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EU urged to recognise different op risk profiles of investment firms

MONTE CARLO - The European Union's plans to make investment firms as well as banks reserve capital against operational risk must acknowledge that one size does not fit all firms in the financial services industry, a leading European financial regulator argued in early July.

    • David Keefe
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Howard Davies, chairman of the UK's Financial Services Authority (FSA), said the EU should avoid a simple extrapolation of the proposed Basel II bank capital adequacy rules to investment firms.

He added it may be necessary to consider a further breakdown of the business lines proposed for measuring operational risk in Basel II in order to allow for a more risk-sensitive operational risk charge based on different scaling factors for different categories of business.

Basel II will determine how much of their assets large international banks in the Group of 10 leading economies must set aside as reserve capital to guard against banking risks from 2005. For the first time the banks will have to reserve capital specifically against the risk of losses from operational hazards such as fraud, technology failure and trade settlement errors.

The European Commission, the EU's executive arm, wants to apply its third capital adequacy directive, which is modelled closely on Basel II, to all banks and investment firms in the 15-nation EU.

The EU's plan has provoked strong criticism from investment management firms and stockbrokers who argue that it will result in damaging increases - of as much as 250% in some cases - in the amount of regulatory capital they will have to set aside. The critics have also argued that the number of business lines nominated by the Baseland EU regulators should be extended to accommodate the differences between banks and other financial firms.

Davies told a conference in Monte Carlo the FSA, the UK's principal financial watchdog, is clear that operational risk capital charges "must be part of the equation in the long run".

But he acknowledged "the initial Basel calibration generated operational risk charges which, for investments firms and fund managers in particular, seem to be well above what might be reasonably required."

Davies agreed with critics that a simple extrapolation to investment firms produced percentage increases for fund managers that were in some cases "quite outlandish".

Meanwhile, FSA officials are urging UK banks and institutions to return as soon as possible the information required by the Commission for its study of the impact of an op risk capital charge on European financial firms. That's despite the Commission's extension of the deadline for the return of data to October 1 from early July.

The extension of the deadline followed the June decision of the architects of Basel II, the Basel Committee on Banking Supervision, to postpone the coming into effect of the accord to 2005 from 2004.

But FSA sources say the information from the EU's impact study is needed to complement the op risk data received from the Basel Committee's own quantitative impact studies, namely QIS 1 (deadline June 1) and QIS 2 (deadline August 1).Operational Risk

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