If crisis breeds new opportunity, the future of in-house lawyers at banks and other financial services institutions appears to be bright following all of the regulatory activity to come out of the global financial meltdown five years ago.
The roles, responsibilities, and reputations of Canadian lawyers, as well as the people trained as lawyers in corporate compliance and risk management departments across the country, have increased in the aftermath of the global credit crisis, observes Jeffrey Graham, a partner practising in the Toronto office of Borden Ladner Gervais LLP.
“The recognition of the important role lawyers play in terms of supporting their institutions, in my view, has increased,” Graham says. “It would be an exciting
opportunity to be working inside these financial institutions that are faced with the need to develop and implement this changing regulatory environment.
Lawyers should feel good about their roles inside these institutions.”
The basics of Basel III
One area lawyers have been engaged in of late is Basel III — part of a larger global framework developed since the late 1980s around capital adequacy. Discussions among central bankers from around the world led to Basel I, which established minimum requirements for capital in 1988. Basel II, initially published in 2004, included a series of recommendations on banking laws and regulations.
The bulk of the changes in Basel III, including new rules around liquidity and systemic risk, are a product of the Basel Committee on Banking Supervision.
Under the direction of the G20, the Financial Stability Board sets policy direction and the Basel Committee turns that direction into regulation.
“Basel III is mostly about improving the quantity and quality of capital,” says Peter Hamilton, a partner in the Toronto office of Stikeman Elliott LLP. “A lot of the deep thinking around how you deal with particular assets and so on was done in Basel II and Basel 2.5. Basel III is 80 per cent about saying, ‘We’ve counted our fingers.
We’ve counted our toes, and this is what our suggested assets are.’”
Basel III has increased the amount of capital Canadian banks have to hold by 2019, says Marion Wrobel, vice president of policy and operations at the Canadian Bankers Association.
Banks will be required to hold 10.5 per cent total capital. And to enhance its quality, seven per cent out of that total 10.5 per cent has to be capital called Common Equity — Tier I. “That is the strongest form of capital,” says Wrobel. “For example, that would be retained earnings. That would be when you issue equity shares. That level of common equity is much higher than it was in the past.”
The Basel framework also introduced a new liquidity standard called a Liquidity Coverage Ratio, which measures an institution’s ability to access cash in times of stress.
The LCR is a test to ensure an organization can manage some degree of stress over a 30-day period, or a one-year period. Basel III relaxed some of its previous
limitations about what assets might be considered “liquid,” as Goodman’s LLP noted in a recent firm update.
Tangled webs we weave
Lawyers observe a host of other regulations around disclosure requirements and corporate governance have been introduced that are not part of the Basel framework.
Considering all of these new initiatives as a whole, Wrobel describes a “tsunami of regulation” arising out of regulators’ concerns about the stability of the global financial system.
The cost of compliance is not cheap. For example, Wrobel estimates individual Canadian banks will have to spend $100 million each to comply with the U.S. government’s introduction of the Foreign Account Tax Compliance Act, which focuses on reporting requirements by foreign financial institutions. FATCA is not even part of Basel III.
Some say it’s not really the quantity of new regulations that presents compliance challenges for in-house lawyers; rather, it’s the complexity involved in implementing them. Take, for example, the Basel III proposal to establish a central clearing of over-the-counter derivatives, which are traded through a dealer network instead of a centralized exchange.
“Commercial law issues around making that work are pretty significant, especially when you are looking at a cross-border scenario,” says Hamilton. “People are burning a lot more neurons thinking about not just the 10,000-foot view as to how that is supposed to work, but the down-in-the-weeds view of how these things are supposed to work. It’s actually trying to understand how you reduce nice, highly stated principles into a practise that you have a pretty high level of confidence will actually work under stress.”
These deliberations only serve to illustrate how various jurisdictions are taking different approaches to Basel III compliance. “There’s been a fragmentation of approach, particularly by the Americans and the Europeans,” says Graham. “Because they have all faced extraordinary shocks to their system, the regulators in each of those jurisdictions have each been subject to intense scrutiny and criticism. They have all pulled their horns in and started to develop their own domestic solutions.”
That makes it tricky for Canadian financial firms to accommodate the various approaches. What’s more, some countries are closer to meeting the 2019 Basel III capital targets than others.
“We are compliant with the rules as they will be in 2019, so we’re already compliant with the ultimate goal,” Wrobel says of Canada’s banks. “We’ve reached the goal line. Others are still at the 40-yard line.”
But being fully compliant with Basel III’s enhanced standards earlier than others may mean Canadian banks are carrying additional capital costs than their international banking competitors. This could adversely affect a Canadian bank’s bottom line, thereby creating a competitive imbalance between Canadian and
international banks. Some say this is more of a business issue than a legal issue, but it has been pointed out that global systemic imbalance is exactly what the Basel regulatory framework intends to avoid.
All of these discussions surrounding Basel III show the importance of lawyers in interpreting the new rules.
“Good regulatory practice very much involves talking to the regulators, and talking to the people who are actually responsible for either the drafting or the interpretation of the rules — particularly in the capital area,” says Graham. “There is a very close partnership between the people who are giving [legal] advice and the [regulators] who have given the guidance to be sure that the rules are interpreted in a manner that is consistent with the intention of the regulators.”