The Internal Audit Function in Banks – How to become a BIS compliant auditor

I am searching today for an internal auditor.... not any internal auditor, but a BIS compliant auditor:

Leading European Universal Bank seeks high caliber internal auditor with sufficient authority, stature, and independence

The Position

Matters of regulatory interest don't petrify you? Independence and objectivity are the anchors of your professional life? You are free from conditions that threaten your ability to carry out your internal audit responsibilities in an unbiased manner? You believe in your work product and make no quality compromises? Then we have the right position for you.

As an internal auditor in our firm, your main task is to help reducing the risk of loss and reputational damage to our bank. Your team will guarantee the quality and effectiveness of our bank's internal control, risk management and governance systems processes.

The position is with our permanent internal audit function and is part of our sound corporate governance scheme. You will report to the head of our audit committee, in charge of overseeing our bank's internal audit function.

Your Responsibilities

Your day-to-day activities will consist of

• ensuring compliance of our business lines with laws and regulations, our sound internal auditing standards, and our code of ethics;
• guaranteeing the effectiveness and efficiency of the internal control, risk management, and governance systems and processes, created by our business units and support functions;
• regularly communicating with supervisors of our internal audit function to identify risk areas, understand risk mitigation measures, and understand and respond to weaknesses;
• evaluating the reliability, effectiveness, and integrity of our management information systems and processes;
• safeguarding our assets;
• supporting our head of internal audit at parent company level in defining the group and holding company’s internal audit strategy, determining the organization of the internal audit function both at parent and subsidiary bank levels, and formulating internal audit principles.

For this purpose, you will be granted access to all bank records and data and will be asked to form an independent and informed view of the risks faced by our bank.

By all means, you will only advise on internal control measures. Designing, selecting, implementing, or operating these measures will be carried out by our senior management.

We know that performing similar tasks and routine jobs may negatively affect your capacity for critical judgment and, ultimately, lead to you loosing objectivity. This is why you will periodically rotate within your function. To preserve your independence, “cooling-off” periods are to be respected if you change function in our group.

Your Qualifications

To join us, you must be a person of integrity, independent of our audited activities, and develop sufficient standing and authority within our bank. We take for granted, that you observe the law and have not been party to any illegal activity. As integrity is key for this position, we will ask you to be straightforward, honest, and truthful.

Additional qualifications include

• observant use of confidential information;
• evaluation of both current and potential future risks;
• willingness and capacity to defend and assume responsibility for your own judgments and assessments;
• ability to collect and understand information, to examine and evaluate audit evidence, and to communicate with stakeholders in our bank;
• practice of care and skills expected of a reasonably prudent and competent professional;
• ability to discuss, your views, findings, and conclusions directly with the audit committee and the board of directors;
• ,as our audit function covers every activity (including outsourced activities) and every entity of our bank, disposal of a high level of intellectual flexibility and ability adapt quickly;
• honesty, diligence, and responsibility.

After a short learning curve, we expect you to be able to judge outcomes and make an impact at the highest level of our organization.

Please note that we will only consider applications from knowledgeable and experienced auditors.

What we offer

We are searching to recruit a high potential candidate and offer him a fast-track career in our company. From day one on, you will be granted access to the board of directors, that is ultimately responsible for the internal audit function.

We guarantee job security, as our internal audit function should normally be conducted by our bank’s own internal audit staff. Even if we should, for specific purposes, outsource internal audit activities in the future, your skills will still be needed in our firm, as our board of directors will always remain ultimately responsible for these activities and for maintaining an internal audit function within our bank.

Your compensation package will be excellent and, in addition, decoupled from the financial performance of your audited business lines.

Your career in our firm will be guided by annual performance reviews. In addition, you will receive feedback from our board of directors that should review the effectiveness and efficiency of the internal control system and the performance of the internal audit function at least once a year.

We have flat hierarchies and ensure an organizational structure that clearly assigns responsibility, authority, and reporting relationships and ensures that delegated responsibilities are effectively carried out.

Resource:

Please don’t compliment me for this post. The language comes, in great part, from BIS’ June 2012 report on the internal audit function in banks.

 http://www.bis.org/publ/bcbs223.htm

Germany's Berenberg Bank – A Report on the 422nd Financial Year

Germany's Berenberg Bank has received good press over the last months. For example, the FT wrote about Berenberg's involvement in Talanx' recent IPO:

“Apart from being Germany’s oldest bank, Berenberg is also a rapidly growing force in equity capital markets, thanks in large part to the relations it has fostered over the years between its traditional client base of wealthy Germans and the world’s biggest fund managers. That success, in turn, stems from its manageable size and its partnership structure – a natural brake on risk and a natural motivator for focusing on clients.”

The bank has been founded in 1590 and is headquartered in Hamburg. Today, Berenberg's staff amounts to 1,100; the bank has 9 offices in Germany and 9 offices abroad. However, in terms of revenues, it is still very much focused on Germany: 80 % of its revenue is generated in Germany, whereas only 20 % is generated abroad.

Heritage

After a glimpse at the cover of its 2011 annual report, you will immediately understand what this bank is proud of:

http://www.berenberg.de/en/82.html

The “report on the 422^nd financial year” describes it more specifically:

• “Today, we are simultaneously the second oldest bank in the world, and one of the most dynamic in Europe.”
• “Our bank is characterized by a high level of continuity. We are proud of our corporate culture, which has matured over centuries, and proud of our many long-standing client relationships and the average length of service of our staff.”
• “[The core capital ratio of 14.1 %] is an expression and evidence of our conservative business policy.”

The bank is privately held by the Berenberg family (> 25 %), Managing Partners (> 25 %), Christian Erbprinz zu Fürstenberg (15 %), Jan-Philipp Reemtsma (15 %), and Compagnie du Bois Sauvage S.A. (12 %). According to the bank, this ownership structure guarantees a special kind of independence of its employees who are free of corporate interests.

Financial Performance

Looking at the financial information, we can see that Berenberg has not only performed strongly during the financial crisis but also has a very solid business performance:

 

Business Divisions

Private Banking

Private Banking serves wealthy private investors and families in protecting and multiplying their wealth. Asset structuring is carried out on a quantitative and qualitative basis. Berenberg puts a special emphasis on art: In 2011, it has set up a subsidiary called Berenberg Art Advice, which answers questions about art as an investment class and advises clients namely on transactions and collection management.

Investment Banking

This business division is organized in three segments, e.g. equities, financial markets, and strategic advisory. The equities segment does equity research (400 European companies in 24 sectors), equity sales and execution, and advisory on equity issues and IPOs. The financial markets segment does fixed income research as well as fixed income and currency trading. Finally, strategic advisory focuses on transaction advisory and corporate broking services.

Asset Management

This business division concentrates on quantitative investment strategies. Clients are of institutional nature and include insurers, pension funds, banks, and foundations.

Corporate Banking

Corporate Banking advises small and middle sized companies on the selection and implementation of optimum funding structures, with a special focus on the shipping industry.

A general principle that applies to the whole bank, is particularly true for the corporate banking division: As a matter of fact, Berenberg does not want to offer every single service possible. To the contrary, it targets niche markets and tries to develop specialist know-how in those areas. Examples include the shipping and real estate sectors.

Comment

Compared to annual reports of universal banks, it is almost a pleasure to read Berenberg's annual report. The bank's business model and big picture are easily understandable. In my view, this straightforwardness is a good concept in today's banking world, where banks are often blamed for being over-complicated and carrying systemic importance.

However, while reading about Berenberg, you get sometimes the impression that it is not really a “bank” as most ordinary persons would understand the expression. For example, Berenberg's corporate banking division only seems to have a “support function” in order to generate business opportunities for the other divisions of the bank. Consequently, Berenberg is more an advisory firm that provides comprehensive financial consulting and corporate services than a traditional bank. From this perspective, it is right that Berenberg is at the same time a very traditional and progressive financial institution.

Resources:

• Berenberg Bank Annual Report 2011
• “Talanx offers lesson on big bank failings” - Financial Times October 22, 2012

ESMA's Draft EMIR Technical Standards – As easy as baking a chocolate cake?

Let's assume you want to make a chocolate cake. You will need to accomplish three steps: First, you take basic ingredients such as eggs, flour, and sugar and mix them up. Second, you add chocolate and mix the dough again. Finally, you bake your cake for some time.

The process of understanding the current status of Europe's EMIR legislation is essentially the same:

• First, you read the EU regulation 648/2012 dated July 4, 2012 – Please skip the first 13 pages and go directly to the actual regulation on page 14. As a matter of choice, you might also skip the regulation altogether and read my post of September 30, 2012.
• Second, you read ESMA's draft regulatory standards issued on September 27, 2012 – Once more, just read annexes II – VII and skip the first 69 pages. If you absolutely want to avoid reading any of ESMA's proposals, just keep on reading this post.
• Finally, you will probably have to spent some time thinking about what you will have read about EMIR. The topic is actually a bit complex and, obviously, not everything will be relevant for your specific purpose.

In its draft regulatory standards, ESMA intensifies the already applicable EMIR regulation 648/2012 in three principal areas:

• Clearing obligation (Annex II of ESMA's final report);
• Central counterparties (Annex III – V of ESMA's final report);
• Trade repositories (Annex VI – VI of ESMA's final report).

Clearing Obligation

Indirect Clearing

ESMA's proposal clarifies the notion of “indirect clearing”. This notion refers to the practice of clearing services offered by a client of a CCP to a third party. As a reminder, EMIR allows for indirect clearing if counterparty risk is mastered and assets and positions of the counterparty are protected.

The draft technical standards now specify that a clearing member shall provide indirect clearing services only to credit institutions and investment firms. In addition, the contractual tripartite documentation must include client's obligation to honor the obligations of the indirect client; it must also be sufficiently accessible to any potential client. Finally, clients' and indirect clients' records and accounts held with the CCP must be separated and their assets and positions be fairly liquid.

Notification of authorized CCP

This notification will detail the type of OTC derivative contracts to be cleared by the CCP as well as phasing-in conditions. Besides, it will give some information about the transaction volume and the degree of standardization of the derivative.

Public Register of Classified OTC Derivatives

The public register that identifies derivatives to be cleared via CCP will include detailed information on

• asset class,
• type of derivative,
• underlying,
• notional and settlement currency,
• maturity, and
• settlement conditions.

Liquidity Fragmentation

I always wonder why regulators must constantly come up with ever more definitions and technical terms. Liquidity fragmentation is an example for this practice. The notion simply means that two parties would like to trade a derivative that is cleared by more than one CCP. In this case, either both parties have to adhere to the same CCP or they adhere to different CCPs which have put in place a clearing arrangement among them. Is it really necessary to regulate this?

Non-financial counterparties

Non-financial counterparties must only clear OTC derivatives via CCP if they exceed the following clearing thresholds:

As already provided for in the EMIR regulation, risk reducing derivatives shall not be taken into account for calculating the above clearing thresholds. As ESMA's new proposal now specifies, risk reducing means

• either covering any direct loss in the value of an asset
• or covering any indirect loss in the value of an asset, due to interest rate, foreign exchange rate, or credit risk fluctuation,
• or qualifying as a hedge under IFRS.

Risk mitigation techniques for OTC derivatives not cleared via CCP

ESMA's proposal adds some details to obligations already set out by the EMIR regulation:

• Timely confirmation means, as regards credit default swaps and interest rate swaps, two business days until February 28, 2014 and one business day thereafter. Other derivative transactions must be confirmed within three business days until August 31, 2013, within two business days until August 31, 2014, and within one business day thereafter.

• Portfolio reconciliation, carried out either by the counterparties themselves or by a qualified third party mandated to this effect, shall be obligatory in the following situations:

• Portfolio compression shall be operated at least twice a year if more than 500 derivative contracts are outstanding among the parties.

• The participants must put in place a dispute resolution mechanism for collateral recognition and valuation. In addition, disputes over 15 MEUR, outstanding for at least 15 business days, shall be reported to local authorities.

• Compared to the EMIR regulation, ESMA further explicates the marking-to-model valuation. However, the relevant criteria (consistence with economic methodologies, independent monitoring, etc.) still remain imprecise. This seems normal as it would be somewhat burdensome to elaborate the model itself in a EU regulation.

• ESMA reveals details on the exemption of intragroup transactions from CCP clearing.

Central Counterparties and Trade Repositories

The ESMA regulations applicable for central counterparties and trade repositories are very detailed. Their presentation would not only exceed the limits of this post (and my time available for writing it) but, I guess, also your tolerance as a reader.

Resources:

• ESMA Final Report – Draft Technical Standards under EU Regulation No. 648/2012.

http://www.esma.europa.eu/content/Draft-Technical-Standards-Regulation-OTC-Derivatives-CCPs-and-Trade-Repositories

• EU Regulation 648/2012 dated 4 July 2012

Clearing Derivatives in the post EMIR Era – “Driving in Safeland will become complicated!”

Assume you are living in Safeland. Safeland is a developed country. Today, it has one major problem: Out of 100,000 inhabitants, 40 people die, on a yearly average, in car accidents (Systemic Risk). This rate compares to 2009 figures of countries like Afghanistan, Egypt, and Eritrea.

Safeland's government (G 20, European Union, ESMA, and Bank for International Settlements) decide to limit the danger inherent in driving a car (Derivative) in Safeland.

To win the battle, the government suggests drastic measures:

• Professional drivers (Financial Counterparties) are no more allowed to drive their own car. Instead, every time they would like to drive, they must lend their car at a national agency (Central Counterparty – CCP). This agency will only borrow you a car if you deposit some guarantee for lending it (Collateral). In addition, you cannot drive as long as you want and where you want. Predefined arrangements are offered which specify the lending conditions (ESMA Classified Derivative).
• Non-professional drivers (Non-Financial Counterparties) participate much less in Safeland's car traffic. They are, therefore, considered less dangerous (systemic) and can still buy and drive their own car. Obviously, the government intends to further specify what a non-professional driver is. The idea is to monitor closely the distance that each individual is driving over specified time periods (Clearing Threshold). However, non-professional drivers must deposit, in addition to the selling price, a guarantee (Collateral) with their car vendor (OTC Counterparty). What's more, non-professional drivers are not only obliged to prepare properly for each trip (Risk Management Techniques) but also to pass regular health checks and to adapt their initial guarantee deposit if necessary (Mark to market / Mark to model). Finally, they will have to fill out surveys on a monthly basis and report any anomaly they have encountered during a trip (Reporting Obligation to the Competent Authority).

As you can imagine, Safeland's professional drivers are not happy. They argue that the proposal is improper. After all, they are professionals and know how to drive cars. “This makes sense.” says Safeland's prime minister on national television and grants several concessions:

• First, if a car can only speed up to 50 km/h (Structured Derivative Transaction / Not ESMA Classified Derivative), even professional drivers can still own it by themselves.
• Second, drivers employed by Safeland's government and other public entities are not subject to limitations. Obviously, the state of Safeland is expected to have enough cash to fix a problem, if any.
• Finally, on private roads, professional drivers can do whatever they like (Intragroup Transactions).

“What about Safeland's tourists?” – asks Peter, a lobbyist for Safeland's tourist industry, who doesn't want his name to appear on this blog – “Can they still visit our beautiful country, bringing their own car?” The short answer of Safeland's government is “No, they will be treated as if they were Safeland citizens.”

Let me finish with a final notice to any Safeland citizens who already own a car today: Don't worry, you can keep it in the future. Hopefully, you have recently bought a new car....