight of the need to carry forward our longer-termagenda towards building a better, stronger financial system.

Your discussions today are an essential part of making progress on this

agenda.

If we can achieve a significant improvement in the quality, comparabilityand timeliness of risk disclosures by financial firms, this will without adoubt help break the vicious cycles of contagion, asset sales and pullbackfrom risk-taking that have paralysed markets repeatedly over the last few

years.

The three pillars of Basel II continue to guide our efforts to strengthenfinancial regulation in the Basel III era and beyond.

We've now accomplished a great deal on Pillar 1 - minimum capitalrequirements.

The task now is to follow through on Pillar 2 by strengthening supervisoryreview, with a focus on firm-wide risk management and risk governance,and on Pillar 3 disclosures, by improving market discipline.

And while Pillar 3 is a good step in the right direction, achieving ouroverall objective of stronger market discipline will require efforts that go

beyond strictly regulatory approaches.


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How do we promote market discipline?

First, we need to make sure that the market has the information it needs.And a key element of market information is sound, consistentlyhigh-quality risk disclosures.

That will be the subject of my remarks, and of course the theme of yourdiscussions today.

But I should also point out that market discipline only works wheninvestors have the right incentives to use the information, and banks havethe right incentives to take account of the signals sent by the market.For these incentives to be right, the perception of a public safety net forbanks that are "too big to fail" needs to be eliminated.

This points to the relevance of the work by the FSB and Basel Committeeto reduce moral hazard by increasing loss absorbency, strengtheningresolution procedures and enhancing supervisory intensity forsystemically important banks.

If we successfully follow through on this work, then investors will havestronger incentives to develop a comprehensive picture of the risks andexposures facing financial institutions, and the banks should face more

pressure to be as accurate and transparent as possible about these

exposures.

The FSB and the Basel Committee have long supported soundaccounting and robust disclosure standards and practices.

Examples include the risk disclosure template for structured creditproducts set out in the Financial Stability Forum's report to the G7 inApril 2008, the Basel Committee's work on Pillar 3 disclosures, and themore recent work to encourage sound expected-loss provisioning rulesand related disclosures.


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Sound standards and practices enhance the quality of informationavailable to investors, depositors and other market participants, as well asto prudential authorities and regulators - including about risk exposures,risk management practices and policies, governance, and capitalmeasures and ratios.

This can lead to greater transparency that can support market confidence,improve market discipline and facilitate sound risk management

practices by financial firms and other companies, and has the potential tolead to more consistent practices over time.

Together with effective supervision, these can help to foster safe andsound banking systems and more stable financial markets.

We should recognise the limitations to what improved information aboutrisks can achieve.

The economy and the financial system are always changing and evolving,and our understanding of key relationships struggles to keep up.

Risks often appear precisely in the areas to which market participants andpublic authorities have paid the least attention, and about which theyhave demanded the least accurate information.

Given these limits to our understanding, we need to be prudent.

This meansprotecting the system against the unknown and unexpected,for example by strengthening capital and liquidity buffers at institutionsand initial margin in traded markets.

Nevertheless, strengthened, transparent disclosure is good for markets,because it helps investors make more informed decisions.

It is good for prudential supervision, because it helps to make banks more

accountable, both to supervisors and investors.


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And it is good for the stability of the system as a whole, because it reducesthe chance that unexpected events will cause major system-widedisruptions.

We should not forget that the official sector has a direct interest inpromoting financial stability through increased transparency; theexperience of the past four years has reminded us of the many costs that a

poorly functioning financial system can impose on taxpayers and the realeconomy.

One might think that market participants would naturally providecomprehensive, relevant disclosure in a timely manner, since it's in theinterest of investors, counterparties and institutions. But as we have seen,this is often not the case.

For example, during the ongoing turbulence related to Europeansovereign debt, investors and market analysts have struggled to develop acomprehensive and reliable assessment of the exposures of financialinstitutions to troubled sovereigns through bond holdings and derivatives

positions.

Some of the disruptions to bank funding markets have reflectedscepticism as towhether enough is known about these exposures, as wellas the chain of exposures related to them - banks' exposures to other

banks, and so on.

We at the BIS regularly publish information on the aggregate exposuresof national financial systems, but of course this says nothing about thenetwork of exposures of individual institutions.

Lacking adequate information to inform their risk assessments, providersof funds have naturally pulled back from European financial firms of allsorts - in the process undermining the stability of the system and puttingstill greater pressure on banks and sovereigns.


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This suggests the public sector has a key role in promoting markettransparency.Whenever one suggests the public sector should dosomething, it's good practice to identify the specific market failures thatimpel public action.

With respect to risk disclosure, I would emphasise the following ones.First, common standards have externalities.

Just as everyone benefits from common weights and measures in thephysical world, or from common standards for electronic media like DVDencoding, there's a social benefit from financial statements following asingle standard, including key concepts, common definitions and

principles, and, to the extent possible, common formats.

In some cases, collaborative efforts by the industry can generate theneeded standards; in others, especially where the subject matter iscomplex and there is a wide range of interested parties, some of whommay not support full, timely transparency, the public sector must play arole.

Second, producing and gathering financial information are subject to"free rider" problems.

It's costly toproduce, interpret and analyse information from disclosures.

But if one investor or counterparty does so, prices adjust and othersbenefit from it. So while investors can and do make money from carefullystudying publicly available information, there's still an incentive to "freeride" - to wait for someone else to gather relevant information, then toshare in the benefit by trading on it.

And preparers may face similar incentives to wait for others beforeproviding useful information about their risk exposures and riskmanagement practices.


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As a result, everyone in the market may just watch each other, instead ofmaking the investment in producing and obtaining accurate information.

There's no way to completely eliminate such free-riding from markets,but establishing common standards goes part way, by reducing the costs -in time, effort and resources - needed to produce and acquiremarket-relevant information.

We want to see a richer array of information made available that is lesscostly to collect, more widely available to market participants, moreusable and more comparable.

This should help take us towards markets where prices are movedprimarily by new information, rather than by herd behaviour, leverage orsudden shifts in risk appetites.

Third, if the information environment is murky, then markets overreact tobad news.

We saw this in the 2007-09 crisis - whenever problems were discovered inone asset class, or one institution, investors started to scrutinise similarly

placed assets or institutions, and downgraded their valuations of them.

This sometimes led to a self-fulfilling process that made things stillworse.

The same has happened in sovereign debt crises, including the currentchallenges in Europe -when one country gets into trouble, investorsimmediately look around to see who's next.

This creates a kind ofcollective actionproblem - it makes sense for eachplayer individually to pull back, but when many players do this the impactis devastating for the market as a whole.


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Greater transparency is one way to help break this cycle, by making itpossible for investors to see more precisely where, and whether, theirconcerns are justified.

Saying there is a public sector role in promoting transparency, for thereasons I've just laid out, is not the same as saying that strengtheningtransparency is the public sector's job alone.

Indeed, industry and investor efforts need to be at the centre ofdeveloping standards, since this will ensure that new requirements havethe proper technical grounding and a strong buy-in by market

participants.

The public sector can contribute by catalysing private sector efforts and

by directing those efforts in fruitful directions.

At the same time, however, if the private sector does not step in to addressthese issues adequately, supervisory and regulatory authorities may needto undertake further reforms to improve disclosure standards and

practices.

Alongside this work at the firm level, the international community hasalso been working to improve transparency by strengthening thecollection, aggregation and dissemination of financial sector data.

The BIS, together with the Committee on the Global Financial System,has long performed this role with respect to cross-border banking andOTC derivatives market activity.

Looking forward, the FSB has made substantial progress in developing adata framework that facilitates monitoring of key interlinkages among themajor global banks in a consistent manner.

While this project is still very much work in progress, it is notable that

national authorities and the FSB are considering storing and pooling the


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data collected nationally on a harmonised basis in a central hub, proposedto be hosted by the BIS.

The FSB and national supervisors are also working to make sure that theshift of derivatives market activity to central trading and clearing

platforms leads to a greater availability of useful market-level data onactivity in these instruments.

Also, following the FSB recommendation earlier this year, the FSB'sStanding Committee on the Assessment of Vulnerabilities, which I chair,is also assessing whether newly identified risks could benefit fromimproved risk disclosure practices.

But even as we work to improve the assessment of risks and the

availability and quality of aggregated industry and market data throughefforts by the official sector, strengthened disclosures by individualinstitutions still offer the most promising benefits in terms ofstrengthening financial stability.

Going forward, I would emphasise a number of key challenges:Following through on convergence of IASB and FASB accountingstandards, including their risk disclosure requirements.

Progress in converging the two main international accounting standards

frameworks will help ensure that users can make meaningfulcomparisons across institutions and entities operating in multiplejurisdictions.

Developing standards for the discussion and analysis that firms provide tocomplement the figures in the financial statements.

Common standards can be useful not only for financial data, but also forthe interpretations given to them.


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Disclosures often seek to provide information "through the eyes ofmanagement" that reflects how organisations measure and manage theirrisks.

While this approach can be helpful in understanding business models andrisk management practices, it can lead to disclosure of information that isnot comparable across firms, and therefore difficult for investors andregulatory bodies to assess.

Strengthening the contribution of external audits to the quality of riskdisclosures.

What is the degree of assurance that auditors provide about publicdisclosures, including those in financial statements, managements'

discussion and analysis sections of financial reports, and risk informationon their clients' websites?

To what extent, and in what ways, do they review or audit the accuracyand reliability of the financial reports that they examine, and how do theyreport on their assessments and findings to the public?

These are deep questions about how to best evolve the audit function asfinancial systems and investor needs evolve, and they won't be resolvedovernight.

They need to be addressed, however, if we are to clarify and to strengthenthe role of auditors in promoting transparency at firms.

The discussions at the FSB Roundtable today will mark important stepstowards progress in many of these areas.

I am confident the FSB and its standard-setting bodies are up to the task,and I encourage key stakeholders in the private sector to join together toencourage and to support better, more transparent risk disclosure

practices.


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Core principles for effective banking supervisionBIS Consultative document, December 2011

The Basel Committee on Banking Supervision has issued for consultationits revised Core principles for effective banking supervision.

The consultative paper updates the Committee's 2006 Core principles foreffective banking supervision and the associated Core principlesmethodology (assessment methodology).

Both the existing Core Principles and the associated assessmentmethodology have served their purpose well in terms of helping countriesto assess their supervisory systems and identify areas for improvement.

While conscious efforts were made to maintain continuity andcomparability as far as possible, the Committee has merged the CorePrinciples and the assessment methodology into a single comprehensivedocument.

The revised set of twenty-nine Core Principles have also been reorganisedto foster their implementation through a more logical structure,highlighting the difference between what supervisors do themselves and

what they expect banks to do:

Principles 1 to 13 address supervisory powers, responsibilities andfunctions, focusing on effective risk-based supervision, and the need forearly intervention and timely supervisory actions.

Principles 14 to 29 cover supervisory expectations of banks, emphasisingthe importance of good corporate governance and risk management, as

well as compliance with supervisory standards.

Important enhancements have been introduced into the individual CorePrinciples, particularly in those areas that are necessary to strengthensupervisory practices and risk management.


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Various additional criteria have been upgraded to essential criteria as aresult, while new assessment criteria were warranted in other instances.

Close attention was given to addressing many of the significant riskmanagement weaknesses and other vulnerabilities highlighted in the lastcrisis.

In addition, the review has taken account of several key trends anddevelopments that emerged during the last few years ofmarket turmoil:the need for greater intensity and resources to deal effectively withsystemically important banks; the importance of applying a system-wide,macro perspective to the microprudential supervision of banks to assist inidentifying, analysing and taking pre-emptive action to address systemicrisk; and the increasing focus on effective crisis management, recovery

and resolution measures in reducing both the probability and impact of abank failure.

The Committee has sought to give appropriate emphasis to theseemerging issues by embedding them into the Core Principles, asappropriate, and including specific references under each relevantPrinciple.

In addition, sound corporate governance underpins effective riskmanagement and public confidence in individual banks and the banking

system.

Given fundamental deficiencies in banks' corporate governance that wereexposed in the last crisis, a new Core Principle on corporate governancehas been added in this review by bringing together existing corporategovernance criteria in the assessment methodology and giving greateremphasis to sound corporate governance practices.

Similarly, the Committee reiterated the key role of robust marketdiscipline in fostering a safe and sound banking system by expanding an

existing Core Principle into two new ones dedicated respectively to


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greater public disclosure and transparency, and enhanced financialreporting and external audit.

As a result of this review, the number of Core Principles has increasedfrom 25 to 29.

There are a total of36 new assessment criteria, comprising 31 newessential criteria and 5 new additional criteria.

In addition, 33 additional criteria from the existing assessmentmethodology have been upgraded to essential criteria that representminimum baseline requirements for all countries.

The Basel Committee welcomes comments on the revised Core

Principles. Comments should be submitted by Tuesday 20 March 2012 byemail to: [email protected].

Alternatively, comments may be sent by post to the Secretariat of theBasel Committee on Banking Supervision, Bank for InternationalSettlements, CH-4002 Basel, Switzerland.

All comments may be published on the Bank for InternationalSettlements's website unless a commenter specifically requestsconfidential treatment.


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The 29 Core Principles are:

Supervisory powers, responsibilities and functions

Principle 1Responsibilities, objectives and powers:An effective systemof banking supervision has clear responsibilities and objectives for eachauthority involved in the supervision of banks and banking groups.

A suitable legal framework for banking supervision is in place to provideeach responsible authority with the necessary legal powers to authorisebanks, conduct ongoing supervision, address compliance with laws andundertake timely corrective actions to address safety and soundnessconcerns.

Principle 2

Independence, accountability, resourcing and legalprotection for supervisors:The supervisor possesses operationalindependence, transparent processes, sound governance and adequateresources, and is accountable for the discharge of its duties.

The legal framework for banking supervision includes legal protection forthe supervisor.

Principle 3Cooperation and collaboration:Laws, regulations or otherarrangements provide a framework for cooperation and collaboration

with relevant domestic authorities and foreign supervisors.

These arrangements reflect the need to protect confidential information.

Principle 4Permissible activities:The permissible activities ofinstitutions that are licensed and subject to supervision as banks areclearly defined and the use ofthe word bank in names is controlled.


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Principle 5Licensing criteria:The licensing authority has the power toset criteria and reject applications for establishments that do not meet thecriteria.

At a minimum, the licensing process consists of an assessment of theownership structure and governance (including the fitness and proprietyof Board members and senior management) of the bank and its widergroup, and its strategic and operating plan, internal controls, riskmanagement and projected financial condition (including capital base).

Where the proposed owner or parent organsation is a foreign bank, theprior consent of its home supervisor is obtained.

Principle 6Transfer of significant ownership:The supervisor has the

power to review, reject and impose prudential conditions on anyproposals to transfer significant ownership or controlling interests helddirectly or indirectly in existing banks to other parties.

Principle 7Major acquisitions:The supervisor has the power to approveor reject (or recommend to the responsible authority the approval orrejection of), and impose prudential conditions on, major acquisitions orinvestments by a bank, against prescribed criteria, including theestablishment of cross-border operations, and to determine that corporateaffiliations or structures do not expose the bank to undue risks or hinder

effective supervision.

Principle 8Supervisory approach:An effective system of bankingsupervision requires the supervisor to develop and maintain aforward-looking assessment of Core Principles for Effective BankingSupervision the risk profile of individual banks and banking groups,

proportionate to their systemic importance; identify, assess and addressrisks emanating from banks and the banking system as a whole; have aframework in place for early intervention; and have plans in place, in

partnership with other relevant authorities, to take action to resolve banks

in an orderly manner if they become non-viable.


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Principle 9Supervisory techniques and tools:The supervisor uses anappropriate range of techniques and tools to implement the supervisoryapproach and deploys supervisory resources on a proportionate basis,taking into account the risk profile and systemic importance of banks.

Principle 10

Supervisory reporting:The supervisor collects, reviews andanalyses prudential reports and statistical returns from banks on both asolo and a consolidated basis, and independently verifies these reports,through either on-site examinations or use of external experts.

Principle 11Corrective and sanctioning powers of supervisors:Thesupervisor acts at an early stage to address unsafe and unsound practicesor activities that could pose risks to banks or to the banking system.

The supervisor has at its disposal an adequate range of supervisory toolsto bring about timely corrective actions.

This includes the ability to revoke the banking licence or to recommendits revocation.

Principle 12Consolidated supervision:An essential element of bankingsupervision is that the supervisor supervises the banking group on aconsolidated basis, adequately monitoring and, as appropriate, applying

prudential standards to all aspects of the business conducted by the

banking group worldwide.

Principle 13Home-host relationships:Home and host supervisors ofcrossborder banking groups share information and cooperate for effectivesupervision of the group and group entities, and effective handling ofcrisis situations.

Supervisors require the local operations of foreign banks to be conductedto the same standards as those required of domestic banks.


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Prudential regulations and requirements

Principle 14Corporate governance:The supervisor determines thatbanks and banking groups have robust corporate governance policies and

processes covering, for example, strategic direction, group andorganisational structure, control environment, responsibilities of thebanks Boards and senior management, and compensation.

These policies and processes are commensurate with the risk profileand systemic importance of the bank.

Principle 15Risk management process:The supervisor determines thatbanks have a comprehensive risk management process (includingeffective Board and senior management oversight) to identify, measure,

evaluate, monitor, report and control or mitigate all material risks on atimely basis and to assess the adequacy of their capital and liquidity inrelation to their risk profile and market and macroeconomic conditions.

This extends to development and review of robust and credible recoveryplans, which take into account the specific circumstances of the bank.

The risk management process is commensurate with the risk profile andsystemic importance of the bank.

Principle 16

Capital adequacy:The supervisor sets prudent andappropriate capital adequacy requirements for banks that reflect the risksundertaken by, and presented by, a bank in the context of the marketsand macroeconomic conditions in which it operates.

The supervisor defines the components of capital, bearing in mindtheir ability to absorb losses.

Principle 17Credit risk:The supervisor determines that banks have anadequate credit risk management process that takes into account theirrisk appetite, risk profile and market and macroeconomic conditions.


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This includes prudent policies and processes to identify, measure,evaluate, monitor, report and control or mitigate credit risk (includingcounterparty credit risk) on a timely basis.

The full credit lifecycle should be covered including credit underwriting,credit evaluation, and the ongoing management of the banks loan andinvestment portfolios.

Principle 18Problem assets, provisions and reserves:The supervisordetermines that banks have adequate policies and processes for the earlyidentification and management of problem assets, and the maintenanceof adequate provisions and reserves.

Principle 19

Concentration risk and large exposure limits:Thesupervisors determines that banks have adequate policies and processesto identify, measure, evaluate, monitor, report and control or mitigateconcentrations of risk on a timely basis.

Supervisors set prudential limits to restrict bank exposures to singlecounterparties or groups of connected counterparties.

Principle 20Transactions with related parties:In order to preventabuses arising in transactions with related parties and to address the risk

of conflict of interest, the supervisor requires banks to enter into anytransactions with relatedparties on an arms length basis; to monitorthese transactions; to take appropriate steps to control or mitigate therisks; and to write off exposures to related parties in accordance withstandard policies and processes.

Principle 21Country and transfer risks:The supervisor determines thatbanks have adequate policies and processes to identify, measure,evaluate, monitor, report and control or mitigate country risk and transferrisk in their international lending and investment activities on a timely

basis.


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_____________________________________________________

Documents

Understanding Risk Management and Compliance, January 2012