The wide range of changes address some of the lessons learned from the financial crisis

The Financial Services Authority (FSA) has today issued proposals aimed at ensuring the financial soundness of firms by strengthening the prudential regime.

The consultation paper sets out the FSA’s proposals for implementing changes that are required following amendments to the EU Capital Requirements Directive.

The wide range of changes address some of the lessons learned from the financial crisis and follows up on aspects of the Turner Review.

The proposals include:

• Improving the quality of firms’ capital by establishing clear EU-wide criteria for assessing the eligibility of hybrid capital to be counted as part of a firm’s overall capital. The proposals specify the features that hybrid capital must have regarding permanence, flexibility of payments and loss absorbency to be eligible as tier one capital;

• Strengthening the capital requirements for the trading book to ensure that a firm’s assessment of the risks connected with its trading book better reflects the potential losses from adverse market movements in stressed conditions;

• Enhancing the management of large exposures by restricting a firm’s lending beyond a certain limit to any one party;

• Improving the risk management of securitisation, including a requirement to ensure that a firm does not invest in a securitisation unless the originator retains an economic interest; so called ‘skin in the game’;

• Imposing higher capital requirements for re-securitisations to make sure that firms take proper account of the risks of investing in such complex financial products; and

• Upgrading disclosure standards to increase market confidence.

The consultation period closes on 10 March 2010. The FSA plans to issue feedback to this consultation together with a policy statement confirming the final rules later on in 2010.