Risk Management Presentation Monday February 4 2013

7/28/2019 Risk Management Presentation Monday February 4 2013

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International Association of Risk and ComplianceProfessionals (IARCP)

1200 G Street NW Suite 800 Washington, DC 20005-6705 USATel: 202-449-9750www.risk-compliance-association.com

Top 10 risk and compliance management related news storiesand world events that (for better or for worse) shaped the

week's agenda, and what is nextDear Member,

I f you want to have only the presentationsof theCertified Risk and Compliance ManagementProfessional (CRCMP) program, you can havethem (at $97 instead of the $297 of the fullprogram). To learn more:www.risk-compliance-association.com/ Distance_Learning_and_Certification_CRCMP_Presentations.htm

Do you know any zombie managers?

Unfortunately, I do.

I heard you You asked:What is a zombie manager George?

Simple: A zombie manager is a manager that is also a zombieNo, wait; we have a better official definition.

According to Bruce Karpati, Chief, SEC Enforcement Division's AssetManagement Unit, U.S. Securities and Exchange Commission:

Zombie funds (or more accurately, zombie managers)result whenprivate equity holdings are not designed for quick liquidity.

International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
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Since zombie managers are unable to raise new capital, their incentivesmay shift from maintaining good relationswith their investors tomaximizing their own revenue using the assets that they have.

Being a zombie manager in and of itself is of course not unlawful andmost zombie managers will continue to act in the best interests of theirinvestors.

However, given the incentives to favor their own interests, we believe thatthere will be someproblematic conduct and possible violations of the law.

Read more at Number 7 of our list.

Michel Barnier, the European Commissioner for Internal Market and

Services, said that the EU and U.S. should implement the Basel measuresin parallel, starting in the first weeks of 2014.

Mr Stefan Ingves, Governor of the Sveriges Riksbank and Chairman ofthe Basel Committee on Banking Supervision, also said that:

1.There is a material variation in risk weights for trading assets acrossbanks (after adjusting for accounting differences and for differences inthe riskiness of different bank portfolios)

2.Certain modelling choices seem to be major drivers of the variation inrisk weights

3.The quality of existing public disclosure is generally insufficient toallow users to determine how much of the variation in reported riskweights is a reflection of underlying risk taking, and how much stemsfrom other factors (eg modeling choices, supervisory discretions).

Read more at Number 1 below.

Welcome to the Top 10 list.

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From ideas to implementation

Remarks by Mr Stefan Ingves, Governor of theSveriges Riksbank and Chairman of the BaselCommittee on Banking Supervision, at the 8thHigh Level Meeting organised by the BaselCommittee on Banking Supervision and the Financial Stability Instituteand hosted by the South African Reserve Bank, Cape Town

Protecting Investors by Seizing theOpportunity to Strengthen Audit Quality

Jeanette M. Franzel, PCAOB Member AmericanAccounting Association Midyear Conference andDoctoral Consortium , New Orleans, LA

EIOPAMulti-Annual Work Programme2012-2014

EIOPA is an independent European Supervisory Authority acting withinthe scope of various Directives covering insurance and reinsuranceundertakings, institutions for occupational retirement provision andinsurance intermediaries as well as related issues not directly covered by

these Directives.



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Recent policy developments forstrengthening the resilience of the financial

sector

Welcoming remarks by H E Sultan Bin NasserAl-Suwaidi, Governor of the Central Bank of the UnitedArab Emirates, at the 8th H igh-Level Meeting for theMiddle East & North Africa Region on Recent policy developments forstrengthening the resilience of the financial sector, organized by theBasel Committee on Banking Supervision (BCBS), the Financial StabilityInstitute (FSI) and the Arab Monetary Fund (AMF), Abu Dhabi.

Suitability Requirements WithRespect To the Distribution of ComplexFinancial ProductsFinal Report

In February 2012, the IOSCO Technical Committee published a

Consultation Report, entitled Suitability Requirements with respect to theDistribution of Complex Financial Products (the Consultation Report).

President Obama discusses hisnomination of Mary Jo White to lead theSecurities and Exchange Commission and

Richard Cordray to continue as Director ofthe Consumer Financial ProtectionBureau.



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FSA statement on Basel I I I rules on capitalrequirements for exposures to CCPs

In July 2012 the Basel Committee on BankingSupervision (BCBS) agreed a revised Regulatoryrules text on the capital requirements for bank exposures to centralcounterparties.

These rules set out the capital treatment forbank exposures to qualifyingcentral counterparties (QCCP).

A QCCP is defined as 'an entity that is licensed to operate as a CCP

(including a license granted by way of confirming an exemption), and ispermitted by the appropriate regulator /overseer to operate as such withrespect to the products offered.



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From ideas to implementation

Remarks by Mr Stefan I ngves, Governor of the SverigesRiksbank and Chairman of the Basel Committee onBanking Supervision, at the 8th High Level Meetingorganised by the Basel Committee on BankingSupervision and the Financial Stability I nstitute and hosted by the SouthAfrican Reserve Bank, Cape Town

Introduction

Let me begin today by thanking Josef Toovsk,Chairman of the

Financial Stability Institute, for organising the latest in its series of HighLevel Meetings.

The Basel Committee continues to view these events as extremelyimportant, as they bring together senior policymakers and supervisors ina forum in which we can share thoughts on critical issues of the momentand reflect on long term challenges.

Let me also extend my thanks to the South African Reserve Bank for its

superb hospitality as the annual host of this High Level Meeting.

Change and reform new ideas and new ways of doing things can bechallenging in good times.

When all is well, the perceived need is low and the costs includingopportunity costs are difficult to justify.

Even small ideas can be difficult to implement.

Crises, on the other hand, provide a catalyst for fundamentally rethinkingpast practices.



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Many banks have learnt this as a painful lesson in recent years: whentimes were good, potential operational, risk management and culturaldeficiencies were not examined closely enough.

When serious problems emerge, however, there is a demand for new ideasand new ways of doing things: the status quo becomes unacceptable.

Of course, the same scenario has applied to the regulatory frameworkmore broadly.

Pre crisis, any call for stronger capital and liquidity rules was generallyhowled down as burdensome and unnecessary.

Post-2008, the costs of a weak regulatory framework have been all too

obvious and painful for the banking sector, and as a result the demand fornew ideas was immediate and forceful.

My theme for today is that successful regulatory reform is about ideas andimplementation.

Certainly, we needed to rethink the regulatory framework in light of whatwe have learnt from the past five years the status quo was notacceptable.

But if we want to be successful, the Committee also needs to make surethat the ideas we developed into Basel I I I are truly put into practice.

From ideas .

The Basel Committees response to the financial crisis was to recognisethat policy weaknesses contributed to the excesses that built up in thefinancial sector.

A substantial overhaul was necessary: minor adjustments to theframework were not going to be enough.

We needed some big, new far-reaching ideas.In summary, we decided that it was necessary to:



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require banks to maintain substantially higher levels of capital, with theminimum common equity requirement increasing from 2% to 7% of riskweighted assets;

require banks to hold higher quality forms of capital, with commonequity at the core of the requirements, and standards to ensure othertypes of capital instruments are truly loss-absorbing.

It is worthwhile emphasising that these reforms also go a long way tosimplifying bankscapital structures, as well as making them moretransparent and comparable;

introduce an additional capital buffer(the capital conservation buffer)designed to enforce corrective action when a banks capital ratio

deteriorates.

The capital conservation buffer allows banks to dip into their capitalreserves, while at the same time providingdisincentivesfor banks to do sodue to the restrictions it imposes on dividend and bonus payments;

add a macroprudential element in the form of the countercyclical buffer,which requires banks to hold more capital in good times to prepare forinevitable downturns in the economy;

supplement the risk-based regime with a simple backstop in the form of a(non-risk based) leverage ratio;

imposeadditional capital requirements on systemically important banks both global and domestic to take account of the externalities theirfailure would impose on society; and

introduce the first international standards for bank liquidity and funding,designed to promote the resilience of a banks liquidity risk profile to bothshort term liquidity shocks (the Liquidity Coverage Ratio LCR) andlonger-term mismatches in funding (the Net Stable Funding RatioNSFR).



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Of course, there are plenty of other big ideas being floated on how thebanking industry should be restructured in the aftermath of the crisis,particularly those related to varying models of structural separation (egthe ideas ofVolker, Vickers and Liikanen).

But for those that fall within the mandate of the Basel Committee, webelieve that the ideas produced by Basel Committee thinking translatedinto the Basel I I I reforms, and subsequently endorsed by the G20 andFinancial Stability Board provide a substantial foundation on which thebanking system can be rebuilt to be much more robust and resilient in thefuture.

Basel II I capital requirements are probably well known to all of you, so Ido not propose to say much more about them today.

What I would instead like to focus on isour thinking in relation toliquidity, and particularly the LCR.

As an idea, it is simple: a bank should have enough liquid assets tosurvive a 30-day period of stress.

And perhaps to some, it might seem underwhelming.

If you tell your spouse that we have implemented a reform that requires

banks to have enough cash to last 30 days, more than likely you will getthe same response I did when I tried to explain it to my wife:whatdoyou mean, only 30 days?

Yet this idea has been one of the most fundamental reforms of the crisis.

It also is a classic example of an idea that had been toyed with for a longtime, but took a crisis to bring to fruition.

A study of Basel Committee history shows liquidity to have been on theagenda almost for the entire existence of the Committee, but we havenever come close to an international standard.

Basel I I I has changed that.



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So even though the LCR is only 30 days of cash, its significance shouldnot be underestimated.

As you would be aware, the focus of the Committee over the past twoyears has been on refining the formulation of the LCR announced in 2010.

Given this is the first time the international community had developed aglobal liquidity standard, it was agreed that it should be subject to anobservation period, during which it could be adjusted as a result of furtheranalysis and assessment.

The aim of the observation process was not to further tighten or weakenthe standard: the goal was purely to ensure the calibration was morereflectiveof empirical evidence and appropriate for implementation as a

minimum standard, across the Committees27 member countries andmore broadly.

The changes agreed to by the Committee focus on three main areas:

High quality liquid assets (HQLA): A diverse and sufficiently largestock of HQLA is essential to help banks withstand liquidity stress.

The revised definition now provides limited recognition of additionalassets such as a broader range of corporate bonds, a selection of listed

equities, and some highly-rated residential associated with such assets,their inclusion in the stock of HQLA is subject to a relatively low limit aswell as significant haircuts.

The Committee has tried to balancethe benefits of greater diversificationof the liquidity pool against the cost of including slightly lower qualityassets.

We have also changed some of the assumed inflow and outflow rates thatdetermine the size of the pool of liquid assets that a bank is required tohold.



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As in the case of the capital conservation buffer, the standards nowmake very clear that liquidity is to be built up and maintained in goodtimes so that it can be used in times of need.

In other words, liquidity is not useful if it is frozen.

In addition, in light of the considerable stress facing banking systems insome regions of the world, the Committee revised the implementationplan of the LCR by introducing a phase-in arrangement.

The LCR will come into force as planned in 2015, althoughbanks now willhave until 1 January 2019 to meet the standard in full.

Nevertheless, I expect many banks will choose to move to the higher

standard more quickly.

In announcing the revisions to the LCR, many headline writerscategorised it assome kind of win for the banking industry over theregulators.

This is simplistic.

We had an observation period for good reason: to make sure we got thesettings right.

There was, I think, legitimate concern that, as a minimum standard, the2010 formulation of the LCR may have been calibrated too conservativelyoverall.

For example, the treatment of traditional retail and commercial bankingwas probably too harsh, and this has been adjusted.

Equally the treatment ofderivative-related risks was probably too weak,and so that has been adjusted too.

Much has been made of the inclusion of RMBS in the definition of highquality liquid assets, but the eligibility criteria are tight and the initial



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perception that the Committee had granted carte blanche to thesecuritisation sector is well wide of the mark.

As the Chairman of the Basel Committeesgoverning body, GovernorKing of the Bank of England, said when announcing the full set ofchanges, they are designed to make the LCR more realistic.

I think this sums it up very well.

Of course, the overall impact of the changes is to improve the reportedLCR of the banking system.

Based on our most recent data (end June 2012), we estimate that theweighted average LCR for a sample of roughly 200 of the worlds largest

banks is around 125%, compared with a little over 100% for the previouscalibration.

This does not mean, however, that all banks are ready and able to meetthe standard today.

Even though the industry average is well above the minimum, ourestimates suggest that roughly one-quarter of our sample could still havean LCR below 100% even with the latest policy changes.

So there remains a significant liquidity shortfall that will need to beaddressed by a number of banks.

One also has to bear in mind that favourable terms from central bankshave helped to improve bank funding.

Central banks serve as lenders of last resort and, as economic conditionsimprove, banks will need to become more self-reliant.

However, the timetable for the gradual introduction of the ratio ensuresthat the new liquidity standard will in no way hinder the ability of theglobal banking system to finance a recovery.

It has taken a lot of time and effort to reach agreement on the LCR.



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It is, as I said, a deceptively simple idea, but its implications are big andfar-reaching.

Unsurprisingly, there is much in the detail that required a lot of carefulanalysis and thought, not to mention a willingness to find a way throughdiffering national perspectives.

It is, however, critical that the new ideas such as the LCR (and the othernew features of Basel I I I such as the capital conservation buffer,countercyclical buffer, leverage ratio and NSFR) are implemented if theirbenefits are to be realised.

Against that background, let me now turn to the work we have started toensure that the Basel I I I framework is implemented as intended.

. to implementation

Steady progress is being made.

As of January 2013,11 out of 19 Basel Committee jurisdictions have finalBasel I I I rules in place, including our hosts today, South Africa.

A number ofnon-member countries also implemented Basel I I I at thebeginning of the year, further expanding its coverage.

While it would be ideal to have much broader coverage at this time (as attoday, around one-third of global banking assets are officially subject tothe Basel I I I requirements), the delays should not be interpreted as anylack of commitment by global regulators to implement the agreedreforms.

At recent international gatherings, all members have been asked toreaffirm their commitment to implementing the agreed reforms as soon

as possible.

And they have given that commitment (subject, of course, to the vagariesof domestic rule-making processes that each must follow).



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Nevertheless, let me be clear: the question being discussed is when thereforms will be implemented, not if.

Any setback to implementation is undesirable, since Basel I I I is a keyplatform on which to rebuild a stronger global banking system.

But the delays are not critical at this point, fortwo reasons.

First, the Basel I I I capital rules contain a lengthy phase-in period,meaning that in 2013 the new requirements should not be particularlyburdensome for banks (eg none of the new deductions from capital areapplied this year).

Second, many regulators who have been unable to implement the new

standards by the beginning of this year are still measuring andmonitoring their bankscapacity to meet the new requirements.And, of course, markets are applying similar pressure.

In other words, theforceof the new capital regime is much broaderthan just those countries that have implemented their domesticregulations.

Nevertheless, to ensure visibility of the implementation of reforms, theBasel Committee has been regularly publishing information about

membersadoption of Basel I I I.

We will continue to do this so as to keep all stakeholders and the marketsinformed, and to maintain peer pressure where necessary.

It is especially important that jurisdictions that are home to globalsystemically important banks (G-SIBs) make every effort to issue finalregulations at the earliest possible opportunity.

But simply issuing domestic rules is not enough to achieve what the G20Leaders asked for: full, timely and consistent implementation of Basel II I.

In response to this call, in 2012 the Committee initiated what has becomeknown as the Regulatory Consistency Assessment Programme (RCAP).



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The regular progress reports are simply one part of this programme,which assesses domestic regulationscompliance with the Baselstandards, and examines the outcomes at individual banks.

The RCAP process will be fundamental to ensuring confidence inregulatory ratios and promoting a level playing field forinternationally-operating banks.

It is inevitable that, as the Committee begins to review aspects of theregulatory framework in far more detail than it (or anyone else) has everdone in the past, we will find aspects of implementation that do not meetthe G20saspiration: full, timely and consistent.

We are going to find parts of the framework that have been implemented

only in part, or late, or inconsistently.

The financial crisis identified that, like the standards themselves,implementation of global standards was not as robust as it should havebeen.

This could be classed as a failure by global standard setters.

To some extent, the criticism can be justifiednot enough has been donein the past to ensure global agreements have been truly implemented by

national authorities.

However,just as the Committee has been determined to revise the Baselframework to fix the problems that emerged from the lessons of the crisis,the RCAP should be seen as demonstrating the Committeesdetermination to also find implementation problems and fix them.

Committee published recently by Professor Charles Goodhart notes thatthe Committee has on more than one occasion over the past 35 yearsconsidered undertaking more detailed analysis of domesticimplementation of global standards, but shied away from this as beingtoo intrusive.



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However, we have now taken that step, since if we are serious aboutfixing the problems of the past, then we need to not just look at the policysettings, but also their application.

Our efforts on implementation should therefore be seen as an integralpart of the reform agenda not just an adjunct to it.

When it comes to ourcountry-by-country assessments, thus far theCommittee has conducted detailed assessments of the final regulationsadopted in Japan, and the draft regulations in the European Union andthe United States.

Follow-up assessments in the European Union and United States will beconducted once final regulations are available.

Assessments under the RCAP are currently underway forSingapore andSwitzerland.

Later this year will follow China, Australia, Brazil and Canada.

As with all of the RCAP work, transparency is critical to success all ofthese reports will, of course, be published in full when complete.

It is important to note that, in undertaking this work, the Basel

Committee has no enforcement power, so it would be meaningless tothink we can force jurisdictions to change their local regulations if we findgaps.

Our goal is therefore framed more positively: to deepen theimplementation process and to help jurisdictions identify the gaps andaddress them.

Ideally, the assessments provide a roadmap by which identified gaps canbe closed.

They also provide stakeholders and markets with a much higher degree oftransparency about the extent of any local divergence from agreedinternational standards, and the importance of these.



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In this way, we believe we will establish the appropriate incentives forlocal rulemakersto apply the global standards, and for markets and othersto apply appropriate pressure where banks may be subject toweaker-then-expected prudential requirements.

More consistent domestic regulations will be an improvement.

But beyond looking at how local regulators have transposed Baselagreements into domestic regulations, the Committee has alsobegunexamining whether the framework(s) are producing consistent outcomes.

Ultimately, what counts is that the capital ratio calculated and reported byindividual banks provides a meaningful and comparable representation oftheir capital strength.

Differencesin regulation, or their application, can undermine theregulatory framework by making it more difficult for bank depositors,counterparties, investors, shareholders and supervisors to haveconfidence that reported capital ratios serve their intended purpose.

In this context, some concerns have been recently voiced that banks arenot calculating risk weighted assets consistently.

The Committee has, in fact, been investigating this issue for much of the

past year.

This work has examined the calculation of risk weights in both thebanking and the trading books.

As with our country assessments, we will publish the results of bothstudies.

The preliminary results of the trading book are most advanced, and will

be published very shortly.

The analysis is based on two sources of data: public disclosures by banksand a hypothetical test portfolio exercise in which 15 large, internationallyactive banks have participated from nine Basel Committee jurisdictions.



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I will not pre-release the detailed results today, but the headline messagesare that:

there is a material variation in risk weightsfor trading assets acrossbanks (after adjusting for accounting differences and for differences inthe riskiness of different bank portfolios);

certain modelling choices seem to be major drivers of the variation inrisk weights; and

the quality of existing public disclosure is generally insufficient to allowusers to determine how much of the variation in reported risk weights is areflection of underlying risk taking, and how much stems from otherfactors (eg modeling choices, supervisory discretions).

In thinking about these results, it needs to be borne in mind that theobjective is not to achieve zero variation.

If we wished to achieve that outcome, we could simply force all banksonto the standardised approach to capital adequacy and remove anymodelling options.

But the standardised approach while an ostensibly consistentmethodology would not necessarily guarantee a meaningful measure of

risk when applied to the worlds largest banks with the biggest and mostcomplex trading portfolios.

Modelling necessarily introduces a degree of variability, since Baselstandards deliberately allow banks and supervisors flexibility in order toaccommodate for differences in risk appetite and local practices, but withthe goal of also providing greater accuracy.

Further, from a financial stability perspective, it is desirable to have somediversity in risk management practices so as to avoid that all banks act ina similar way.

When banks would have identical response functions, economiccyclicality would increase, potentially creating additional instability.



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At the same time, excessive variation in risk measurement is clearlyundesirable.

Finding the right balance is the key.

The preliminary work suggests we may not have the balance right in thecurrent set-up.

But as with all of our work on implementation, it is necessary to identifyproblems before we can set about correcting them.

The on-going analysis has generated a wealth of information about riskmodelling by banks.

This is useful for international policymakers.

The Committee has not yet decided what actions it might take inresponse to the analysis, but some of the possible policy options couldcomprise improvements in public disclosure practices, limitations in themodeling choices for banks, and further harmonisation of supervisorypractices.

These ideas will also feed into the current fundamental review of thetrading book.

In addition, our international study provides national supervisors with amuch clearer understanding of how the risk models of their bankscompare to those of international peers.

This means that national supervisors are much better equipped to discussthe results with their banks and take action where needed.

The Committee will be doing further work on the trading book, inaddition to the banking book work, to explore the outcomes in moredepth.



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Much of the Basel Committeeswork on big ideas that respond to theshortcomings in the regulatory framework identified by the financialcrisis is reaching the end stage.

The capital rules are set (and, in an increasing number of jurisdictions,coming into force), and the revisions to the LCR have recently beenagreed.

In 2013, we will seek to set out the specification of the backstop leverageratio, and the NSFR will be refined between now and the end of 2014.

Clearly, we still have work to do, but increasingly it is about getting thetechnical details correct rather than new far-reaching ideas.

Even when the Committeespolicy response to the crisis is complete,much more work will still be needed.

Implementation needs to be seen as an integral part of the reform agenda,not a sideline activity.

As we examine this issue to a depth that it has not previously beenexamined, we will inevitably find things that need improvement.

Turning a blind eye to these, as may have occurred in the past, is not an

option we need to persevere and find those areas where additionalmodifications to the regulatory framework are needed to ensure it iseffective.

If we do not work to improve implementation, we will not embed thereforms into domestic banking systems in the full, timely and consistentmanner that is in everyones interests.



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Protecting Investors by Seizing theOpportunity to Strengthen Audit Quality

Jeanette M. Franzel, PCAOB Member AmericanAccounting Association Midyear Conference andDoctoral ConsortiumNew Orleans, LA

I am honored to be here today at the mid-yearauditing section conference of the AmericanAccounting Association (AAA).

Before I get started, I must tell you that the views I

express today are my personal views and do not necessarily reflect theviews of the Board, any other Board member, or the staff of the PCAOB.

In preparing for this conference, I noted that the theme for the AAA'supcoming annual conference in August deals with viewing currentsignificant challenges as "Brilliantly Disguised Opportunities."

This is a fantastic theme, and I thought I'd take the opportunity to get allof us thinking along these lines now, as we begin 2013.

The "brilliantly disguised opportunity" I want to talk to you about todayis strengthening audit quality in the aftermath of the recent financialcrisis.

We find ourselves, once again, forced to evaluate the integrity of theassurance provided to the financial markets through financial reportingand auditing.

All participants in the supply chain of financial reporting and auditing, as

well as the regulators and corporate governors, need to seize the"opportunities" we are currently facing to instill lasting change that willprotect investors and help ensure that we can continue to pass alongopportunity and prosperity to future generations of Americans.



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Each of you, too as educators of students entering the accountingprofession and as researchers on the issues we are facing, plays a key rolein the solutions.

At the PCAOB, we are taking on an ambitious list of significant issues tohelp ensure investor protection and high quality audits now and for thelong term.

Today, I will discuss four of these key issues in audit oversight and ourplans for change: audit quality, professional skepticism, inspections andremediation, and standard setting.

Audit Quality, Professional Skepticism, Inspections andRemediation, and Standard Setting

We've all heard those words before.

Two are about how auditors do their work -- audit quality andprofessional skepticism; and the others are about how the PCAOB doesits work -- inspection and remediation, and standard setting.

In 2013, the Board is looking at them anew. In revising our strategic planlast year, we stepped back, took stock, and looked at these issues with along term view.

As the PCAOB marks its 10th anniversary this year, it is appropriate andnecessary to evaluate our progress.

The PCAOB is a relatively new regulator and still has work to do toestablish sustainable regulatory approaches for the long term, whileremaining nimble and responsive to emerging risks and issues.

The Board's recently updated strategic plan[1] reflects this. I ts near term

priorities for 2013 include:

Audit Quality: identifying audit quality measures, with a longer term goalof tracking such measures for domestic global network firms[2] andreporting changes in these measures over time;



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Inspection Findings: enhancing the PCAOB's processes and systems torefine the analysis of PCAOB inspection findings, including comparativeanalysis across firms over time, to further inform the investing public andPCAOB's standard-setting and other regulatory activities;

Inspection Reports: improving the timeliness, content and readability ofinspection reports;

Remediation Determinations: improving the timeliness of remediationdeterminations and providing additional information on the PCAOB'sremediation process;

Standard Setting: enhancing the framework for the PCAOB'sstandard-setting process and the related project-tracking information

provided to the investing public; and

Audit Committees: enhancing the PCAOB's outreach to, and interactionwith, audit committees to constructively engage in areas of commoninterest, including auditor independence and audit quality.

Assessing and Tracking Audit Quality

The first of these near term priorities that I want to talk about today isassessing and tracking audit quality.

Ten years after the establishment of the PCAOB, it is fair to ask, "What isthe present state of audit quality?" and "Has audit quality improved sincethe enactment of the Sarbanes-Oxley Act?"

We've had many stakeholders and members of the profession tell us thatthey believe audit quality has improved, and we, at the PCAOB, tend toagree.

PCAOB inspections, however, continue to find serious audit deficienciesin public company audits on a regular basis.

In addition, the results of our first round of inspections of audits ofbrokers and dealers are troubling.



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In pursuing our core mission of protecting investors through auditoversight, the Board has a number of initiatives targeted at improvingmajor areas of audit practice that establish audit quality.

In light of the many financial reporting and auditing crises over recentdecades, I find it surprising that a generally understood and measurableconcept of audit quality has not emerged.

This issue was raised at the outset of the recent financial crisis in arecommendation of the Department of the Treasury's AdvisoryCommittee on the Auditing Profession (ACAP).

The committee recommended that the PCAOB study the feasibility ofdeveloping key indicators of audit quality and effectiveness.

And, earlier this week, the International Auditing and AssuranceStandards Board issued a consultation paper on a proposed frameworkfor audit quality that sets out key attributes that are conducive to auditquality.

A recent synthesis paper, Audit Quality: Insights from the AcademicLiterature, notes that despite more than two decades of research, there islittle consensus about how to define, let alone measure, audit quality.

Furthermore, the various stakeholders in the financial reporting processhave different views as to what constitutes audit quality.

While some might define a quality audit in terms of audit inputs -- such aswhether auditors follow standards -- investors and audit committeemembers may focus on certain audit outcomes -- demanding that auditsuncover fraud, for instance.

Many have also viewed audit quality in terms of the absence of negativeoutcomes such as restatements, litigation, or subsequently discoveredmaterial problems.

The divergence in viewson audit quality has contributed to the"expectations gap" over what an audit should be.



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This has persisted for decades, and also causes a divergence in definitionsof what constitutes an audit failure.

PCAOB uses its own definition of audit failure in inspection reports.

It is a deficiency of such significance that the firm, at the time it issued itsaudit report, failed to obtain sufficient appropriate evidence to support itsaudit opinion on the financial statements and/ or on the effectiveness ofinternal control.

Under the definition, deficiencies include instances where a firm did notidentify or address appropriately financial statement misstatements orimproper disclosures, as well as failures by the firm to follow auditingstandards.

The Board has made it a 2013 priority to identify audit quality indicators.

A longer term goal is to track such measures for domestic global network

firms and report on those measures over time.

This project is already underway and will include the identification ofaudit quality measures in the areas of audit process and results, as well asthe development of methods for objectively measuring those audit qualityindicators.

Because of the complexity of these issues, our process for developingthese measures likely will be iterative.

Due to the multi-dimensional nature of audit quality, a "balancedscorecard" approach with various indicators and measures likely will benecessary.

I anticipate that the development, measurement, and analysis of auditquality indicators will inform PCAOB policy making and provide keyinformation about the state of audit quality across firms and over time.



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The results of this process will also provide us with information forreviewing, adding context to, or clarifying our current definition of"auditfailure" for our inspection reports.

In my view, the PCAOB's project on audit quality indicators andmeasures will represent a significant development in helping to advanceaudit quality and the reliability of audits now and in the long term.

The PCAOB is in a unique position to observe, track, and measure manyaspects of audit quality inputs and provide benchmarking information tofirms, promote firm accountability, and provide transparency and usefulinformation to investors and other stakeholders.

Such information will be useful in the marketplace as well, so that

investors and audit committees can demand better audit quality and shiftaudit firm competition over price to competition over quality.

Auditors' Use of Professional Skepticism in Audits

A key element of audit quality is the auditor's use of professionalskepticism.

Professional skepticism is particularly important in those areas of theaudit that involve significant management judgment or transactions

outside the normal course of business, and the auditor's consideration offraud.

These are often the high risk areas of the audit.

PCAOB inspections have identified numerous audits with deficiencieswhere auditors did not consistently and diligently apply professionalskepticism.

In many of those cases, the audit teams did not obtain sufficientappropriate evidence to support their audit opinions.



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This issue has been of such prevalence that we have identified theapparent failure to appropriately apply professional skepticism as asystemic quality control issue in some firms.

In addition, as part of the Board's outreach on auditor independence overthe past 18 months, a major theme that the Board heard from a variety ofstakeholders was the need for professional skepticism to be emphasizedmore in the education, training, and standard setting for auditors, as wellas in the firms' cultures, tone at the top, and systems of quality control.

On December 4, 2012, PCAOB issued Staff Audit Practice Alert No. 10:Maintaining and Applying Professional Skepticism in Audits toemphasize and remind auditors of the requirement to appropriately applyprofessional skepticism throughout audits.

It provides specific examples of audit deficiencies in which a lack ofprofessional skepticism was at least a contributing factor.

The Practice Alert includes examples that raise concernsabout a lack ofprofessional skepticism, such as instances in which engagement teamsdid not:

- obtain an understanding of the specific methods or assumptionsunderlying estimates;

- evaluate the significance ofevidencethat supported values other thanthose closest to the issuer's recorded prices;

- test beyond inquiring of management the significant assumptionsunderlying valuations;

- question whether certain assets were potentially impaired, despiteevidence that the carrying amount may not be recoverable; and

- question an issuer's use of a GAAP exception even though doing soconflicted with the plain language of the exception and with the firm'sinternal accounting literature.



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It is often difficult to determine if a lack of skepticism is the primarycause of audit deficiencies, and if so, which factors led to the lack ofskepticism.

Specifically,was it a problem with the auditor recognizing that a potentialissue exists that may require more work or effort (lack of skeptical

judgment)?

Orwas it a failure of the auditor to change behavior in response to anissue that was recognized (lack of skeptical action)?

What were the specific characteristics and circumstances attributable tothe auditor, the evidence, the client, and the audit environment that mayhave contributed to or caused the lack of appropriate professional

skepticism in an audit?

The PCAOB will continue to focus on the appropriate application ofprofessional skepticism in our inspections and our discussions with thefirms.

This is an area where the firms could benefit from academic thoughtleadership, research, and application tools.

I encourage you in the auditing section of the AAA -- to consider ways

to provide relevant research results to the firms, and to assist firms indeveloping and implementing potential tools, such as surveys and othermetrics, for tracking and assessing how professional skepticism is appliedon audits.

We would like to hear your ideas, too.

Inspections and Remediation

The third subject I 'd like to talk to you about today

also among theBoard's 2013 priorities is ourinspections and our oversight of therelated remediation of identified deficiencies in firms' systems of qualitycontrol.



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As you know, the largest PCAOB-registered public accounting firms those auditing more than 100 issuers are inspected annually by thePCAOB.

Firms that issue 100 or fewer issuer audit reports each year are subject toinspection at least every three years.

During 2012, the PCAOB inspected nine firms that audited more than 100issuers in 2011.

As we were conducting the 2012 inspections, we were also issuing theinspection reports for the 2011 inspections of these firms.

During 2012, we issued the 2011 inspection reports for six of the nine

annually inspected firms.

In addition, during 2012, the PCAOB conducted 244 triennial inspectionsat 167 domestic and 77 foreign firms.

The length of time it takes to complete preparation of the inspectionreports has been an ongoing challenge for the PCAOB, but we've recentlymade significant progress in clearing a backlog of older inspections.

During 2011, the Board processed numerous older inspection reports,

issuing a total of 344 inspection reports that year. (As a reference point,the Board conducted a total of 254 inspections during the previous year.)

During 2012, the Board continued to make progress in clearing most ofthe remaining backlog of older inspection reports.

The Board issued a total of 257 inspection reports during 2012. (Thiscompares to a total of 213 inspections conducted during 2011.)

The Board also is working through the related remediationdeterminations that follow the issuance of inspection reports.



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Firms are given 12 months from the date of the inspection report toremediate any deficiencies noted in their quality control systems, whichare included in the nonpublic Part I I of the reports.

Otherwise, they face publication of that portion of the inspection report.

As we become more current in our issuance of inspection reports andremediation determinations, we are taking a fundamental look at ourprocesses for issuing these reports.

We want to develop processes and tracking metrics to help improve theoverall timeliness of these reports and to prevent backlogs from occurringin the future.

In addition, we plan to conduct a thorough review of the content andreadability of our inspection reports.

This review will include proactive outreach to users, such as yourselves,to help us identify ways to improve the usefulness of the reports.

Before I move on, let me talk a minute about our inspection findings.

As I 'm sure you know, the number of serious deficiencies we reportedspiked in our 2010 inspections, and remained high in the 2011 inspections.

Common areas where we found audit deficiencies included revenuerecognition, fair value of financial instruments, testing and evaluatinginternal controls, related party transactions, the auditor's assessment ofand response to fraud risk, and the auditing of equity financinginstruments, among others.

Quality control findings in the nonpublic Part I I of our inspection reportsfocus on issues that may have caused the audit performance deficienciesreported in Part I, as well as other aspects of the firm's management of itsaudit practice that could negatively impact audit quality.

Some examplesof areas of specific concern that have appeared in Part I Iinclude problems in the areas of professional skepticism, internal



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inspections, and firms' quality control processes related to specificaspects of auditing, such as testing and evaluating internal control overfinancial reporting, fair value, and other areas.

The Board regularly engages in constructive dialogue with firms toencourage them to improve their practices and procedures.

Successful remediation and sustained improvements in audit quality areclearly the goals of this process.

Fortunately, we have seen most firms take their responsibilities forremedial efforts and improvements seriously.

Based on the timing of the related remediation periods and the firms'

efforts in those areas, it is reasonable to expect that firms would achievesignificant improvements in their PCAOB inspection results for theaudits of the 2012 financial statements -- which will be inspected during2013 -- in those areas identified as problems during the 2010 and 2011inspections.

I would also hope that we see some improvements emerge in the firms'inspection results for the 2012 inspection cycle in comparison to the 2010inspections.

Standard-Setting Activities

Lastly, I'd like to speak to you today about 2013 enhancements in the areaof standard setting.

The PCAOB is uniquely positioned to use its insight from inspectionactivities to improve existing auditing standards to support high qualityaudits to protect investors and the public interest.

As we look to what the PCAOB has accomplished through its standardsetting, and what still needs to be done, we have taken on an ambitiousproject to broadly reexamine our standard-setting approach.



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In our current strategic plan, we included a new strategy for standardsetting for audits of emerging growth companies, in light of the recentlyenacted Jumpstart Our Business Startups Act (JOBS Act).

We expect to continue to devote significant time and resources topreparing analyses to assist the Securities and Exchange Commission inmaking determinations under this Act regarding the applicability of newPCAOB standards to emerging growth companies, as well as continuingto explore ways to further incorporate economic analysis into ourrulemaking processes.

For the long term, we are doing the work necessary to establish a visionand framework to guide and prioritize our standard-setting activities.

Such a framework would be flexible and adjustable to respond toemerging risks and trends.

As part of this framework, we will consider using a combination of variousapproaches and related criteria for standard-setting projects, dependingon the circumstances.

We are thinking about the different categories or "tracks" for ourstandards projects.

For instance, when we determine that a project is necessary because ofunique circumstances related to U.S. issuers, we choose to take on aproject even if other standard-setting organizations are not dealing withthe issue.

In other cases, there may be issues that other standard-settingorganizations have raised or have acted upon where we can leverage thatwork to varying degrees in our own related projects.

As part of these efforts, we are looking to find a mechanism to eliminatethe notion of "interim" standards the title we use for the originalAICPA standards the Board adopted when it began operations back in2003.

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Documents

Risk Management Presentation Monday February 4 2013