1. OpRisk Europe – April 2006 Compliance & Capital, or ‘MiFID and the CRD’ ISDA www.isda.org Copyright ® 2006 International Swaps and Derivatives Association, Inc. Richard Metcalfe Senior Director, Policy

2. 2 ISDA MiFID and CRD 1)Market in Financial Instruments Directive 2)Capital Requirements Directive 3)CRD + MiFID = “CRMiFID”? 4)The bigger picture

3. 3 ISDA MiFID – translation Market in Financial Instruments Directive –Updates Investment Services Directives (1993) –Implies capital requirements (CRD) –Implementation in EU Member States – Nov 2007 Transposition (into national law) – end-Jan 07

4. 4 ISDA MiFID – what? Governs investment business –Not just ‘investment firms’. –common EU rules / ‘passport’ Includes business on exchanges and Multilateral Trading Facilities (MTFs) Reflects growth in financial instruments (eg, credit derivatives; NB, commodity derivatives) Covers ‘advice’

5. 5 ISDA MiFID – How? I.Definitions & Scope II.Authorisation & Operating Conditions: Outsourcing/OpRisk (Article 13); Conflicts (Art. 18) Best execution (Art. 21); Order handling (Art. 22) III.Regulated Markets IV.Competent Authorities Whistle-blowing obligation on auditors (Art 55) V.Final Provisions  Annex I: Services & Activities  Annex II: Professional Clients

6. 6 ISDA Article 13.5, MiFID An investment firm shall ensure, when relying on a third party for the performance of operational functions which are critical for the provision of continuous and satisfactory service to clients and the performance of invesment activities on a continuous and satisfactory basis, that it takes reasonable steps to avoid undue additional operational risk. Outsourcing of important operational functions may not be undertaken in such a way as to impair materially the quality of its internal control and the ability of the supervisor to monitor the firm’s compliance with all obligations. An investment firm shall have sound administrative and accounting procedures, internal control mechanisms, effective procedures for risk assessment, and effective control and safeguard arrangements for information processing systems.

7. 7 ISDA Organisational structure consider IT Client services Client management Data capture Branch structure Legal Internal audit Trade execution Compliance Risk management MarketingHR Source: FSA, ‘Planning for MiFID’ Governance oversight Policies and procedures Trading & infrastructure

8. 8 ISDA EU & Financial Services EU ‘Financial Services Action Plan’ –Market Abuse, Prospectus, Collateral ‘Lamfalussy’ Directive – 4 levels: 1.Framework 2.Implementing Measures ** 3.Co-ordination 4.Enforcement ** CESR. NB 1) Best execution 2) Advice

9. 9 ISDA 2 CRD

10. 10 ISDA Capital Requirements Directive ‘Basel II’ Accord, translated into EU ‘Recasts’ Directives on Capital Adequacy (1996) + Credit Institutions (2000) Basel I blocked ‘race to the bottom’ –8% * [Risk Weighting] * Asset/Exposure But… –Crude + vulnerable to arbitrage –Basel II adds operational risk… and requirements

11. 11 ISDA Operational Requirements (eg, Credit Derivatives) Legally binding and enforceable contract Procedures and processes for residual risks Elgible providers: –Low-weighted Sovereigns, Banks, Securities Firms –Single-A entities, including related company weighted <obligor

12. 12 ISDA 3 “CRMiFID”

13. 13 ISDA When Directives Collide FSA: SYSC pulled at last minute (Sept ’04) –“Need for consistency of approach” –FS05/1: ORM not required to manage systems and controls Brussels (?) –Compliance with CRD is satisfied by compliance with requirements of MiFID… as far as they go CRD Art 22 (governance, risk reporting, internal control) Basel –‘Compliance… in banks’ (April 2005)’ - within OpRisk function? CEBS-CESR (-CEIOPS) co-operation –2006 Cross-sectoral Work Programme

14. 14 ISDA OpRisk types – relevance of MiFID Fraud – internal Fraud – external Workplace Clients… Damage Disruption Delivery… People PROCESS SYSTEMS Events –Legal risk, including regulatory fines REGULATORY FINES? CUSTOMER ACTION? (REPUTATIONAL DAMAGE?)

15. 15 ISDA From Annex 7 Level 2 Level 3 Internal Fraud External Fraud Employment Practices and Workplace Safety Clients, Products & Business Practices Suitability, Disclosure and Fiduciary Improper Trade Practices Advisory Activities Aggressive sales Account Churning Disputes over performance of advisory activities Damage to Physical Assets Business disruption and system failures Execution, Delivery & Process Customer Intake (documentation) Client permissions / disclaimers Source: Basel II

16. 16 ISDA Relevance of MiFID / Basel business line Corporate Finance Trading & Sales… Retail Banking Commercial Banking Payment and Settlement Agency Services… Retail Brokerage… Asset Management –Sales; Market Making –Custody (MiFID 13.7) –MiFID passim

17. 17 ISDA MiFID and the 4 AMA elements  data  data (external)  scenarios business environment and control factors

18. 18 ISDA H106H206H107H207H108 AMA FSA CPFSAreviewsLIVE ‘SYSC’ CP* MiFID Level 2 /EPCoB CP (Oct) 31 i 07: Transp. LIVE (Nov) Other “EUSarbOx”? Timetables (UK) * Delayed from Sept ’04

19. 19 ISDA ‘Stable yet dynamic’ directives Lamfalussy Directive (MiFID) Framework Directive (CRD) Developments in Basel –Especially likely on evolving discipline of OpRisk? CEBS * –April 6 2006: consulation on outsourcing: “the management of risks related to [material activities]”; “any activities having a significant impact on its risk management” * http://www.c-ebs.org/pdfs/CP02rev.pdf

20. 20 ISDA 4 Other

21. 21 ISDA The broader environment Market Abuse Directive –Insider trading UCITS –Investor suitability Prospectus –Risk disclosure ‘[Complex Structured] Financing transactions’ Corporate Governance – unresolved EU debate…

22. 22 ISDA …Corporate governance (Unresolved EU debate) –Abortive attempts to 1)Launch Directive (2004) 2)‘SarbOx’ Company Law Directives # 4 & 7 (Q205) –Corporate Governance Forum set up – Oct 2004 –Dec 05-Mar 06 Consultation on ‘future priorities’ –Announced: Public Hearing, Brussels, 3 rd May

23. 23 ISDA OpRisk Europe – April 2006 MiFID and the CRD or ‘2004/39/EC and Re-cast 2000/12/EC + 93/6/EEC’ ISDA www.isda.org Copyright ® 2006 International Swaps and Derivatives Association, Inc. Richard Metcalfe Senior Director, Policy