Investment banking

All that said, IBs still face a significant volume of regulatory change in 2024. Many reforms developed over the past few years, including the latest iterations of the Markets in Financial Instruments Regulation (MIFIR), the European Market Infrastructure Regulation (EMIR) and the Central Securities Depositories Regulation (CSDR), are close to implementation. Although the EU and UK have each gone their separate ways, the extent of divergence is not as great as initially expected. However, there are important differences in detail and implementation timelines. These will require IBs to sharpen their regulatory mapping capabilities to derive potential synergies from implementation of regulatory change programmes and to anticipate peak demands on key resources, especially IT staff.

The final deadline for FRTB implementation is very close and IBs face the prospect of higher market risk RWAs under both the revised standardised approach (SA) and Internal Model Approach (IMA). All IBs will have to report SA capital calculations by January 2025 in the EU and July 2025 in the UK and the US.

Success in implementing FRTB SA will be based on having a scalable and robust calculation engine which supports increasingly granular regulatory reporting and the requirement for daily capital monitoring. Many banks continue to struggle with the availability and quality of sufficiently granular data and being able to calculate the SA daily. EU banks have a head start, needing to report FRTB SA as part of the Capital Requirements Regulation (CRR2), but their existing solution is unlikely to be sufficiently scalable to satisfy global FRTB reporting requirements.

IMA will take FRTB implementation a step further. IBs will need to apply for approval for individual desks resulting, on some estimates, in 20–50 times more data generated daily. The accuracy and timeliness of data and alignment between first line of defence and second line of defence will also be a challenge. To generate material benefits from IMA, IBs will need to optimise the number of risk factors they can model and identify non-modellable risk factors in a way which is quite different to how IBs currently manage their trading book risks.

Many IBs are still assessing the capital benefits of IMA, and some may conclude that they are outweighed by the cost of seeking and maintaining approval. However, before making the final decision, IBs must consider the possibility that even if they do not apply for IMA, supervisors may still require IMA-equivalent granularity of information, to satisfy their financial soundness and stability needs, with no resulting capital benefit for IBs. A supervisory ‘Catch 22’.

As a result, we expect supervisors to continue to use all the tools available to them in respect of IBs, with a particular focus on their CCR management practices. In October 2023, the ECB published the outcome of its review of sound practices in CCR governance and management³, specifically focusing on exposure to NBFIs. The PRA also identified shortcomings in CCR management process⁴, while the FCA found poor management of client relationships and inadequate knowledge of clients’ business profiles⁵.

Even though there are differences in the detail between the ECB, PRA and FCA they share common priorities that IBs need to be ready for in 2024. These include the need for:

• improved customer due diligence procedures;
• enhancements of stress testing frameworks to consider the impact of tail risks on counterparties and own balance sheet and to adapt quickly to rapidly changing risks; and
• consideration of material and complex CCR exposures in risk appetite statements.

Although supervisors’ focus will be on IBs’ financial resilience, they will also scrutinise their operational resilience, particularly that their operational processes are sufficiently robust and scalable to withstand extended periods of increased volatility.

In a period of ongoing macroeconomic uncertainty and market volatility, supervisors are increasingly concerned that new conflicts of interest may emerge, or firms may prioritise commercial interests over regulatory obligations, undermining controls' effectiveness. Supervisors might challenge IBs to demonstrate that their culture and controls remain sufficiently robust despite revenue headwinds. In particular, the FCA will focus on new conflicts arising from market environment changes. For example, when an IB develops new products that align with the UK Government’s agenda of increasing retail participation in capital markets but allows its pursuit of higher volumes and/or margins to override its obligations under the Consumer Duty (‘the Duty’).

In addition, we expect a focus on conduct and culture to continue to drive supervisory activity in some EU jurisdictions, particularly those where wholesale trading has increased as a result of IBs relocating activity following Brexit. IBs need to do more to ensure that they embed a conduct-focused culture effectively into their day-to-day operations. Supervisors will be scrutinising IBs’ ‘speak-up’ culture policies, in particular in areas of improper behaviour and non-financial misconduct.

IBs in the UK will, where relevant to their product set, be working towards compiling the evidence and engaging with the Board to deliver their first Duty compliance report before 31 July 2024. Although IBs may feel that they are not at the top of the FCA’s priority list for Duty compliance, the FCA requires all firms to put their customers’ needs first in particular if they have a direct relationship with retail clients or manufacture products that can ultimately reach retail clients. We expect the FCA to scrutinise and challenge IBs’ reports.

IBs should review their current data and MI on distribution and ultimate destination of their products to determine if they are sufficient to evidence compliance with the Duty and establish the right ‘tone from the top’ to foster an environment where staff are focused on delivering good consumer outcomes.

As visibility for some key capital markets regulations improves in 2024 and many regulatory initiatives enter the implementation stage, IBs will need to step up, once again, their regulatory change management programmes. IBs will have to implement the changes whilst keeping up with ongoing supervisory engagement in traditional areas such as risk management and newly emerging ones such as Consumer Duty.