Response to the FSA’s consultation Strengthening liquidity standards 3: liquidity transitional provisions, CP 09/14

Introduction
 
The Building Societies Association (BSA) represents all 53 building societies in the United Kingdom. Building societies(1) have total assets of over £375 billion and, together with their subsidiaries, hold residential mortgages of over £245 billion, more than 20% of the total outstanding in the UK. Societies hold over £240 billion of retail deposits, accounting for more than 20% of all such deposits in the UK. Building societies also account for about 36% of all cash ISA balances. Building societies employ approximately 50,000 full and part-time staff and operate through approximately 2,000 branches.

Summary

We welcome the FSA’s proposal for a phased implementation plan for various elements of the new regime (systems and controls requirements, quantitative requirements, and reporting), which will be proportionate and differentiated by class of firm.  We believe the FSA is right to concentrate first on the systemically important firms.  We also appreciate the efforts made by the regulator to spell out what it expects from different types of firms for example, large and smaller building societies.

However, we do find it hard to comment definitively on the proposals for transitional provisions without an agreed, final policy on liquidity risk management.  Building societies and other firms are still much in the dark (in the absence of a definitive feedback statement on CP 08/22) on aspects such as the exact composition of the liquid asset buffer, and final scope and eligibility for the simplified regime.  We pointed this out in our response to the consultation on liquidity reporting.  The timetable, as currently set out, could prove unrealistic for some, maybe even the majority, of building societies, depending on some key policy decisions on CP 08/22 proposals that are yet to be communicated.  

In view of the lack of certainty and time pressure, and given that for building societies at any rate, liquidity levels are already high and closely monitored by FSA supervisors, we suggest that a longer, and more flexible, implementation timetable is introduced, whose starting point should be the date of publication of the final liquidity policy and rules.

Finally, we are keen to stress the point - especially  in relation to the simplified regime, where we wait to see how the serious concerns detailed in our response to CP 08/22 will be addressed – that a lengthy transitional period, while desirable in itself, is not a substitute for ensuring, and demonstrating, that the new “steady-state” policy is the right one.
 
Annex 10

List of questions

To assist FSA’s understanding of the responses to individual questions, once disaggregated, we have repeated text where relevant rather than cross-referred.

Chapter 2 – implementation of the FSA’s new liquidity regime

Q1: Do you agree with our proposal to provide transitional arrangements on a phased basis, differentiated by class of firm and type of requirement? If not, how could we amend it?

We welcome the FSA’s proposal for a phased implementation plan for various elements of the new regime (systems and controls requirements, quantitative requirements, and reporting), which will be proportionate and differentiated by class of firm. We agree that systemically important firms should be targeted first.  We also appreciate the efforts made by the regulator to spell out what it expects from different types of firms for example, large and smaller building societies.

But we do find it hard to comment definitively on the proposals for transitional provisions without an agreed, final policy on liquidity risk management.  Building societies and other firms are still much in the dark on aspects such as the exact composition of the liquid asset buffer and the final scope and eligibility for the simplified regime.  We pointed this out in our response to the consultation on liquidity reporting, CP 09/13: “… unhelpful to comment definitively on proposed liquidity reporting when the policy on liquidity risk management is still under discussion and consequently the rules not yet published. Societies sense a lack of clarity with the FSA’s approach to liquidity.”

Implementation of the first part of the new liquidity regime, systems and controls, is scheduled for Q4 2009.  But when in this three-month period?  As the British Bankers’ Association has pointed out, there is a huge difference between 1 October and 31 December.  If the former, far fewer firms will be able to comply.  We suggest that this date is put back, preferably (given – as mentioned above – that societies’ liquidity management is already intensively supervised by FSA) until mid-2010, but at least until 1 January 2010. (As the BBA intimate, procedural and reporting burdens are unnecessarily increased – to no benefit - where the compliance date is the year-end rather than the following day.)

Chapter 2.7 says: “In developing the transitional proposals we need to be aware of the potential impact on firms and the need to give them time to consider the complete package of measures for the liquidity regime.”  Societies welcome this aim but argue that they do not have time to consider the complete package – this is exactly the problem we outline above, caused by FSA needing to deal with reporting and transitional issues before clarifying its underlying policy.  With so many consultations overlapping, we suggest a regulatory pause to give firms time to absorb the final version of what is being proposed (once known) and how the changes might affect them.

Even the FSA itself appears to be under pressure in this regard, and is sending out conflicting messages.  For example, eligibility for the simplified regime for building societies differs between two consultations: this paper makes the assumption for CBA purposes that it will cover only those societies currently using the matched or administered treasury risk management approach, whereas CP 09/17 Specialised Sourcebook for Building Societies makes clear that eligibility extends to societies on the extended approach. The position has recently been clarified, though initially causing considerable confusion to societies, but the inconsistency nonetheless shows the pressure the FSA is under in trying to do too much too quickly.

Q2: Do you agree with our proposals to defer implementation of our proposed self-sufficiency requirements for different classes of firms and to agree with each firm a “window of time” to apply for a waiver?

We agree with the proposal to defer implementation of the self-sufficiency requirements, given the magnitude of the change (although this is not a very major issue for building societies generally).  But, like the BBA, we would like more information on the content and timeline (including the “window of time”) of the waiver process.  Building societies would also appreciate details on the criteria the regulator will apply when assessing waiver applications.

Q3: How long do you consider you would need after the waiver decision has been made to prepare for compliance with the new regime?

We acknowledge that firms affected, including some building societies, will need plenty of time to comply with the new requirements.  The BBA has suggested a minimum of 12 months – we would support this.

Q4: What are your views on our proposed supervisory approach through to economic recovery?

We welcome the gradual pathway for building-up minimum levels of liquidity buffers over several years.  This is clearly a more appropriate course of action than overnight implementation.  But it still has major resource considerations for all firms, not just building societies.

Chapter 1.2 says that the transitional provisions allow most firms additional time to make their preparations for the new regime.  We do not believe this to be entirely correct as the uncertainties surrounding the liquidity regime mean that firms have indeed very little time to “make preparations”, let alone introduce, test and monitor new systems and processes.  This rush will lead inevitably to competing demands on IT systems providers and significant resource pressures for firms. The gradual building up of the quantity of liquidity required, while welcome in itself, does not affect the burden of having systems and processes fully ready on day one.

One example may help to make this clear. Societies aspiring to the simplified regime are currently expected - as proposed in CP08/22, though the BSA has argued vigorously against this -to hold their standardised buffer entirely in Treasury bills. In order for those T bills to be of any use, each such society will need to make arrangements to be able to realise them – either by outright sale, or preferably by using them as collateral for secured funding. The fact that the quantum of T bills required may gradually increase over the transitional period does not affect the fact that the capability to turn them into cash has to be fully operational on day one. Societies that have hitherto never needed to develop expertise and systems actively to manage financial collateral may now need to do so – unless the final policy develops in the direction the BSA has urged, and recognises other forms of high-quality liquidity that are more appropriate for smaller societies. However, notwithstanding informal indications that the final policy may be more sensible, societies cannot yet assume this but may have to prepare for the worst.

As we have argued elsewhere, we believe that the Q4 2009 date to implement the new rules and guidance on liquidity risk management, including transitional provisions, is too early and does not properly reflect the extent to which societies are in the middle of “planning blight” until the CP 08/22 policy is finalised.

Individual liquidity guidance

Chapter 1.12 is clear on how the phased build-up of the minimum liquidity buffer for simpler building societies is to proceed: a transitional rule will be provided that will require simplified building societies to maintain the higher of the amount that would be required by IPRU (BSOC) chapter 5 and the amount of the liquidity required by applying a sliding scalar to the requirement in BIPRU 12.6.7 R.  This will be 30% (year 1), 50% (year 2), 70% (year 3) and 100% (from year 4) of the final figure.  We welcome such clarity.
 
But the consultation is less clear on how this should happen for other firms such as the non-simplified building societies.  The FSA says merely: ”Quantitative constraints on individual firms’ liquidity positions will be set within ILG, with the FSA taking a view on the overall pace at which liquidity positions can sensibly be strengthened….”  We would appreciate further clarity on the pace of strengthening, even a baseline figure as the BBA has suggested.

Chapter 3 – cost-benefit analysis

Q5: Do you agree with the approach to estimate current short-term Sterling treasury bills held by firms?

While the extrapolation from holdings of gilts with a contractual flow of up to three months may be the least bad proxy, this may well overstate the current short term T bill holdings of those societies likely to end up on the simplified approach: typically, these societies may hold no T bills at all, while holding longer-term gilts, at a more acceptable yield, some of which may on any particular date have migrated down to the three month bucket.

Q6: Do you consider the estimated ratio of 3% reasonable?

See above. 3% could well be an overestimate.

Q7: Do you agree that the transitional regime as such will not impose significant additional administrative and reporting cost on simplified banks and building societies?

We do not agree. Paragraph 3.12 indicates that the baseline scenario is the hypothetical one of a continuation of existing requirements, so we are clear that the transition to the new regime will undoubtedly impose additional costs – mainly in terms of staff, systems and training - on simple building societies.  But the costs will be less than if there were no phasing of the transition, as is proposed in CP 09/14.

Q8: Do you believe that simplified banks and building societies incur additional transaction cost when accessing the government bond market?

As the BBA has pointed out, there is one type of firm that will incur major additional transaction costs when accessing the government bond market: a firm that had never held bonds of any kind, and never intended to, operated purely in deposits and loans, and therefore had no dealing system for bonds, no accounting procedures, no account or agent at any of the clearing systems, and so on.  Such a firm would have to set up an operation to hold bonds, the cost of which will be significant.

Even where a firm – such as a small society – may have bought small parcels of gilts from time to time and held them to maturity, the systems and processes for doing so may well be less comprehensive than would be needed where a firm is expecting more active involvement in the gilt or T bill market, and – as mentioned above –requires a constant capability to turn T bills into cash preferably by using them as collateral for secured funding.

Q9: Do you agree with the costing methodology for the simplified regime transitional arrangements?

Our comment in response to QQ 5-6 are also relevant here: we suspect 3% is an overestimate of current T bill holdings by these societies, and therefore the methodology is liable to underestimate the cost of transitioning to a T bill based buffer.

Q10: Do you agree with the cost estimates for the simplified regime transitional arrangements?

We doubt these estimates, primarily for the reason given above. They do not correlate with cost estimates that individual societies have tried to draw up for themselves. The average £ figure is not particularly helpful – while systems costs may be relatively insensitive to size /volumes, if the  main component of the cost is the yield loss on holding T bills, this is of course directly a function of the society’s size, and would be more usefully expressed as a percentage of total assets.

Q11: Do you agree that the proposals will result in the benefits described in this section?

Broadly, yes. We would underline the importance of  managing, and staggering, the aggregate impact on the market of  all deposit-taking firms in effect being required to hold a larger proportion of Government debt in various forms.

Chapter 4 – compatibility statement with our objectives and the principles of good regulation

Q12: Do you agree that our proposed liquidity regime is compatible with our statutory objectives and principles of good regulation?

Not entirely. As explained in our response to CP 08/22, we consider that some of those proposals do not satisfy the FSMA tests.

Our main concern relates to the impact of the simplified regime (as originally proposed) on those societies that are almost entirely retail-funded, which is highly disadvantageous. Since it will reduce the ability of these societies to lend, and disproportionately increase the liquidity cost of attracting retail savings, we consider that- unless modified - this element of the proposals fails against the third, sixth and seventh principles of good regulation, as we said in our earlier response. The anti-competitive effect is especially serious.

Having said that, to the extent that it is possible to separate the purely transitional aspect from the “steady-state” new policy, we agree that the transitioning arrangements are compatible with the statutory objectives and the principles. Given our, and the BBA’s, identification of the problem arising from societies and other firms not yet knowing the final policy requirements but having to prepare for initial compliance with systems and controls from an unspecified date in Q4 2009, we do not consider that the transitional proposals themselves represent (as FSMA requires, and mentioned at paragraph 4.14) the most appropriate way for FSA to meet its objectives.

Annexes 1 to 9 : we comment only on the matters covered in Annexes 4 and 5, as the contents of the other Annexes are not applicable to building societies.

Annex 4 – transitional measures for building societies not within the simplified ILAS regime

Q25: Do you agree with the proposed approach for systems and controls requirements?

Not entirely. Building societies – like banks – generally welcome the new requirements as they mostly represent good practice that is already being applied in the sector.  But they need to know what “Q4 2009” means - rather than 1 October, which (in the absence hitherto of any definitive statement of the final overall policy) is clearly too soon, they suggest 1 January 2010 at the earliest. We have explained above how systems and controls cannot be totally independent of the content of the final policy, so they clearly cannot be finalised in isolation. Even more helpful – and less disruptive to their businesses – would be a delay in implementation until mid 2010. There is no great lacuna  in the current supervision of building society liquidity that justifies hurried implementation.

Q26: Do you agree with the proposed approach for quantitative requirements?

Those building societies not using the standardised buffer find it hard to comment authoritatively on the phased approach without more details on the size of the buffer. But they believe a phased approach is welcome and appropriate.

Q27: Do you agree with the proposed supervisory approach?

We support the “economic pathway” approach of gradual strengthening set out in paragraph A 4.7, and low level backstop ILG is a suitable vehicle for that approach.

Q28: Do you agree with the proposed approach to reporting requirements?

As we have pointed out in our response to CP 09/13, we are still concerned that new reporting requirements are being rushed. For convenience, we reproduce below the relevant comments submitted in response to CP 09/13.

Building societies are currently informing the FSA of their liquidity position through a mix of data items on GABRIEL, older, supposedly obsolete forms (FSA handbook SUP 16 Annex 3R) and ad hoc reports. Clearly, this is cumbersome and only a short-term solution but it seems to work. We therefore suggest that implementation of the liquidity reporting for building societies is postponed until all stakeholders agree a “new” normality has descended. Recent events have shown that this is some time off. By agreeing to a delay, the FSA has time to introduce, and test thoroughly, a system that is helpful to all and not merely a kneejerk reaction to a political imperative.
 
A delay would also help building societies, and other regulated firms, have access to the services of specialist IT and software vendors at a controlled pace, rather than them all competing for their services at the same time (and at possibly inflated prices). Many societies are still trying to cope with GABRIEL, which does not yet provide a consistent full service, and would appreciate breathing space to allow that system to bed in.

Annex 5 – transitional proposal for building societies within simplified ILAS

Q29: Do you agree with the proposed approach for systems and controls requirements?

Not entirely. Building societies – like banks – generally welcome the new requirements as they mostly represent good practice that is already being applied in the sector.  But they need to know what “Q4 2009” means - rather than 1 October, which (in the absence hitherto of any definitive statement of the final overall policy) is clearly too soon, they suggest 1 January 2010. We have explained above how systems and controls cannot be totally independent of the content of the final policy, so they clearly cannot be finalised in isolation – and we gave a specific example of how this can be problematic for simplified firms. So, more helpful – and less disruptive to their businesses – would be a delay in implementation until mid 2010. There is no great lacuna in the current supervision even of simplified building societies’ liquidity that justifies hurried implementation.

Q30: Do you agree with the proposed approach for quantitative requirements?

We welcome the proposed phasing of the quantitative requirements over the period 2010-2012: this is a sensible approach. We remain concerned about some of the features of the simplified regime, and should re-iterate that a lengthy transitional period - while desirable in itself- is not a substitute for ensuring that the new “steady-state” policy is the right one.

Q31: Do you agree with the proposed supervisory approach?

The application of the standardised buffer within the simplified approach means that ILG as such is not necessary. We agree that it is important that other guidance should still be available to societies as part of normal supervisory engagement.

Q32: Do you agree with the proposed approach to reporting requirements?

As we have pointed out in our response to CP 09/13, we are still concerned that new reporting requirements are being rushed. For convenience, we reproduce below the relevant comments submitted in response to CP 09/13.

Building societies are currently informing the FSA of their liquidity position through a mix of data items on GABRIEL, older, supposedly obsolete forms (FSA handbook SUP 16 Annex 3R) and ad hoc reports. Clearly, this is cumbersome and only a short-term solution but it seems to work. We therefore suggest that implementation of the liquidity reporting for building societies is postponed until all stakeholders agree a “new” normality has descended. Recent events have shown that this is some time off. By agreeing to a delay, the FSA has time to introduce, and test thoroughly, a system that is helpful to all and not merely a kneejerk reaction to a political imperative.
 
A delay would also help building societies, and other regulated firms, have access to the services of specialist IT and software vendors at a controlled pace, rather than them all competing for their services at the same time (and at possibly inflated prices). Many societies are still trying to cope with GABRIEL, which does not yet provide a consistent full service, and would appreciate breathing space to allow that system to bed in.

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