Loss control case reports to OPE25 on FinTech for SOX ratio to consider for solvency and insurance underwriting

• Published date: 01 July 2023
• Author: John P. Koeplin,Pascal Lélé
• Date: 01 July 2023
• DOI: http://doi.org/10.1002/jcaf.22617

Received:  November  Accepted:  December 

DOI: ./jcaf.

RESEARCH ARTICLE

Loss control case reports to OPE25 on FinTech for SOX ratio

to consider for solvency and insurance underwriting

John P. Koeplin1Pascal Lélé2

School of Management, University of San

Francisco, California, USA

School of Management in association

with HCM Accounting Academy,

Innovation Hub Of LELE-HCM

ACCOUNTING INDUSTRY INC.,

Atlanta, Georgia, USA

Correspondence

John P.Koeplin, School of Management,

University of San Francisco, San

Francisco, CA, USA.

Email: koeplin@usfca.edu

Abstract

With the OPE we now have a rd ratio for the capital structure: Economic

Capital/Incentivized Pay. The SOX ratio is the financial instrument for internal

audit, solvency monitoring by the investor and banking supervision for OPE—

Calculation of RWA for operational risk, new version in force on January , .

It is part of the entity’s process to meet the three minimum conditions required

by BCBS for the use of the standardized approach: (a) Its board of directors and

senior management, as appropriate, are actively involved in the oversight of the

operational risk management framework; (b) It has an operational risk manage-

ment system that is conceptually sound and is implemented with integrity; and

(c) It has sufficient resources in the use of the approach in the major business

lines as well as the control and audit areas. Equity corresponds to the means

made available to a bank by its shareholders or other investors, as well as to the

profits it has made, and which have not been distributed. Economic Capital (EC)

belongs to this last category of means. The OPE in force so far based on the

mathematical approach (statistics and probabilities), will expire on December

, .

KEYWORDS

loss control, management strategy, regulation

1 INTRODUCTION

Effective as of December , and updated in March ,

the requirements of OPE will be out of force as of Decem-

ber , . It will be replaced by OPE, the management

accounting approach binding on all firms from January ,

, as a single standard (BCBS, a). The internal con-

trol and audit of banks as well as insurance companies and

Counterparties Credit Risk (CCRs) are now able to cor-

rect deficiencies which were the aggravating causes of the

financial crisis of . The US Senate vote creating “The

Human Capital Assessment and Accountability Frame-

work (HCAAF)” was passed in , that is, the same year

as the SOX Act whose Section  (Corporate Responsi-

bility for Financial Report) was to be taken into account

with Sections  (Operational Risk Control),  (Finan-

cial Reports and Internal Controls),  (Feedback in Real

Time), and  (Criminal Requirements for Falsificationof

Documents): See the th United States Congress, July ,

 (Koeplin & Lélé, ).

Usually SOX controls include control environment, risk

assessment, control activities, information and commu-

nication, and monitoring. SOX requires that all financial

reports include a report on internal controls. This report

should show that the company’s financial data is accurate

and that appropriate and adequate controls are in place to

ensure financial security and stability based on the abil-

ity to articulate non-GAAP and GAAP measures (Sarbanes

124 ©  Wiley Periodicals LLC. J Corp Account Finance. ;:–.wileyonlinelibrary.com/journal/jcaf

KOEPLIN  LÉLÉ 125

Oxley , ). The financial technology that exists to

provide Economic Capital (EC) accounts of the non-GAAP

measures of the SOX Ratio that have been missing so far is

the FinTech SOX (also called FinTech SAF, Sustainability

Accounting FinTech [Barnett & Sergi, ]).

This article extends our previous article “Human cap-

ital management accounting issues for SOX compliance

with Basel III final framework operating risk standards”

(Koeplin & Lélé, ) demonstrating the full compliance

with expectations regulators on the accounting approach

commonly called the standardized approach. The objective

is to deepen the practical aspect to help banks, insurance

companies and CCRs (Industries and Services, including

Local Authorities) to explore and calculate the cost-benefit

ratio of the compliance of their Internal Control and SOX

Audit with OPE.

The OPE is limited by the danger of unpredictabil-

ity and chance which puts internal control outside the

accounting and financial concerns of the SOX Act in the

United States and the internal control laws of other coun-

tries. Wherever Advanced Measurement Approach(AMA)

is used, a bank must demonstrate that its operational risk

measure meets a soundness standard comparable to that

of the internal ratings-based approach for credit risk (i.e.,

comparable to a one year holding period and a .% per-

centile confidence interval) (BCBS, b). Human capital

management accounting (HCMA) focuses on the unex-

pected loss (UL) and the expected loss (EL) measures

treated separately, as discussed in paragraph  of the

Basel II framework (CEPS, ). Not covered by Section

G “Treatment of expected losses and recognition of pro-

visions” of BCBS, Dec. , these are the expected losses

from “Other operating expenses” under the “Services”

business indicator: losses incurred due to the operating

loss events that were not provisioned/reserved in previous

years (BCBS, ).

Unlike the mathematical model of relative VaR (UL),

for the standardized accounting approach, UL data are

retrieved from the risk register already in place (or con-

figured by estimation for small and medium enterprises

(SME) based on the typology of Basel II incidents) and are

included in the accounting formula for absolute VaR (EL

+UL) of “Net loss after taking into account the impact of

recoveries” (BCBS, ).The ELs are provided by the anal-

ysis of the gaps in the management accounts over  years

of the financial information system in place (Bezzina et al.,

).

The process of mitigating operational risk losses

(expected “economic benefits”) is programmed and

carried out for each reporting date at the rate of .%

for banks and .% for insurers and risk counterparties

(Industries and services). The Risk Appetite Threshold

driven by the workstation interaction modules is therefore

.% for banks and .% for insurers and their risk

counterparties.

This is an internal control and SOX audit process coor-

dinated by the CFO to account for value creation costs.

The OPE standard approach requires that the SOX pro-

cess should lead to forward-looking provisioning scenarios

considering the EC generated. Models are used to pre-

dict the capital buffers the organization needs to cover

its operational risk. The CFO was assisted in this activ-

ity by financial analysts or actuaries who until now, in

the absence of internal reporting indexing losses on socio-

economic indicators available to all employees to mitigate

losses, used stochastic analysis, an indicator technique

normally used in the stock market, to represent the dis-

tribution of chance and manage uncertainty. Contrary to

market risk, operational risk management is not based, as

was believed until the subprime crisis, on the decision-

making tool or stochastic calculus used by the actuary.

Since the analyst is responsible for the calculations and

not for the approval, the OPE and the laws in force now

place this responsibility on the CEO and the Board (BCBS,

b), European Directive article a of May,  (EUR-

Lex, ). SEC Non-GAAP Financial Measures of April ,

) (SEC, ).

This re-establishes a fact that has been known for a

long time. A decision-making system does not replace the

operational systems that are in daily use by the company

in management accounting, cost accounting, or business

accounting. A decision-making platform is the key ele-

ment for the analysis, the simulation, and the optimization

of the performance of the company. But its efficiency

and the reduction of its margin of error depend on the

capacity of the cost-accounting tool to feed in the forward-

looking analysis using the current and historic real data of

operational risk of the company (Grima et al., ).

KPMG points out in “Implementation of Basel IV

Standardized Approach for Operational Risk” (“SAOR”)

(KPMG, ), that audit firms, even when using math-

ematical models in vogue since Basel , had understood

the urgency of filling the lack of skills and tools for

internal team cross-cutting interaction. Banks will have

to ensure their internal Loss Component (LC) processes

are sufficiently robust and cover the required -year his-

tory. The materiality threshold for LC has been set at

HKD (Hong Kong dollar) , (HKMA, ). These

LC requirements are more detailed and onerous than

currently required for Basic Indicator Approach (BIA),

including expectations of form an independent review of

data quality. Because of this, the following applies:

. Banks will need to invest in training and incentive

schemes for individuals involved in LC, in data

quality processes (automated or semi-automated