Is Keystone Doomed To Be a Historical Footnote?

Is Keystone Doomed To Be a Historical Footnote?

By Ben Winkley Wall Street Journal

WHO NEEDS KEYSTONE, ANYWAY?

As 2013 rolls on from summer into fall there is still no end in sight to one of the great energy impasses of the year—will the Keystone XL pipeline ever be approved, or is it fated to become a historical footnote?

The pipe, in case you have forgotten, is planned to allow 830,000 barrels a day of heavy crude to move from Canada’s oil sands development all the way to refineries on America’s Gulf Coast.

Keystone needs approval from the State Department because it crosses the Canadian-U.S. border. The debate on whether it is a good idea or not has seemingly been endless and a decision may not now be made until 2014.

U.S. refiners increasingly doubt that Keystone will ever be built, The Wall Street Journal’s Ben Lefebvre reports. Only now, thanks to the expansion of other pipelines, the record amount of oil being produced in the U.S. and the rapid expansion of crude-by-rail, they don’t particularly care.

Which is all well and good for American refiners—and probably for these seven adorable species threatened by Keystone—but potentially ruinous for Canadian drillers.

Extracting Canada’s huge deposits of oil sands in the next few years might not be economically viable without Keystone XL. Oil-sands production capacity is predicted to more than double by 2030, to more than 5 million barrels a day—if Keystone doesn’t happen, output could exceed shipping capacity as soon as 2016.

This will mean that Canadian heavy crude will continue to trade at a steep discount to other grades of oil for the next few years, which could weigh on the economics of developing the oil sands.

So Canada hopes to build some pipes of its own—one all the way from Alberta to the Atlantic coast, and one to the Pacific. The former faces the challenge of scale; the latter of local opposition.

If Canada gets one or both of these off the ground, however, it could mean that Keystone turns out to be a lot of fuss over nothing. A lifeline could be thrown its way, though. The U.S. Federal Railroad Administration has begun an investigation into the business of moving hazardous materials—read: crude oil—on the tracks in light of the fatal accident in Quebec earlier in the year.

Any new safety measures or restrictions (say, on moving crude through residential areas) could increase the cost of moving oil-by-rail, and make that pipeline look a more attractive option once more.

INDIA BETWEEN A ROCK AND A HARD PLACE

India is considering a plan to reduce its ballooning current-account deficit that includes holding its oil imports from Iran steady, potentially putting the country in jeopardy of losing an exemption from U.S. sanctions against countries that do business with Iran.

The subcontinent is stuck between a rock and a hard place. Its currency, the rupee, has recently hit record lows against the U.S. dollar, making crude-oil imports much more expensive.

India imports more than three-quarters of the crude oil it requires, and the depreciating local currency would make those imports more expensive in rupee terms and add to the costs of government fuel subsidies.

India is turning to the Middle East, looking for deals. Oil exporters are eager to boost supplies to India to compensate for shrinking U.S. demand.

India and Iraq are working toward a 10-year oil-supply deal and the former may offer a stake in state-run India Oil Corp.’s planned refinery in the east of the country, the Journal’s Saurabh Chaturvedi and Biman Mukherji report.

Dealing with Iran will prove more contentious. India buys oil from the Islamic Republic by depositing rupees into a bank account, and then Iran imports Indian goods, potentially including food, drugs, consumer products and auto parts, debiting rupee amounts from the same account.

A bizarre ongoing dispute over an Indian oil tanker that was detained by Iran’s navy threatens to stall negotiations, but India may feel its need for fuel is greater than America’s need to squeeze Iran.

Deloitte survey: Financial institutions increasing focus on risk management

Thursday 22, August 2013 by Robin Amlôt

Deloitte survey: Financial institutions increasing focus on risk management

 

Heightened regulatory scrutiny and greater concerns over risk governance have led financial institutions to elevate their focus and attention on risk management, a new global survey from Deloitte finds. In response, banks and other financial services firms are increasing their risk management budgets and enhancing their governance programs.

 

According to Deloitte’s eighth biennial survey on risk management practices, titled “Setting a Higher Bar,” about two-thirds of financial institutions (65 per cent) reported an increase in spending on risk management and compliance, up from 55 per cent in 2010.

 

A closer look at the numbers finds, though, that there is a divergence when it comes to the spending patterns of different-sized firms. The largest and the most systemically important firms have had several years of regulatory scrutiny and have continued their focus on distinct areas like risk governance, risk reporting, capital adequacy and liquidity. In contrast, firms with assets of less than $10 billion are now concentrating on building capabilities to address a number of new regulatory requirements, which were applied first to the largest institutions and are now cascading further down the ladder.

 

“The financial crisis has led to far-reaching major changes of doing business in financial institutions’ risk management practices, with stricter and ruled based regulatory requirements demanding more attention from management and increasing their overall risk management and compliance efforts,” said Joe El Fadl, Financial Services Industry Leader at Deloitte Middle East. “That said, risk management shouldn’t be viewed as either a regulatory burden or a report destined to gather dust on a shelf. Instead, it should be embedded in an institution’s framework, philosophy and culture for managing risk exposures across the organisation.

“Knowing that a number of regulatory requirements remain in the queue, financial institutions have to be able to plan for future hurdles while enhancing their risk governance, enhancing management capabilities with better risk awareness using data analytics, and improving in data quality,” added El Fadl. “Those that do will be well placed to steer a steady course though the ever-shifting risk management landscape.”

The majority of the institutions participating in the survey (58 per cent) plan to increase their risk management budgets over the next three years, with 17 per cent anticipating annual increases of 25 per cent or more. This is not a trivial matter as 39 per cent of large institutions – particularly those based in North America – reported having more than 250 full-time employees in their risk management function.

 

Risk management moves up the boardroom agenda

Alongside increased spending, risk management has also significantly risen up the agenda in the boardroom. According to the survey’s results, 94 per cent of company boards now devote more time to risk management oversight than five years ago, and 80 per cent of chief risk officers report directly to either the board or the chief executive officer (CEO). Additionally, 98 per cent of company boards or board-level risk committees regularly review risk management reports, an increase from 85 per cent in 2010.

 

“Regulators have been focusing more and more on the role of the board of directors in risk governance, engaging them to approve the institution’s risk appetite and risk policies, overseeing their implementation by management and increasingly looking to understand the challenge that the board makes in its oversight of the financial institution’s risk management of key issues,” said Fadi Sidani, partner in charge, Enterprise Risk Services at Deloitte Middle East.

Other major findings in the survey include:

Almost three out of four risk managers rated their institution to be either extremely or very effective in risk management overall, an increase from 66 percent in 2010’s survey results.

 

The impact of increased regulation is having a significant effect on business strategy and the bottom line, with 48 percent of firms confirming that they have had to adjust product lines and/or business activities, a percentage that doubled from 24 percent in 2010.

The use of institution-wide enterprise risk management (ERM) programs is continuing to grow. Today, 62 percent of financial institutions have an ERM strategy in place, up from 52 percent in 2010, while a further 21 percent are currently building a program. The total of 82 percent of firms either with or building an ERM program is significantly up from 59 percent in 2008.

 

Institutions are increasingly confident about their effectiveness in managing liquidity risk (85 percent rate themselves as extremely or very effective vs. 77 percent in 2010); credit risk (83 percent against 71 percent in 2010); and country/sovereign risk (78 percent vs. 54 percent in 2010).

 

Stress testing has become a central plank in many institutions’ risk management efforts. Eighty percent of the institutions surveyed stated that stress-testing enables a forward-looking assessment of risk, and 70 percent said that it informs the setting of their risk tolerances.

Technology used to monitor and manage risk is a particular concern and, according to the report, significant improvements in risk technology are needed. Less than 25 percent of institutions rate their technology systems as extremely or very effective while 40 percent of institutions are concerned about their capabilities in the management of risk data.

 

Progress in linking risk management with compensation has changed only incrementally since 2010’s survey results. Currently, 55 percent of institutions incorporate risk management into performance goals and compensation for senior management, which is little changed from 2010. The use of “clawback” provisions in executive compensation, however, has increased (41 percent vs. 26 percent of institutions in 2010).

 

“Financial institutions are becoming increasingly confident in their risk management abilities, but they also recognize where there are gaps,” said Sidani. “Where concerns linger particularly is around operational risk, with a number of recent headlines – like management breakdowns and large-scale cyber-attacks – underscoring the important impacts this area can have on an institution’s reputation. This is a gap that may trigger significant operational risk combined with reputational risk that needs to be properly addressed.”

According to the report, operational risk, which is a key component of Basel II, has been a continuing challenge for institutions. The lack of ability to measure operational risk and the complexity of many operational processes are key causes of this. Only 45 per cent of firms rated themselves as extremely or very effective in this area, down slightly from 2010.

 

Deloitte’s survey assesses the risk management programs, planned improvements, and continuing challenges among global financial institutions. The eighth edition surveyed chief risk officers – or their equivalent – at 86 financial institutions, and represents a range of financial services sectors, including banks, insurers, and asset managers, with aggregate assets of more than $18 trillion. The survey was conducted from September to December 2012.

 

The report may be viewed at http://www.deloitte.com/us/globalrisksurvey

 

Banks Replacing Enron in Energy Incite Congress as Abuses Abound

 

Banks Replacing Enron in Energy Incite Congress as Abuses Abound

 

The U.S. government permitted Wall Street firms to expand in the energy industry a decade ago, when the collapse of Enron Corp. and its army of traders left a void in the market. The results aren’t pretty.

 

JPMorgan Chase & Co. (JPM) settled Federal Energy Regulatory Commission claims this week that employees engaged in 12 bidding schemes to wrest tens of millions of dollars from power-grid operators. A Barclays Plc (BARC) trader stands accused of bragging he “totally fukked” with a Southwest energy market. Deutsche Bank AG workers, faced with losses on a contract, allegedly altered electricity flows to make it profitable instead.

 

The FERC’s investigations are fueling a debate among lawmakers and the Federal Reserve over whether to reverse more than a decade of policy decisions that let Wall Street banks keep or build units handling commodities and energy. Senators examining the firms’ roles have said they may call bankers and watchdogs to a September hearing amid concern traders are abusing their ability to buy and sell physical products while betting on related financial instruments.

Banks have been seen as “sources of capital investment and market liquidity,” said Marc Spitzer, a partner at law firm Steptoe & Johnson LLP in Washington and a former FERC commissioner. “But the tradition and culture of large banks is different than the conservative and risk-averse culture of regulated utilities.”

 

Rolling Blackouts

 

JPMorgan, the largest U.S. lender, announced last week that it’s considering ways to exit the physical commodities business, which includes energy trading. The New York-based company, led by Chief Executive Officer Jamie Dimon, 57, will pay a $285 million fine and disgorge $125 million in gains to settle the FERC’s case without admitting or denying wrongdoing.

 

“We’re pleased to have this matter behind us,” Brian Marchiony, a spokesman for the firm, said as the accord was announced.

 

“It is up to Congress, and not FERC, to decide if banks should continue to be allowed to participate,” FERC Chairman Jon Wellinghoff said in an e-mailed statement. “We welcome anybody in the markets who wants to play in those markets fairly, whether it be banks, traditional utilities or other traders. We just want to make sure that they play by the rules.”

 

Details of Enron’s market abuses surfaced in the years after the world’s biggest power trader collapsed in an accounting fraud in 2001. The company, whose actions led to rolling blackouts in California, eventually reached a $1.5 billion settlement with state authorities, while employees pleaded guilty to criminal charges.

 

Enron’s Void

 

To prevent future misconduct, a congressional overhaul of U.S. energy policies gave the FERC additional enforcement powers in 2005, setting the stage for the current jump in cases.

 

Enron’s fall left a hole in the market. Utilities and companies needed more stable and dependable power brokers for their transactions. Banks, with relatively strong balance sheets and credit ratings, were among companies that saw an opportunity. Congress already had loosened energy-market restrictions in the 1990s, as well as a ban on banks’ involvement in commercial businesses in 1999. Regulators let firms proceed.

 

UBS AG (UBSN), Switzerland’s largest lender, bought Enron’s energy-trading business in 2002, later shrinking the unit. That same year, Bank of America Corp. also won the FERC’s approval to make electricity transactions. Altogether, more than 50 firms including banks filed applications with the FERC from December 2001 through February 2003 to make trades in that market.

 

Edison’s Backer

 

“Banks have assumed a prominent role in energy trading since the collapse of Enron and other energy marketers, in part, because financial institutions generally have significant financial assets to back their trades,” said Richard Drom, a partner at law firm Andrews Kurth LLP who focuses on energy regulation. “Such trading can improve energy markets by promoting market liquidity and energy price transparency.”

JPMorgan’s website credits a predecessor of the bank with helping bring about the advent of electricity by financing Thomas Edison’s research. In 2005, a unit of the company won FERC approval to provide power in wholesale electricity markets, according to the agency. Three years later, the firm inherited U.S. energy holdings and sales arrangements, including power plants in Southern California and Michigan, through its acquisition of failing investment bank Bear Stearns Cos.

 

The FERC found that J.P. Morgan Ventures Energy Corp., a unit overseen by commodities chief Blythe Masters, engaged in 12 separate bidding strategies from 2010 to 2012. Ten allegedly began while the agency’s probe was in progress.

 

Profits Predicted

 

The bank controlled older power plants that had marginal costs that were typically higher than the market prices of electricity, according to its consent agreement with the FERC. To ensure their profitability, the firm sought to exploit pricing rules, the agency wrote.

JPMorgan used strategies such as offering below-market rates for some hours of energy production, then charging exorbitantly high rates for hours that state bidders agreed to pay for the plants to “ramp” production, according to the FERC.

 

Masters, 44, was told in an October 2010 document that the firm’s bidding strategies would enable it to produce $1.5 billion to $2 billion in gains through 2018, according to the FERC. She wasn’t accused of wrongdoing. The company’s settlement releases her from any future FERC enforcement actions in the case.

 

Enron Worse

 

Some JPMorgan bidding tactics were similar to abuses that occurred in the Enron era, FERC Chairman Wellinghoff said in an interview this week.

“That doesn’t mean that they are as widespread or that they are resulting in the level of consumer losses that we saw during that period,” he said.

A recent jump in the watchdog’s cases targeting a variety of companies stems from the additional authority Congress granted its investigators in 2005. Wellinghoff has said that the agency isn’t seeking to single out Wall Street firms.

“We now have a very sophisticated and very deep enforcement team” able to identify and stop market manipulation swiftly, he said in the interview.

 

The FERC’s case against Barclays and Frankfurt-based Deutsche Bank centered on their alleged abuse of power-market influence to benefit related positions on financial instruments.

 

Barclays Fighting

 

At Barclays, the FERC’s investigators found traders made transactions in fixed-price electricity products — often at a loss — with the intent of moving an index to benefit the London-based bank’s other bets on swaps. The regulator’s staff estimated that the abuses, spanning 2006 to 2008, caused $139 million “in harm to the market.”

Barclays has said the FERC’s accusations are without basis. The firm has vowed to fight an order that it pay $469.9 million in penalties and forfeited profits. Swaps allow investors to hedge or speculate on changes in underlying assets such as interest rates, currencies or the ability of a borrower to repay debt.

 

Deutsche Bank agreed to pay the FERC more than $1.6 million in January without admitting or denying wrongdoing. The bank was accused of moving electricity to benefit its position on financial instruments known as congestion revenue rights.

Enron employees targeted by prosecutors took a direct approach: They sought to drive up electricity prices to squeeze more money out of power-starved utilities, businesses and consumers. Wholesale power prices soared and electricity supplies dwindled, leaving millions of Californians to suffer blackouts in 2001. The state’s two largest utilities became insolvent.

 

Enron Testimony

 

The focus on derivatives in some of the bank probes echoes at least one Enron case. In 2004, Enron settled claims brought by the Commodity Futures Trading Commission that employees rapidly bought up natural gas in the spot market, creating “artificial” prices for natural gas futures contracts.

That behavior helped make Enron a repeat topic during a Senate Banking Committee subcommittee hearing on July 23 to examine whether banks are abusing their roles in commodities markets.

 

“There is at least a very plausible argument that Enron was the pioneer in discovering a business model” that combined the handling of physical commodities and derivatives bets, Saule T. Omarova, a law professor at the University of North Carolina at Chapel Hill, told the Senate panel. “Once that model was discovered, that model was up for the taking.”

The notion that some firms are emulating Enron “suggests that this movie does not end well,” Senator Elizabeth Warren, a Massachusetts Democrat, said at the hearing. It shows “we are now putting more and more risk into this system.”

 

‘Grandma Millie’

 

The cases against banks in the past year have resurrected concerns that traders are disregarding markets and consumers.

Enron workers were caught on audiotapes as they discussed tactics with code names like “Death Star” and “Fat Boy” that could be used to take advantage of consumers, whom they termed “Grandma Millie.” In that case, prosecutors said employees used a variety of strategies, such as creating artificial congestion on transmission lines so that Enron could earn additional fees for relieving the crunch.

One Barclays trader accused of manipulating prices in the U.S. Southwest wrote in an internal message that he had “totally fukked with the Palo mrkt today,” the FERC said in an order this month. Another trader wrote that he was “trying to drive price in fin direction,” referring to transactions he made to benefit derivatives positions, the agency said.

At Odds

 

The claims against banks are fueling a regulatory debate that may push those firms back out of certain markets. The Fed said July 19 that it’s reviewing a 2003 decision that physical commodities are “complementary” to banking, allowing lenders such as JPMorgan to operate in both industries. Such a reversal would demonstrate authorities’ growing discomfort with allowing complex trading strategies into markets that ultimately heat people’s homes.

 

Banks’ and utilities’ interests are fundamentally at odds, with financial firms earning more from volatility and consumers needing stability, said Miki Kolobara, a Phoenix-based attorney who specializes in energy-trading cases. Banks’ hunt for gains will gravitate to derivatives, where profits are theoretically unlimited, rather than in power lines and physical infrastructure, where returns are capped by regulators, he said.

 

Electricity and natural gas — the two main commodities under the FERC’s oversight — are areas in which banks should tread carefully, because the government is wary of practices that hurt people’s ability to meet basic needs.

“Trading in energy requires not just expertise, but also an awareness of a highly complex regulatory structure,” said Harvey Pitt, the SEC chairman during Enron’s collapse. “If traders view energy as just another commodity, then they will find themselves on the wrong side of FERC.’”

 

To contact the reporters on this story: Keri Geiger in New York at kgeiger4@bloomberg.net; Brian Wingfield in Washington at bwingfield3@bloomberg.net

 

To contact the editors responsible for this story: David Scheer at dscheer@bloomberg.net; Christine Harper atcharper@bloomberg.net; Jon Morgan at jmorgan97@bloomberg.net

 

Eight Ways to Move Toward a Culture of Compliance

Originally Published June 7, 2013, 12:01 AM ET

Eight Ways to Move Toward a Culture of Compliance

More than just a set of policies and procedures, effective compliance risk management at the enterprise level can be viewed as a cultural ethic that should function like any other business asset that reaches across an organization. An effective way to get there is through a risk intelligent framework that brings compliance into the open, running throughout all business processes, with responsibility shared among all employees.

“A risk intelligent framework can be a radical shift from the way most companies see compliance today,” says Donna Epps, a partner and U.S. co-leader of Governance and Risk Management at Deloitte Financial Advisory Services LLP. “To move a company in that direction, the chief compliance officer will need to gain the backing and support of stakeholders from across the organization, including executive peers, business-unit and functional leaders, and the board of directors.”

Following are eight initiatives a Chief Compliance Officer (CCO), working with the CFO, can lead to help bring about a more holistic program of compliance risk management through a risk intelligent approach and elevate awareness at the enterprise level.

1. Get the Top Brass on Board

The road to holistic risk compliance can be much smoother if the CEO, CRO and the board of directors understand what the CCO is trying to do and why they should want to help. Risk intelligent compliance requires clear channels of communication between the compliance risk management program and the enterprise risk management (ERM) program, and the CRO’s engagement is critical. Luckily, the CRO’s shared interest in improving risk management effectiveness can make risk intelligent compliance a relatively easy sell.

The CEO’s role in supporting risk compliance is to empower the CCO with the authority needed to drive meaningful change, as well as to provide the necessary investment, political support, and, if needed, enforcement. Gaining the CEO’s support can require the CCO to make clear the risk management benefits of robust compliance processes, as well as collateral benefits of cost reduction and revenue enhancement. Any up-front investments must also be addressed early, such as the purchase of more effective technology to replace spreadsheet-based tracking and reporting.

The board of directors can play a role in holding management accountable for results of the enhanced programs. “The CCO’s task is to set expectations, develop metrics and establish milestones that are both substantive and realistic, as well as establish a multiyear master plan,” says Scott Baret, partner, Governance, Regulatory and Risk Strategies, Deloitte & Touche LLP, who also serves as global leader, Financial Services Enterprise Risk Services. “Many boards prefer to spend time on risk management rather than on compliance, so CCOs may want to consider framing board discussions in the context of ERM.”

2. Take the Company’s Bearings

Like any transformation, the pursuit of risk intelligent compliance begins with understanding the current state. Important questions include:

What are the company’s current compliance obligations and risks?

Who owns each risk?

What controls are in place against them?

How does the organization respond to control failures?

How are remediation priorities set?

What supporting technologies are used?

3. Develop the ERM-aligned Compliance Risk Management Program

Coordinating compliance risk management with ERM provides CCOs the operational basis for establishing, strengthening and validating the link between compliance and enterprise value. How a CCO accomplishes this at any particular company will depend greatly on internal organizational dynamics. “For insights on how to maintain effective cross-communication with ERM, the CCO may want to look at the way the internal audit function interacts with ERM to evaluate company risks,” says Mr. Baret.

4. Align the Compliance Function

The process of aligning compliance activities and investments with business priorities starts with the compliance function itself. The CCO should allocate the compliance function’s activities across the company’s compliance risks according to the relative importance of each compliance risk to enterprise value. In some cases, this may mean deploying people and infrastructure to countries, programs and/or activities where greater investment seems counterintuitive. In others, it may mean scaling back on one or more “sacred cows.” In either case, the CCO should be able to back up his or her decisions with reasons that tie solidly back to ERM priorities.

The corollary is that CCOs themselves should prioritize requests for investments in the compliance function based on their expected risk management benefit. Barring obvious infrastructural or resource gaps, the choice of what to ask for first may sometimes come down to a frank judgment call.

5. Lobby Hard for Effective Technology

The “right” technology and data architecture, both within and outside the compliance function, can go a long way toward improving compliance efficiency and effectiveness. Automating controls, for instance, can help lower costs and increase reliability, especially if the controls are first rationalized to reduce duplication. Companies can also avail themselves of a growing array of tools to support the compliance risk management process, some stand-alone, some sold as part of larger “enterprise governance, risk and compliance” solutions.

Some of the newer compliance tools feature: automated monitoring of regulatory releases; workflow capabilities to facilitate compliance process execution and tracking; and integrated “front end” interfaces that allow users to execute, document and track compliance activities in multiple areas from a single point of access.

6. Piggyback on Each Other’s Work

Looking for ways to reduce duplication of effort with other internal groups can help a CCO stretch the compliance function’s limited budget and resources. In particular, the CCO should enlist internal audit in supporting compliance oversight by testing and auditing compliance-related internal controls and business processes. Compliance personnel can advise internal audit on what tests would be most useful to the compliance function, as well as on what tests might be better left to the compliance function’s specialists to perform.

7. Foster a Culture of Compliance

Changing corporate culture can take years. CCOs should expect to work with the office of the CEO—as well as human resources, legal and communications—to supervise the change initiative and supply compliance-specific guidance as needed. Important areas to address include:

Performance management and compensation

Training

Leadership development

Communications

8. Participate in Strategic Planning

The risk intelligent CCO should help leaders set a strategy that takes compliance into appropriate account by bringing relevant compliance perspectives to the strategic planning process. For instance, the CCO should explain what compliance obligations are associated with each of the strategic options being considered, help evaluate the likely compliance risk associated with each option and describe the nature and extent of the investments that may be needed to maintain compliance risk exposures within acceptable tolerances under a variety of conditions. “Once the strategy is set, the CCO should help the company understand and prepare to address compliance obligations that are expected to arise in execution,” adds Ms. Epps.

Related Resources

Aligning Compliance Risk Management to Business Priorities

The Risk Intelligent Chief Compliance Officer

This publication contains general information only and Deloitte LLP and its subsidiaries (“Deloitte”) are not, by means of this publication, rendering business, financial, investment, or other professional advice or services. This publication is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional advisor. Deloitte shall not be responsible for any loss sustained by any person who relies on this publication. Copyright © 2013 Deloitte Development LLC.