In the years since the onset of the financial crisis, the role of several internal departments have come into the spotlight. Among these are those of compliance, enterprise risk management, and internal audit. This post will focus on the latter. Public interest in the role of internal audit increases and decreases with time. Naturally, it increases dramatically in times of crisis – whether it is the crisis of a single organization or a more widespread crisis across a system. Additionally, the spotlight’s focus on the internal audit role can shine on companies in all industries, not just the oft-discussed financial sector.

Internal audit is truly critical to the decision-making process in any organization. It is an activity that is an exercise in risk management and the provision of information and consulting. This exercise requires discipline to marry various skill sets – from investigation to organization to communication – to analyze and manage risks. It is very similar to some functions of compliance in this sense – there is a focus on appropriate processes and controls being in place to ensure that organizational objectives are being met. Additionally, internal audit plays an important role in understanding and monitoring internal fraud. For example, the Fraud Triangle is a framework that people in oversight roles should always be aware of given that there is no perfect system to deter irregular actions. This framework allows people in such roles to monitor for possible motivations for fraudulent activities – whether they be through opportunity, rationalization, or pressure – and to remove them in order to deter said activities. Internal audit is a key company safeguard in this sense.

Overall, an effective audit program, coupled with a compliance program, is crucial to the success of any business, small or large. Even if it is simply an informal activity for a small business or in a hybrid form in others, most businesses would be taking a material risk to go without some form of audit. What is important is that the audit should not merely have the goal of confirming the vision of senior executives. It is an investigation to test existing controls and to ensure that appropriate processes are in place.

It is important to note that, in spite of Canada coming out of the financial crisis relatively unscathed, the Canadian financial system is not completely infallible. It is for this very reason that Canadian regulators cannot lose sight of the pursuit of a safe and sound financial system and the steps that it takes to maintain one. The timely implementation of Basel III is one of the most crucial steps that need to be taken in order to ensure that Canadian financial institutions remain stable. Before delving into the reasons why it is important for Canada to implement Basel III sooner rather than later, this post will give a brief overview of Basel III.

What were the main objectives of the Basel Committee for Banking Supervision (BCBS) in formulating Basel III? Primarily, there was the goal of strengthening global financial regulations, particularly capital and liquidity regulations, in order to create a more resilient global financial system and banking sector. The secondary objective, which was not adequately addressed in previous accords, was to increase financial institutions’ ability to absorb shocks. Given these two main objectives, the Basel III proposals centre on capital reforms, liquidity standards, and other initiatives to improve the financial system’s resiliency.

Now, why would it be in Canada’s best interest to implement the Basel III requirements as soon as possible, rather than a gradual execution as other countries have settled on? Generally speaking, it is better and more prudent to take a proactive approach than a reactive approach. In fact, OSFI’s Superintendent recently reiterated this by saying that, “When in unchartered (sic) waters, you do not want to test whether the boat is sound enough.” Essentially, it is better to act in a preventative fashion rather than wait until turmoil is on the horizon. Another reason why it is important for Canada to implement the Basel III rules is simply to remain competitive and reduce the chances for regulatory arbitrage. A final point is for Canada to maintain its international reputation for vigilant supervision. The accolades that the country has seen, whether it is from top international central bankers or gatekeepers, are the result of strong monitoring and regulation of financial institutions. The only way to maintain this global standing as an example of strong regulation is to not slip into complacency with the status quo and only change when it is necessary.

As part of an ongoing series of posts on financial regulation, this post will focus on the subject of tax policy and regulation. Specifically, it will discuss the Foreign Account Tax Compliance Act (FATCA) of the United States. While this is an American law, its target is international and thus relevant for many multi-jurisdictional companies.

Before delving into the implications of FATCA, it is worth going over its background and the motivations behind its implementation. The act itself forms a part of the wider Hiring Incentives to Restore Employment Act (HIRE Act), which encourages businesses, through means such as the use of tax breaks, to hire unemployed workers and engage in job creation. FATCA is classified as an offset provision under Title V of the HIRE Act in order to recover the costs of the rest of its provisions.

But how does FATCA achieve this? It requires non-US financial institutions (i.e. foreign financial institutions, FFIs) to report the holdings of American taxpayers in order to combat tax evasion and avoidance. Failure to comply will result in material penalties. This is reinforced through the Internal Revenue Service’s (IRS) tax policies, which state that US taxpayers are required to report offshore financial activities. Before this, self-reporting was deemed to not be effective enough by the Government Accountability Office. The overall effect of FATCA will result in the generation of USD 800 million over the coming years.

The implications of the act has caused a number of criticisms from FFIs and individuals alike. What appears to be one of the primary points of contention is its role as an offset provision – that is, through the generation of the aforementioned millions of dollars, it burdens foreign institutions with the task of pseudo-tax collecting for the United States. For example, in 2011 it was reported that several large European banks were divesting themselves of American clients due to FATCA. The rationale for this sort of action is simply that the reporting requirements set out by the act have been widely deemed to be too expensive to integrate into compliance regimes.

The extraterritorial implications of FATCA, along with those that make FFIs tax collectors and enforcers, are just a few among the several controversies surrounding the act. However, regardless of controversial requirements, compliance must be achieved at the end of the day by FFIs. This includes meeting reporting and due diligence obligations placed onto these institutions. The best way to go about this is to initiate adequate procedures when establishing new relationships with customers for proper identification. Additionally, there is a very clear need to communicate to applicable clients about any of their obligations towards the IRS. Overall, companies should reinforce a culture of compliance rather than steer towards questionable areas of creative compliance or non-compliance. Using and building on existing systems and protocols is the first step towards meeting the obligations of FATCA.

References: Hiring Incentives to Restore Employment Act

Offshore Financial Activity Creates Enforcement Issues for IRS

Reaction to US Tax Law: European Banks Stop Serving American Customers

The video game industry is easily one of the fastest-growing and most profitable industries in the world. It represents so much of what developed nations strive to achieve with regards to the composition of their respective economies – it is a, for the most part, a very knowledge-based industry. The popularity of the video game itself has grown at an almost exponential rate since the latter half of the twentieth century. Naturally, a generation of Saturday morning video gamers has grown into a sprawling cohort of university-educated engineers, programmers, artists, and designers who are all keen to develop games to meet the demands of a twenty first century market. This article will briefly discuss the demands on today’s video game industry workers and how publishers have positively responded – by creating welcoming work environments that become small communities in themselves.

The demands on these employees are not light; there should be no false impression that video game development is a field without deadlines and stress. It is in fact, quite the opposite. They often work very long hours in a high stress environment. It is certainly not a field for everyone – the stresses of the job were famously described in the blog entry ‘EA: The Human Story.’ But for those who are truly passionate about their commitment to developing games, it can be a very rewarding and satisfying career path.

Video game developers have recognized that their industry is not for the faint of heart – it takes dedication and passion. As time goes on, these developers are increasingly choosing to create work environments that cater to the happiness and satisfaction of their most important resource – employees.

For example, some of the larger studios in the industry have chosen to locate their offices not in bustling financial districts or sprawling corporate parks, but rather trendy-yet-cozy neighbourhoods that are still within some of the world’s largest cities. Some go a step further and locate themselves in historical buildings with great architectural value; giving employees a work environment that has a story itself, just like the games they are creating.

Then, they can go one to provide a great deal of perks for employees to complete their responsibilities. More specifically, one of the largest developers paid for an employee’s boating and sailing lessons in order to ensure that an authentically rendered naval scene could be created out of it.

These are simply a few examples of the way an industry has responded to criticisms; however, the lessons that were taught are not constrained to the video game industry. Any business in any sector should know the value of their employees. Without people, a business would grind to a halt. It is necessary to take a step back and look at how you are treating your workers – is it fair? What can be done to improve their work environment for their benefit? At the end of the day, increased worker satisfaction will often inevitably lead to productivity, regardless of the industry.

Reference: EA: The Human Story

It seems that the economic turmoil that countries face across the globe is not going to be ceasing anytime soon; for example, it seems that Cyprus is the latest country to be faced with the prospect of bank bailouts. However, the financial crisis that has been churning through the world’s economies over the past several years has enabled onlookers to gain insights into how similar events can be mitigated in the future. One strategy that has been often discussed is that of the ‘living will.’

For example, two years ago, the U.S. Federal Deposit Insurance Corporation (FDIC) and the Federal Reserve Board (FRB) issued a joint rulemaking with regards to the need for systemically important financial institutions (SIFIs) to plan for resolution through the preparation of ’living wills.’ This obligation would see that certain companies, those with consolidated assets of $50 billion USD or more and other specifically designated companies deemed to be of systemic importance, not only create and submit resolution plans, or ‘living wills,’ but upkeep them. These plans would allow for companies to be resolved in an orderly fashion that aligns with applicable regulations.

Several companies have submitted their plans to American regulators and the expectation for them is to maintain and modify their plans as necessary. The overall goal of this maintenance requirement is that the plans will continue to be relevant and address important issues that might impact a firm’s ability to resolve in an orderly fashion. This is absolutely critical – if an organization is to fail, particularly a systemic one, it must be dismantled in such a way as to not negatively impact the overall financial system.

Overall, living wills have clear uses. For complex organizations, particularly SIFIs, they provide a plan for shutting down that would not have to rely on government bailouts and result in financial turmoil. Even for smaller companies, they can certainly be useful in the event that it needs to shut down; making the process much more orderly and mitigating unforeseen risks.

After much anticipation, the Department of Justice (DOJ) and the Securities and Exchange Commission (SEC) most recently issued their guidance on the application and enforcement of the Foreign Corrupt Practices Act (FCPA).

This emphasizes that enforcement is still of primary importance to the American economy and underlines different situations where the government may (or may not) exercise their enforcement powers into formal action.
The guidance is both informative in its outline of regulatory and legislative obligations and practical for firms looking to develop effective compliance programs. In particular, it provides useful information for companies looking to protect themselves through establishing effective compliance regimes, thereby mitigating their potential exposure to possible enforcement actions due to failed or inadequate compliance systems.

Some of the more salient points that the two bodies discussed regarding compliance programs are outlined below:
Primarily, the guidance provides reiteration of the standard for compliance programs – there is no cookie-cutter solution to every organization’s compliance concerns. A truly successful compliance program, whether it’s all-encompassing or for the FCPA alone, addresses very specific risks that will inevitably vary from organization to organization. These risks need to be assessed individually and have compliance controls and monitoring procedures based off of them. This forms the foundation for a risk-based compliance regime.

The guidance goes on to specify various strategies to form a risk-based compliance regime for the FCPA. For example, it emphasizes ample resource allocation to assess material contracts in particularly high-risk locations. This is particularly useful for those organizations that do not have many resources and would benefit from this sort of prioritization. Another strategy put forth in the guidance is that of making an example of those who have received disciplinary action. This would ideally work to illustrate to others the potential perils of misconduct and illicit behaviour.

Overall, these are just a few examples of the DOJ and SEC emphasizing that they do not take their FCPA enforcement abilities lightly. Most importantly, the guidance provides many useful compliance strategies and sheds further light on the regulatory approach that the American government is taking in light of both the current domestic and global economic situations.

References: A Resource Guide to the U.S. Foreign Corrupt Practices Act

This is an update on what will be coming from Banfield in the next few weeks: the FCPA in the United States recently had guidance notes released on it from two major regulators. Banfield will highlight the guidance and emphasize the role of enforcement in financial regulation. In addition to this, there will be more Regional Focus posts along with other posts relating to business strategy, financial regulation, and more!

In their paper, Inside Debt, Bank Default Risk and Performance during the Crisis, Bennett, Guntay, and Unal explore the impact that the structure of executives’ compensation packages, particularly those of chief executive officers, can have on the default risk and the performance of financial institutions during financial crises. Specifically, they focus on bank holding companies during the recent global financial crisis and the use of inside debt and inside equity as compensation.

This is a particularly interesting study, especially in light of recent financial turmoil. Since the onset of the crisis, executive compensation via incentive-based remuneration has come under close scrutiny. An example of this increased focus is demonstrated through the fact that the recent Dodd-Frank Act acknowledges that incentive-based compensation has a correlation to lower levels of risk aversion. Bennett et al. choose to explore inside debt (such as pension benefits) as a form of compensation as opposed to inside equity (such as stock options), which has already garnered much attention. One of their primary findings from exploring the use of inside debt is that bank holding companies that chose to compensate using more inside debt than inside equity weathered the crisis better than those that did not. This indicates that using inside debt can aid in the mitigation of a bank holding company’s default risk. A final significant finding to take away from this study is that it is important to consider various forms of employee compensation and that it can be beneficial to align the interests of executives with those of debt holders, not just shareholders.

The “Occupy” movement has truly spread around the world since it began on Wall Street last month. This post is coming to you from London where, not but two tube stops away, Occupy London is currently taking place.

But, what’s the whole point? The underlying theme of the global protests seems to be the role of the financial sector and markets in the financial crisis that still prevails today. One can certainly see the emphasis on the necessity for appropriate financial regulation. It can be seen over the past few years how many of the world’s leaders in finance have backtracked on their previous views of regulation. It is no longer seen as the bureaucratic stereotype of the past, but as a necessary tool for the prevention of future global crises. Just yesterday, it was announced that Europe will see a “…sweeping set of financial-regulation reforms that seek to rein in derivatives trading and increase oversight of high-frequency strategies” (See: “EU Plans Overhaul of Financial Rules“). Whether or not the majority of protesters are aware of it, the riskiness of derivatives and other financial instruments played a large role in the financial crisis. While regulation must constantly be adjusted in order to remain appropriate and relevant, it is good to see, after so much back and forth, changes finally being made.