Basel 3

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Basel iii Compliance Professionals Association (BiiiCPA)
http://www.basel-iii-association.com

The Basel iii Compliance Professionals Association (BiiiCPA) is the largest association of Basel iii Professionals in the world. It is a business unit of the Basel ii Compliance Professionals Association (BCPA), which is also the largest association of Basel ii Professionals in the world.

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Basel 3

  1. 1. 1Basel iii Compliance ProfessionalsAssociation (BiiiCPA)1200G Street NW Suite800Washington, DC 20005-6705USA Tel:202-449-9750Web: www.basel-iii-association.comDear Member,Todaywewill start from the disclosurerequirementson thecompositionof banks capital.Composition of capital disclosure requirements- RulestextJune2012TheBasel Committeeon BankingSupervisionhaspublisheda set ofdisclosurerequirementson thecomposition of banks capital.During the financial crisis, marketparticipantsand supervisorswerehampered in their effortsto undertakedetailed assessmentsof banks capitalpositionsand make cross-jurisdictionalcomparisons.Thesource of this difficultywasinsufficientlydetailed disclosurebybanksand a lack of consistencyinreporting betweenbanksand acrossjurisdictions.Thislackofclaritymayhavecontributedtouncertaintyduring the financial crisis.Thedisclosurerequirementsaim toimprove market disciplinethroughenhancingboth transparencyand comparability.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  2. 2. 2Composition of capital disclosure requirementsIntroductionDuring the financial crisis, many market participantsand supervisorsattempted to undertake detailed assessmentsof thecapital positionsofbanksand comparisonsof their capital positionson a crossjurisdictionalbasis.Thelevel of detail of thedisclosureandthelack of consistencyin thewaythat it wasreported typically madethis taskdifficult and oftenmade itimpossibletodo withanyaccuracy.It is often suggestedthat lack of clarity on thequalityof capitalcontributedtouncertaintyduring thefinancial crisis.Furthermore, the interventionscarried out by the authoritiesmay havebeen more effectiveif capital positionsof the banksweremoretransparent.Toensurethat banksback their risk exposureswithahigh qualitycapitalbase,Basel III introduceda set of detailed requirementsto raise thequalityand consistencyof capital in thebankingsector.In addition, Basel III establishedcertainhigh level disclosurerequirementstoimprove transparencyof regulatory capital and enhancemarket disciplineand noted that more detailed Pillar 3 disclosurerequirementswouldbe forthcoming.This document setsout thesedetailed requirements.Toenablemarket participantsto compare thecapital adequacyof banksacrossjurisdictionsit is essential that banks disclosethefull list ofregulatorycapital itemsand regulatory adjustments.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  3. 3. 3In addition, toimproveconsistencyandeaseofuseofdisclosuresrelatingtothe composition of regulatory capital, and tomitigatethe risk ofinconsistent formatsunderminingtheobjectiveof enhanced disclosure,theBasel Committeehas agreed that internationally-activebanksacrossBasel member jurisdictionswill be required to publish their capitalpositionsaccordingtocommon templates.Therequirementsare set out in thefollowing5sections:Section 1:Post 1January 2018disclosure templateAcommon templateisestablishedthat banksmust usetoreport thebreakdown of their regulatory capital whenthe transitionperiod for thephasing-in of deductionsendson 1January 2018.It is designed tomeet the Basel III requirement todiscloseall regulatoryadjustments,includingamountsfallingbelow thresholdsfor deduction,andthusenhanceconsistencyand comparability in thedisclosureof theelementsof capital betweenbanksand acrossjurisdictions.This template may beused in advanceof 1January 2018in certaincircumstances, whichare set out in Section 1.Section 2: reconciliation requirementsA3 step approachfor bankstofollowis establishedtoensurethat theBasel III requirement toprovidea full reconciliation of all regulatorycapital elementsback tothepublishedfinancial statementsismet in aconsistent manner.This approach is not based on a common template becausethe startingpoint for reconciliation, the bank‟sreportedbalancesheet, will varybetweenjurisdictionsdue to the application of different accountingstandards.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  4. 4. 4Section 3: main features templateA common template is established that banks must use to meet the BaselIII requirement to provide a description of the main features of regulatorycapital instrumentsissued.Section 4: other disclosure requirementsThis section setsout what banks must doto meet theBasel IIIrequirement to provide the full termsand conditionsof regulatorycapitalinstrumentson their websitesand the requirement toreport thecalculationof any ratiosinvolving componentsof regulatorycapital.Section 5: template during the transitional periodThis section requiresbanks to usea modified version of the post 1January 2018templatein Section 1duringthetransitional phase.This template isestablishedtomeet theBasel III requirement for bankstodisclosethecomponentsof capital that arebenefiting from thetransitional arrangements.Implementation date and frequency of reportingNational authoritieswill giveeffect tothedisclosurerequirementsset outin this document by nolater than 30June2013.Banks will be required to comply withthe disclosurerequirementsfromthedateofpublicationoftheirfirstset offinancialstatementsrelatingtoabalancesheet date on or after30June2013(with theexceptionof thePost1January2018template set out in Section 1).Furthermore, except asrequired in paragraph 7, banksmust publish thisdisclosurewith the same frequencyas,and concurrent with, thepublication of their financial statements,irrespectiveof whetherthefinancial statementsare audited(ie disclosurewill typically be quarterlyor half yearly).Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  5. 5. 5In the caseof themain featurestemplate(Section 3) and provision of thefull terms and conditionsof capital instruments(Section 4), banksarerequiredtoupdatethesedisclosureswheneveranewcapitalinstrument isissuedand includedin capital and wheneverthere is a redemption,conversion/ write-downor other material changein thenature of anexistingcapital instrument.Under Pillar 3, large banksare required tomake certain minimumdisclosureswithrespect tocertaindefinedkeycapitalratiosandelementson a quarterlybasis,regardless of the frequencyof financial statementpublication.Thedisclosureof key capital ratios/elementsfor thesebankswillcontinueto be required under Basel III.Banks‟ disclosures required by this document must either be included inbanks‟published financial statementsor, at a minimum, these statementsmust provide a direct link tothe completed disclosure on their websitesoron publicly availableregulatory reports.Banks must alsomake availableon their websites, or through publiclyavailableregulatoryreports, an archive (for a suitableretention perioddetermined bytherelevant national authority) of all templatesrelatingtoprior reportingperiods.Irrespectiveof thelocation of thedisclosure (published financial reports,bank websitesor publicly available regulatory reports), all disclosuresmust be in the format required bythis document.Section 1:Post 1January 2018disclosure templateThecommon template that theBasel Committeehasdevelopedisset outin Annex 1, alongwith an explanationof itsdesign.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  6. 6. 6Thetemplateis designedto capture thecapital positionsof banksafterthetransition period for the phasing-inof deductionsendson 1January2018andmust beusedbybanksforreportingperiodsonorafterthisdate.If a jurisdictionpermitsor requires itsbankstoapplythe full Basel IIIdeductionsin advanceof 1January 2018(ie doesnot phase-inthedeductionsor acceleratesthephase-in period of deductions),it canpermitorrequire itsbankstousethetemplateinAnnex 1asanalternativetothetransitional templatedescribed in Section 5 from the date of applicationofat least the full Basel III deductions.In such casesthe relevant banksmust clearlydisclosethat theyare usingthistemplatebecausetheyarefullyapplying the Basel III deductions.Section 2: Reconciliation requirementsThis section setsout a common approach that banksmust followtocomplywiththerequirement of paragraph 91of theBasel III rulestext, which statesthat banks should disclose“a full reconciliationof allregulatorycapital elementsback tothebalancesheet in theauditedfinancial statements.”This requirement aimsto addressthe problem that at present there is adisconnect in manybanks‟disclosurebetweenthenumbersused for thecalculationof regulatory capital and thenumbersusedin thepublishedfinancial statements.Banks are required totake a 3 step approach toshowthe link betweentheir balancesheet in their publishedfinancial statementsand thenumbersthat are used in the compositionof capital disclosuretemplateset out in Section1.The3 stepsrequire banks to:Step 1: Disclosethereported balancesheet under the regulatoryscope ofconsolidation.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  7. 7. 7Step 2: Expand thelinesof thebalancesheet under the regulatoryscopeof consolidation to displayall of thecomponentsthat areused in thecomposition of capital disclosure template.Step 3: Map eachof the componentsthat aredisclosedin Step 2 tothecomposition of capital disclosure templateset out in Section 1.The3 step approach outlinedbelow is designed to offer the followingbenefits:Thelevel of disclosureis proportionate, varying withthecomplexityof thebalancesheetofthereportingbank (iebanksarenot subjecttoafixedtemplate that is designedtofit themost complex banks.Abank can skip a step if there is nofurther information addedby thatstep).Market participants and supervisors can trace the origin of the elementsof the regulatory capital back to their exact location on the balance sheetunder the regulatory scopeof consolidation.Theapproach is flexibleenough to be used under anyaccountingstandard: firms are required tomap all the componentsof theregulatorycapital disclosure templatesback to the balance sheet under theregulatoryscope of consolidation, regardlessof whether the accountingstandardsrequire the sourceto be reportedon the balancesheet.Step 1:Disclose the reported balance sheet under the regulatoryscope of consolidationThescope of consolidationfor accountingpurposesand for regulatorypurposesare oftendifferent.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  8. 8. 8This factor often explains much of the difference between the numbersused in the calculation of regulatory capital and the numbers used in abank‟spublished financial statements.Therefore,akeyelement in anyreconciliationinvolvesdisclosinghowthebalancesheet in thepublishedfinancial statementschangeswhen theregulatoryscope of consolidation is applied.Step 1is illustrated inAnnex 2.If the scope of regulatory consolidation and accounting consolidation isidentical for a particular banking group, it would not need to undertakeStep 1.The banking group could simply state that there is no difference betweenthe regulatory consolidation and the accounting consolidation and movetoStep 2.In additiontoStep 1, banks are required to disclosethe list the legalentitiesthat are included within accountingscope of consolidationbutexcludedfrom the regulatoryscope of consolidation.This will better enablesupervisorsand market participantstoinvestigatetherisksposedby unconsolidatedsubsidiaries.Similarly, banks arerequiredtolist thelegal entities included in theregulatoryconsolidationthat are not included in the accountingscope ofconsolidation.Finally, if some entitiesare included in both the regulatoryscope ofconsolidationand accounting scope of consolidation, but themethod ofconsolidationdiffersbetweenthese twoscopes, banks are required to listtheselegal entitiesseparatelyand explain thedifferencesin theconsolidationmethods.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  9. 9. 9Regardingeach legal entitythat isrequired to bedisclosedbythisparagraph, banksmust alsodiscloseitstotal balancesheet assetsandtotal balancesheet equity (asstated on the accountingbalancesheet ofthelegal entity) and a description of the principleactivitiesof the entity.Step 2: Expand the linesof the regulatory balance sheet todisplay all of the components used in the definition of capitaldisclosure templateMany of the elementsused in the calculationof regulatory capital cannotbereadily identifiedfrom theface of thebalancesheet.Therefore,banksshould expand therowsof theregulatory-scope balancesheet such that all of the componentsused in thecompositionof capitaldisclosuretemplate(described in Section 1) are displayed separately.For example, paid-inshare capital maybe reported asone lineon thebalancesheet.However,someelementsof thismay meet therequirementsfor inclusionin Common EquityTier 1(CET1) and other elementsmay onlymeet therequirementsforAdditional Tier 1(AT1) or Tier 2 (T2), or may not meettherequirementsfor inclusionin regulatorycapital at all.Therefore, if the bank hassome paid-in capital that feedsintothecalculationof CET1 and some that feedsintothe calculationofAT1, itshould expand the„paid-in sharecapital‟lineof thebalancesheet in thefollowingway(alsoillustrated inAnnex 2(step 2)):In addition, asillustratedabove, each element of theexpanded balancesheet must be given a referencenumber/letter for usein Step 3.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  10. 10. 10Asanotherexample,oneoftheregulatoryadjustmentsisthedeductionofintangibleassets.While at first it mayseem asif thiscan be taken straight off the face of thebalance sheet, there are a number of reasonswhy this is unlikely to be thecase.Firstly, the amount on the balancesheet may combine goodwill, otherintangiblesand mortgage servicesrights.MSRsare not to bededucted in full (theyare instead subject to thethreshold deduction treatment).Secondly, the amount tobe deducted is net of any relateddeferred taxliability.This deferred tax liability will be reported on the liabilitysideof thebalancesheet and is likely tobe reportedin combination withotherdeferred tax liabilitiesthat havenorelationto goodwill or intangibles.Therefore, thebank should expand thebalancesheet in the followingway:Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  11. 11. 11It is important to note that banks will only need to expand elementsof thebalance sheet to the extent that thisis necessary to reach the componentsthat are usedin thecomposition of capital disclosure template.So, for example, if all of the paid-incapital of thebank met therequirementstobeincludedin CET1,thebank wouldnot needtoexpandthisline.Thelevel of disclosureis proportionate, varying withthe complexityofthebank‟sbalancesheet and itscapital structure.Step 2 is illustratedinAnnex 2.Step 3: Map each of the componentsthat are disclosed in Step 2to the composition of capital disclosure templatesWhen reportingthedisclosuretemplate, describedin Section1andSection 5, the bank isrequired to usethereference numbers/ lettersfromStep 2 toshow the source of every input.For example, thecomposition of capital disclosure templateincludestheline“goodwill net of relateddeferred tax liability”.Next to thedisclosureof this item in thedefinitionof capital disclosuretemplatethebank shouldput “a–d” toillustratehowthesecomponentsofthebalancesheet under theregulatory scope of consolidation have beenused to calculatethisitem in the disclosuretemplate.Additional comments on the 3 step approachTheBasel Committeeconsidered requiringbanks touse a commontemplatetodisclosethereconciliationbetweenbanks‟balancesheetsandtheir regulatorycapital.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  12. 12. 12However,it doesnot feel that this wouldbe possibleat thisstage giventhat banksbalancesheetsare not reported in a common wayacrossjurisdictionsdue to the application of different accountingstandards.Withina singlejurisdiction, theuse of a common templatemay bepossible.Therefore,therelevant authoritiesmaydesignacommon templatethat isconsistent withthe 3step approach set out above and require banksusethisin order toachievegreaterconsistencyin thewaythe3stepapproachis implementedwithin their jurisdiction.Section 3: Main features templateBasel III requiresbanks todisclosea descriptionof the mainfeaturesofregulatorycapital instrumentsissued.While bankswill alsobe required tomake availablethe full termsandconditionsof their regulatory capital instruments(see section 4), thelength of thesedocumentsmakes the extractionof the key featuresaburdensome task.Theissuingbank is better placedtoundertake thistask than marketparticipantsandsupervisorsthat want anoverviewof thecapital structureof the bank.Basel II Pillar 3 guidancealreadyincludesa requirement that banksprovidequalitativedisclosure that setsout “Summary information on thetermsand conditionsof themain featuresof all capital instruments,especiallyin thecaseof innovative, complex or hybrid capitalinstruments.”However,the BaselCommitteehasfound that thisBasel II requirementis not met in a consistent waybybanks.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  13. 13. 13Thelackof consistencyinboth thelevelof detail providedandtheformatof the disclosuremakes the analysisand monitoringof this informationdifficult.To ensure that banksmeet the Basel III requirement to disclose the mainfeatures of regulatory capital instruments in a consistent and comparableway, banks are required tocompletea „main featurestemplate‟.This template representsthe minimum level of summarydisclosurethatbanksare required toreport in respect of each regulatory capitalinstrument issued.Thetemplateis set out inAnnex 3of thisreport, along witha descriptionof each of the itemstobe reported.Somekey pointstonote about thetemplate are:- It hasbeen designed to be completed by banksfrom when theBaselIII frameworkcomesintoeffect on 1January 2013.It thereforealsoincludesdisclosurerelatingto instrumentsthat aresubjecttothetransitional arrangements.- Banks are required toreport each regulatorycapitalinstrument, includingcommon shares, in a separatecolumnof thetemplate, such that the completed templatewouldprovide a „mainfeaturesreport‟that summarisesall of theregulatorycapitalinstrumentsof thebankinggroup.- Thelist of main featuresrepresentsa minimum level of requiredsummarydisclosure.In implementingthisminimum requirement, each BaselCommitteemember authorityisencouraged toadd tothis list if therearefeaturesthat it isimportant todisclosein the context of thebanks theysupervise.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  14. 14. 14- Banks are required tokeepthecompleted main featuresreportup-to-date, such that the report isupdated and made publiclyavailablewhenevera bank issuesor repaysa capital instrument andwheneverthere isa redemption, conversion/ write-downor othermaterial changein thenature of an existingcapital instrument.- Given that thetemplate includesinformation on theamountrecognisedin regulatory capital at the latest reporting date, themainfeaturesreport should either be included in the bank‟spublishedfinancial reportsor, at a minimum, thesefinancial reportsmustprovidea direct link towherethe report can be found on the bank‟swebsiteor publicly availableregulatoryreporting.Section 4: Other disclosure requirementsIn additiontothedisclosurerequirementsset out in Sections1to 3, andaside from thetransitional disclosurerequirementsset out in Section 5,theBaselIII rulestext makesthefollowingrequirementsinrespectof thecomposition of capital:Non-regulatory ratiosBanks whichdiscloseratiosinvolvingcomponentsof regulatory capital(eg“Equity Tier 1”, “Core Tier 1” or “TangibleCommon Equity” ratios)must accompanysuch disclosureswitha comprehensive explanationofhowtheseratiosarecalculated.Full termsand conditionsBanks are required tomake availableon their websitesthe full terms andconditionsof all instrumentsincludedin regulatory capital.Therequirement for banksto make available the full termsandconditionsof regulatorycapital instrumentson their websiteswill allowmarket participantsand supervisorstoinvestigatethe specificfeaturesofindividual capital instruments.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  15. 15. 15An additional related requirement isthat all banksmust maintain aRegulatoryDisclosuressection of their websites, whereall of theinformation relatingto disclosureof regulatory capital is made availabletomarket participants.In caseswheredisclosurerequirementsset out in this document are metvia publicationthrough publicly availableregulatory reports, theregulatorydisclosuressection of thebank‟swebsiteshould providespecific linksto therelevant regulatoryreportsthat relateto thebank.This requirement stemsfrom the supervisory experiencethat, in manycases,thebenefit of Pillar 3 disclosuresisseverely diminished by thechallengeof findingthedisclosurein the first place.Ideallymuch of the information that wouldbe reported in theRegulatoryDisclosuressectionof the websitewouldalsoincluded in thepublishedfinancial reportsof thebank.TheBasel Committeehasagreed that, at minimum, thepublishedfinancialreportsmust direct userstotherelevant sectionof their websiteswherethe full set of required regulatorydisclosureisprovided.Section 5: Template during the transitional periodTheBaselIII rulestext statesthat: “During the transition phasebanksare required todisclosethespecific componentsof capital, includingcapital instrumentsand regulatoryadjustmentsthat are benefitingfromthetransitional provisions.”Thetransitional arrangementsfor Basel III phasein the regulatoryadjustmentsbetween1January 2014and 1January 2018.Theyrequire20% of theadjustmentstobemadeaccordingtoBaselIII in2014,withthe residual subject to existingnational treatment.In 2015thisincreasesto40%, and soon, until thefull amountof theBaselIII adjustmentsare applied from 1January 2018.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  16. 16. 16Thesetransitionalarrangementscreatean additional layer of complexityin thedefinitionof capital in theperiod between1January 2013and 1January2018,especiallyduetothefactthat existingnationaltreatmentsoftheresidual regulatory adjustmentsvary considerably.This complexitysuggeststhat there wouldbe particular benefits insettingout detaileddisclosurerequirementsduring thisperiod to ensurethat banksdonot adopt different approachesthat make comparisonsbetweenthem difficult.This section of thecomposition of capital disclosure rules text aimstoensure that disclosure during the transitional periodisconsistent andcomparable acrossbanksin different jurisdictions.Banks will be required tousea modified version of the Post 1January 2018Disclosure Template, set out in Section 1, in a way that captures existingnational treatmentsfor the regulatory adjustments.Theuse of a modified version of the Post 1January 2018DisclosureTemplate, rather than thedevelopment of a completelyseparate set ofreporting requirements, should help to reducesystemscostsfor banks.Thetemplateis modified in justtwoways:(1)An additional column indicatesthe amountsof the regulatoryadjustmentsthat will be subjectto theexistingnational treatment;and(2)Each jurisdictionwill insert additional rowsin four separate placestoindicatewherethe adjustment amountsreported in the added columnactuallyaffect capital during thetransition period.Themodificationstothetemplateareset out inAnnex 4,alongwithsomeexamplesof how thetemplate will workin practice.Banksarerequiredtousethetemplate for all reportingperiodsonor aftertheimplementationdate set out inparagraph5, and banksarerequiredtoBasel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  17. 17. 17report thetemplatewith the same frequencyasthepublicationof theirfinancial statements(typically quarterly or half yearly).Annex 1Post 1January 2018 Disclosure TemplateKey pointsto note about the template set out in thisAnnex are:- Thetemplateis designedtocapture thecapital positionsof banksafter the transition period for the phasing-in of deductionsendson 1January 2018(thetemplatefor banks to usetoreport their capitalpositionsduring this transitional phase is set out in Section 5).- Certainrowsarein italics. Theserowswill be deletedafter all theineligiblecapital instrumentshave beenfully phased out (ie from 1January 2022onwards).- Thereconciliationrequirementsincluded in Section 2result in thedecompositionof certain regulatoryadjustments.For example, thedisclosuretemplatebelowincludestheadjustment„Goodwill net of relatedtax liability‟.Therequirementsin Section 2 will lead tothedisclosureof both thegoodwill component and the relatedtax liabilitycomponent of thisregulatoryadjustment.- Regardingthe shading: Each dark grey row introducesa new sectiondetailing a certain component of regulatorycapital.Thelight greyrowswithnothickborderrepresent thesum cellsin therelevant section.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  18. 18. 18Thelight grey rowswithathick border showthemain componentsofregulatorycapital and the capital ratios.- Also providedbelowisatablethat setsout anexplanationof eachlineof the template, withreferencesto the appropriateparagraphsof theBasel III text.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  19. 19. 19Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  20. 20. 20Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  21. 21. 21Set out inthefollowingtableisanexplanationofeachrowof thetemplateabove.Regardingthe regulatoryadjustmentsbanksare required toreportdeductionsfrom capital aspositive numbersand additionsto capital asnegativenumbers.Forexample,goodwill (row8) shouldbereportedasapositivenumber, asshouldgainsduetothechangeintheowncredit riskofthebank (row14).However,lossesdue to the changein theowncredit risk of thebankshould be reported asa negativenumber astheseareaddedback in thecalculationof Common Equity Tier 1.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  22. 22. 22Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  23. 23. 23Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  24. 24. 2441. In general, to ensure that the common templates remain comparableacross jurisdictions there should be no adjustments to the version banksusetodisclosetheir regulatory capital position.However,the followingexceptionsapplyto take account of languagedifferencesand toreduce the reportingof unnecessaryinformation:Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  25. 25. 25- Thecommon template and explanatorytableabove can be translatedbythe relevant national authoritiesintothe relevant nationallanguage(s) that implement the Basel standards.Thetranslated version of the template will retain all of the rowsincludedthe templateabove.- Regardingthe explanatorytable, thenational version can referencethenational rulesthat implement therelevant sectionsof Basel III.- Banks arenot permitted to add, deleteor changethedefinitionsofanyrowsfrom thecommon reportingtemplateimplementedin theirjurisdiction.This will prevent adivergence of templatesthat could underminetheobjectivesof consistencyand comparability.- This national version of the templatewill retain thesame rownumberingused in the first column of thetemplateabove, such thatmarket participantscan easily map thenational templatestothecommon version above.However,the common template includescertainrowsthat referencenational specific regulatory adjustments(row 26, 41, and 56).Therelevant national authorityshould insert rowsafter each of thesetoproviderowsfor bankstodiscloseeach of the relevant nationalspecific adjustments(withthetotalsreported in rows26, 41and 56).Theinsertion of anyrowsmust leavethe numberingof the remainingrowsunchanged, eg rowsdetailingnational specific regulatoryadjustmentstocommon equityTier 1couldbelabelledRow26a,Row26b etc, toensure that the subsequent row numbers arenot affected.- In caseswherethenational implementation of Basel III applies amore conservativedefinition of an element listedin thetemplateBasel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  26. 26. 26above, national authoritiesmay choosebetweenone of twoapproaches:Approach 1: in thenational version of thetemplatemaintain thesamedefinitionsof all rowsasset out in the templateabove, and requirebanksto report the impact of the more conservativenational definitionin thedesignatedrowsfor national specific adjustments(ie row 26,row 41,row 56).Approach 2: in thenational version of the templateusethedefinitionsof elementsasimplementedinthat jurisdiction, clearlylabellingthemasbeing different from the Basel III minimum definition, and requirebanksto separatelydisclosethe impact of each of thesedifferentdefinitionsin thenotestothe template.Theaim ofbothapproachesistoprovideall theinformationnecessarytoenablemarket participantstocalculate thecapital of bankson acommon basis.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  27. 27. 27Annex 2Illustration of the 3 step approachto reconciliationStep 1Under Step 1banksare requiredto taketheir balancesheet in theirpublishedfinancial statements(numbersreported themiddlecolumnbelow, in a balancesheet that isprovidedfor illustrative purposes) andreport thenumberswhenthe regulatory scopeof consolidationis applied(numbersreported in the right hand column below of the illustrativebalancesheet).If there are rowsin the balancesheet under theregulatory scope ofconsolidationthat are not present in thepublishedfinancialstatements,banksare required toadd theseand givea value of zero inthemiddlecolumn.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  28. 28. 28Step 2Under Step 2banksare required toexpandthe balancesheet under theregulatoryscope of consolidation (revealedin Step 1) to identify all theelementsthat are used in the definitionof capital disclosuretemplate setout inAnnex 1.Set out below are some examplesof elementsthat may need to beexpanded for a particular banking group.Themore complex the balancesheet of thebank, themore itemswouldneed to be disclosed.Each element must be given a referencenumber / letter that can be usedin Step3.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  29. 29. 29Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  30. 30. 30Step 3UnderStep 3banksarerequiredtocompleteacolumnaddedtothepost 1January 2018disclosure templatetoshow the source of everyinput.For example, thePost 1January 2018DisclosureTemplateincludestheline“goodwill net of related deferred tax liability”.Next to thedisclosureof this item in thetemplate thebank wouldberequiredto put “a–d” toshow that row 7 of the template hasbeencalculatedasthedifferencebetweencomponent “a” of thebalancesheetunder the regulatory scopeof consolidation, illustratedin step 2, andcomponent “d”.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  31. 31. 31Annex 3Main featurestemplateSet out below isthetemplate that banksmust usetoensure that the keyfeaturesof all regulatory capital instrumentsare disclosed.Banks will be required to completeall of theshaded cellsfor eachoutstandingregulatory capital instrument (banks should insert “NA” ifthequestion is not applicable).Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  32. 32. 32Thistemplate wasdeveloped in a spreadsheetthat will be made availabletobanks on theBasel Committee‟swebsite.Tocompletemost of thecellsbankssimplyneed toselect an option froma drop down menu.Usingthe referencenumbersin theleft column of the tableabove, thefollowingtable providesa more detailedexplanation of what banksarerequiredto report in each of the grey cells,including, whererelevant, thelist of optionscontainedin thespreadsheet‟sdrop down menu.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  33. 33. 33Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  34. 34. 34Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  35. 35. 35Annex 4Disclosuretemplate during the transition phaseThetemplatethat banksmust useduringthetransitionphaseisthesameasthe Post 1January 2018disclosure template set out in Section 1exceptfor the followingadditions(all of whichare highlighted in the templatebelowusing cellswithdotted borders and capitalisedtext):- Anew column hasbeen added for banksto report the amount of eachregulatoryadjustment that is subject totheexistingnational treatmentduring thetransitionphase(labelledasthe “pre-BaselIII treatment”).Example1: In 2014bankswill be required to make 20% of theregulatoryadjustmentsin accordancewith BaselIII.Considera bank with“Goodwill, net of related tax liability” of $100mnand assume that thebank isin a jurisdiction that doesnot currentlyrequirethis tobe deducted from common equity.Thebank willreport$20mnin thefirst ofthetwoemptycellsinrow8andreport $80 mn in thesecond of thetwocells.Thesum of thetwocellswill thereforeequal thetotal BaselIII regulatoryadjustment.- While thenew column showsthe amount of each regulatoryadjustment that issubject to the existingnational treatment, it isnecessarytoshowhow this amount isincludedunder existingnational treatment in the calculationof regulatory capital.Therefore,new rowshave been added in each of thethree sectionsonregulatoryadjustmentstoalloweach jurisdictionto set out theirexistingnational treatment.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  36. 36. 36Example2:Assume that thebank describedinthebullet point aboveisina jurisdictionthat currentlyrequiresgoodwill to be deductedfrom Tier 1.This jurisdictionwill insert a new row in betweenrows41and 42, toindicatethat duringthe transition phasesome goodwill will continuetobedeductedfrom Tier 1(in effectAdditional Tier 1).The$80mn that thebank had reportedin the last cell of row 8, will thenneed to be reported in this new row insertedbetweenrows41and 42.In additiontothe phasing-inof some regulatoryadjustmentsdescribedabove, the transitionperiod of Basel III will in some casesresult in thephasing-out of previousprudential adjustments.In thesecasesthe new rowsadded in eachof thethree sectionsonregulatoryadjustmentswill be used by jurisdictionsto set out theimpactof thephase-out.Example3: Consider a jurisdictionthat currentlyfilters out unrealisedgainsand losseson holdingsofAFSdebt securities and consider a bankin that jurisdictionthat hasan unrealised lossof $50mn.Thetransitional arrangementsrequire this bank torecognise20% of thisloss(ie $10mn) in 2014.This meansthat 80% of this loss(ie$40mn) is not recognised. Thejurisdictionwill thereforeincludea row betweenrows26and 27thatallowsbanks to add back thisunrealisedloss.Thebank will then report $40mn in this row asan additiontoCommonEquityTier 1.- Totake account of the fact that the existingnational treatment of aBaselIII regulatory adjustment may be toapplya risk weighting,jurisdictionswill alsobeabletoaddnewrowsimmediatelypriortotherow on risk weightedassets(row 60).Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  37. 37. 37Theserowswill need to be defined by each jurisdictiontolist theBaselIII regulatory adjustmentsthat are currentlyrisk weighted.Example4: Consider a jurisdictionthat currentlyrisk weightsdefinedbenefit pension fund net assetsat 200% and in 2014a bank has$50mn oftheseassets.Thetransitional arrangementsrequire this bank todeduct 20% of theassetsin 2014.This meansthat the bank will report $10 mn in the first empty cell in row15and $40 mn in the second emptycell (the total of the two cellsthereforeequalsthe total Basel III regulatory adjustment).The jurisdiction will disclose in one of the inserted rows between row 59and 60 that such assetsare risk weighted at 200% during the transitionalphase.Thebank will thenbe required to report a figure of $80mn ($40mn *200%) in that row.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  38. 38. 38Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  39. 39. 39Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  40. 40. 40Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  41. 41. 41MAS Consults on Proposed Review of Risk-based CapitalFramework for Insurance BusinessSingapore, 22June 2012TheMonetaryAuthority of Singapore (MAS) today releasedaconsultationpaper on the review of theRisk-BasedCapital (RBC)frameworkfor insurancebusiness.TheRBC frameworkwasfirstintroducedin Singaporein 2004.It adoptsarisk-focusedapproachtoassessingcapital adequacy and seeksto reflecttherelevant risksthat insurancecompaniesface.MAS is reviewingthe framework, given evolving market practicesin theinsuranceindustry and in international accountingand regulatorystandards.Thereview aimstoimprove the comprehensivenessof the riskcoverageand risk sensitivityof the framework, and is not expected to result in asignificant overhaul to the current framework.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  42. 42. 421.TheRBC frameworkfor insurancecompanieswasfirst introducedinSingapore in 2004.It adoptsarisk-focusedapproachtoassessingcapitaladequacyandseekstoreflect the relevant risks that insurancecompanies face.Theminimum capital prescribed under theframeworkservesasa buffertoabsorblosses.TheRBC framework alsoprovidesclearerinformation on the financialstrengthofinsurersandfacilitatesearlyandeffectiveinterventionbyMAS,if necessary.2.Whilst theRBC frameworkhasserveduswell, MAS is embarkingonareview (“RBC 2”) of theframework in light of evolving market practicesand global regulatory developments.Thereview will takeintoaccount therevisedInsuranceCore PrinciplesandStandards issued by the InternationalAssociation of InsuranceSupervisorslast year.3.Arisk-focusedapproach to capital adequacycontinuesto beappropriateand relevant in the supervisionof insurers.As such, theRBC 2 review is not expected to result in a significantoverhaul to thecurrent framework.Rather, the review aimsto improve the comprehensivenessof the riskcoverageand the risk sensitivityof the framework, aswell asdefiningmore specifically, MAS supervisoryapproach withrespect tothesolvencyintervention levels.4.Section2 of thepaper detailsthe proposed review in the areasofrequiredcapital.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  43. 43. 43This toucheson theexpansion of the current framework toaddressmorerisk types, the introduction of target criteria for risk calibration, thediversificationbenefits from correlationsbetweenrisk types, and theusageof internal models.5.Section3 elaborateson the componentsof availablecapital. Theseincludethe treatment for negative reservesand aggregateprovisionsfornon-guaranteedbenefits.In addition, it isenvisaged that there will be some degreeof convergencewith Basel III global capital standards, asMAS seeksto improve thealignment of capital standardsbetweenthebanking and insuranceindustries.6.Section4 setsout thetwoexplicit solvencyintervention levels,thePrescribed Capital Requirement aswell asthe Minimum CapitalRequirement.Having clear and transparent solvencyintervention levelsisuseful forinsurers.MAS expectationson the type of correctivecapital actionstobe takenbyinsurers,and theurgencywhichtheseactionsshouldbe taken, will bereferencedagainst thesesolvencylevels.7.Section5 setsout theproposed approach withregardstorisk-freediscount rate, and consultson an alternativeapproachtothederivationoftheprovision for adverse deviation (or risk margin).8.TheRBC 2review will not just focussolelyonthequantitativeaspectsof capital requirements.It alsoseeksto enhanceinsurers‟risk management practices.Assuch, the scopeof the review includesqualitativeaspectsonEnterpriseRisk Management, asoutlinedin Section 6.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  44. 44. 441.9MAS hopestowork closelywiththeindustryon thereview, aswasthecasewhenthe RBC framework wasfirst developed.We anticipatethat the industry will be involvedthrough workgroupparticipation, quantitativeimpact studiesand consultation feedback.COMPONENTSOF REQUIRED CAPITAL1.TheRBC frameworkrequiresinsurerstohold capital againsttheir riskexposuresknown asthe Total Risk Requirements(“TRR”).Risksarisingfrom an insurer‟sassetsand liabilitiesare groupedin tothreedistinct components:- Component 1(C1) requirement relatestoinsurancerisksundertakenbyinsurers.C1requirement for general insurancebusinessis determined byapplying specificrisk chargeson an insurer’spremium and claimsliabilities.Riskchargesapplicableto different businesslinesvary withthevolatilityof theunderlying business.The requirement for life insurance business is calculated by applyingspecific risk margin to key parameters affecting policy liabilities suchasmortality, morbidity, expensesand policy termination rates.- Component 2(C2) requirement relatestorisksinherent inaninsurer‟sasset portfolio, such asmarket risk and credit risk.It is calculatedbased on an insurers exposure tovariousmarketsincludingequity, debt, property and foreign exchange.TheC2 requirement alsocapturesthe extent of asset-liabilitymismatchpresent in an insurer’sportfolio.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  45. 45. 45- Component 3(C3) requirement relatestoasset concentrationrisks incertain typesof assets,counterpartiesor groupsof counterparties.C3 chargesare computed based on an insurer‟sexposure in excessoftheconcentrationlimitsasprescribed under theInsurance(Valuationand Capital) Regulations2004.2.Thefollowingparagraphsset out whereenhancementsare expected.Inclusion of New Risk Types3.Thecurrent RBC framework alreadycapturesmost of thematerial riskssuchasmarket risk, credit risk, underwritingrisk and concentration risk.For riskswhicharenot specificallyquantified under RBC, theyareconsideredqualitativelyunder MAS riskbased supervision and MAShasthepowersunder theInsuranceAct to imposeadditional capitalrequirementsif necessary.For theRBC 2 review, MAS is reviewingthe risk coveragein linewithevolvingglobal regulatoryand market developments.Spread risk4.Thecurrent RBC framework takesintoaccount thecredit risk ofcorporatebondsbut doesnot capture credit spread risk.In MASannual stresstesting exercise, insurerswerefound to besusceptibleto credit spread shocks.This is not surprisinggiven that insurershold a high proportion ofcorporatebonds.MAS proposestoexplicitlycapture credit spread risk under the RBC 2framework.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  46. 46. 46This is similar tothe credit spread shocksappliedduring stresstesting.Spreadrisk resultsfrom thesensitivityof thevalueof assetsandliabilitiestochangesin the level or in the volatility of credit spreadsover therisk-freeinterestrate.Proposal 1MAS proposestoincorporate an explicit risk chargetocapture spreadrisk within the RBC 2 framework.Liquidity risk5.Liquidityrisk is the exposureto lossin theevent that insufficient liquidassetsareavailablefrom theassetssupportingthepolicyliabilities,tomeet thecash flow requirementsof policyholder obligations,or assetsmay be available,but can onlybeliquidatedtomeet policyholderobligationsat excessivecost.6.However, wedonot proposeto imposean explicit riskchargeforliquidityrisk asthereis nowell-establishedmethodology toquantifycapital requirementsfor liquidityrisk. MAS will continueto assesstherobustnessof insurers‟liquidityrisk management through supervision.Proposal 2MAS proposesnot toimposean explicit risk chargefor liquidityrisk.MAS will workwiththe industry toconduct liquiditystress-testing, andassessthesoundnessof theinsurer’sliquidityriskmanagement practicesaspart of MASrisk-basedsupervision.Operational risk7.Operational risk refersto the risk of lossarisingfrom complexoperations,inadequate internal controls,processesand informationBasel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  47. 47. 47systems, organisationchanges,fraud or human errors, (or unforeseencatastrophesincludingterrorist attacks).Operationalriskisrecognisedasarelevant andmaterialriskthat needstobe addressed in a supervisory framework.Currentlythere is noexplicit risk chargefor operational risk under theRBC framework,though operational risk is assessed aspart of MASongoing supervisionof insurers.However,both Basel II and a number of major jurisdictionshaveexplicitlyintroduced capital requirementsfor operational risk in theircapital framework.8.Methodologiestoquantify operational risk continuetoevolveglobally.Theinsuranceindustry alsodoesnot presently collect sufficientoperational risk data.Assuch, MAS intendstostart off withasimplified andpragmaticmethodtoquantify the operational risk charge, and refineitsmethodology infutureasmore databecomesavailableand practicesaremoreestablishedinternationally.Theproposed method is broadly similar to some of the approachesusedin other jurisdictionssuch asthe European EconomicArea (under thestandardisedformula approachof SolvencyII) andAustralia.9.MAS proposestoput a cap on the amount of operational risk chargesuch that it will not be larger than 10% of an insurer’stotal riskrequirements.This is based on our observation on banks‟operational risk charge asapercentageof the total capital requirements.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  48. 48. 48There is noevidenceto suggest that an insurer’soperational risk wouldbevastlydifferent from that experiencedby a bank.Proposal 3MAS proposestoincorporate an explicit risk chargetocaptureoperational risk within the RBC 2 framework, calculated as:x% of the higher of the past 3 years‟ averagesof (a) earnedpremiumincome;and (b) grosspolicyliabilities,subject to a maximum of 10%ofthetotal risk requirements.Where x = 4% (except for investment-linkedbusiness, wherex = 0.25%giventhat most of themanagement of investment-linkedfund isoutsourced)Consultation Question 1Is thisformula or baseschosen appropriate?Should webe usingwrittenpremium or net policyliabilitiesinstead?Should there be differencesintheformula for different types of insurers,for example, direct life, directgeneral and reinsurers?Consultation Question 2What type of data can theinsuranceindustrystart tocollect in order tobuild up sufficient data tobetter quantifyor model operational risks?Insurancecatastropherisk2.10While concentration risk is coveredunder the existingframework(asC3 risk requirements), it is onlyconfined to asset concentration risk.TheRBC framework doesnot capture insurancecatastropherisk, whichistheriskthat acatastrophecausesaone-timespikein claims experience,with a corresponding impact on claims and/ orliabilities.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  49. 49. 49Such claimsexperiencecan havea significant impact on an insurer’ssolvency, particularlyif the insurer hasa concentration of riskswrittenina particular area or businessline.Recent natural catastrophesin the region have shown that insurancecatastropheriskis a real and relevant risk toinsurershere whichwriterisksin theregion.11.ThereareafewoptionstoexplicitlyaddressthisriskundertheRBC 2framework.Oneoption wouldbe to require insurersto construct a catastrophescenario that ismost relevant to them and hasthe greatestimpact, benchmarked to some target criteria (e.g. 1in 200yearevent), and work out thecapital that hasto be set asidetomeet thatevent net of reinsurancearrangements.This is similar totheapproach of allowingthe useof internal models (Asadoptedunder SwissSolvency Test in Switzerland).The second option (As adopted in Bermuda and in European EconomicArea under Solvency II) would be for the regulator to prescribe a numberof man-madeand natural catastrophescenarios.An explicit risk chargeis then computedaccordinglyfrom a combinationof thesescenarios.Thethird option wouldbetoget theinsurerstostresstest on anumber ofstandardisedcatastrophescenarios, and additional capital requirementswouldonly beimposed for the insurersthat are more vulnerable.This would, however, be lesstransparent.12.As a target, MASis of the view that it wouldbe appropriate to adoptthefirst option, whichis similar to allowingthe use of internal models.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  50. 50. 50This option wouldensure that the catastrophescenario constructed byeach insurer is relevant toitsown businessand circumstances.However,werecognisethat insurerswouldneed time to build their owncatastrophicrisk modeling capabilities.As such, for a start, MAS proposestoadopt the second option to beginimposingspecific risk chargesfor catastropherisks.Under this option, MAS intendsto work with theindustryassociations,reinsurancebrokers and the other risk institutes/ academiain Singaporetodesign relevant standardisedcatastrophicscenariosto derive explicitrisk chargesfor insurance catastropherisk.2.13For the life business, theexplicit insurancecatastropherisk chargecan be derived based on a pandemicevent.It is noted that a few major jurisdictionshave used 1.5deathsper 1,000inderivingtheinsurancecatastropherisk charge for itslife business.We propose to adopt a similar approach.Proposal 4MAS proposestoincorporate an explicit insurancecatastropheriskchargein the RBC 2 framework.This would be done through prescribing a number of man-made andnatural catastrophe scenarios, with an explicit risk charge computedaccordinglyfrom a combination of thesescenarios.MAS intendsto work with the industryassociations,reinsurancebrokersandtheother risk institutes/ academiain Singapore to design relevantstandardisedcatastrophic scenarios.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  51. 51. 51For life business, theexplicit insurancecatastrophicrisk charge can bederivedbased on a pandemicevent.14.Currently, the offshoreinsurancefund of reinsurersis subjecttoeither a simplified solvencyregime (in thecaseof locallyincorporatedreinsurers)or exemptedfrom anycapital or solvencyrequirementsaltogether(in the caseof reinsurancebranches).MAS will, in consultation withtheaffectedplayers, be reviewingthecapitaltreatment oftheoffshoreinsurancefundforall reinsurers,whetherlocallyor foreign incorporated, under RBC 2.There will be a separate consultation paper on this.Target Criteria for Calibration of Risk Requirements15.TheRBC frameworkrelies on the Fund SolvencyRatio(“FSR) andtheCapitalAdequacy Ratio (“CAR”) asindicatorsof solvencyat thefundand company level respectively.Theseratiosprovidea snapshot of theinsurer‟sfinancial condition at apoint in time, without any considerationof theconfidencelevel and timehorizon.Under RBC 2, MASintendstorecalibratethe riskrequirementsbasedona specified risk measure, confidencelevel and timehorizon.16. There are 2 common risk measuresused internationally:- Valueat Risk(“VaR”) – this is the expectedvalue of lossat apredefined confidencelevel (e.g. 99.5%).Thus, if the insurer holds capital equivalent toVaR, it will havesufficient assetstomeet its regulatory liabilitieswith probability of aconfidencelevel of 99.5% over a one year timehorizon; andBasel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  52. 52. 52- Tail Valueat Risk(“tVaR”) – thisis theexpectedvalueof theaveragelosswhereit exceedsthe predefinedconfidence level (eg 99.5%).It isalsoknownastheconditionaltail expectation(“CTE”), expectedshortfall or expected tail loss.If an insurer holdscapital equivalent totVAR, it will have sufficientassetsto meet the averagelossesthat exceed thepredefinedconfidencelevel (of say99.5%).17.TheVaR approach, whileit hasitslimitations,isagenerallyacceptedrisk measure for financial risk management.It iseasiertocalibratetherisksunder aVaR approach comparedtousingtVaR. However, VaR, unlike tVaR, tendsto underestimate the exposuretotail events.18.On balance,MASproposestoadopt theVaR measureasit iseasiertocalibrate.Tail VaR can be consideredunder the internal model approach(seeparagraphs2.25 and 2.26), if insurersdeem it tobe more appropriate fortheir businessor risks.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  53. 53. 53Tail event analysis can alsobe doneduring the annual industry widestresstestingexerciseor the insurer’sown risk and solvencyassessment(seeSection 6).19.MASalsoproposesto adopt atime horizon of one year, and aconfidencelevel of 99.5%.This correspondsto an investment grade credit ratingand is usedcommonlyby mostof the other major jurisdictions.20.There will be a changein the approach in derivingmost of theasset-relatedrisk requirementsunder RBC 2.Instead of applying a fixedfactor on themarket value (e.g. 16%on theequitymarket valuefor equityrisk requirement) asper currentapproach, wewill now applya shocktotheNet Asset (AssetslessLiabilities)and measure the impact of the shock.Theshockiscalibratedat aVaR of99.5%confidencelevelover aoneyearperiod.Thenew risk requirement will be equivalent tothe amount of changeinNet Asset for each respectiverisk.21. For insurance riskrequirements,theapproach will be similar.For life business, thecurrent insurancerisk requirement is computed byapplying prescribed loadingson best estimateassumptionssuch asmortality, lapseand expense.Underthenewapproach, thebestestimateassumptionswillbeloadedupbysome prescribed factorswhich will be calibratedat a VaR of 99.5%confidencelevel over a one year period whichis theproposed targetcriteria.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  54. 54. 54For general business, prescribedfactorswill still be applied tothepremium and claimsliabilities,though the factorswill now be calibratedat the new target criteria.22.MASwill consult separatelyon thedata and methodology to beusedfor calibration, aswell ason the recommended calibrationfactorsorshockscenariosto be used to achievetheproposed new target criteria.Proposal 5MAS proposestorecalibrate riskrequirementsusing the Valueat Risk(“VaR”) measure of 99.5% confidencelevel over a one year period.MAS will be engagingthe industry on the calibrationexercise,and targettofinalisethe calibrationfactors/shock scenariosby 1Q 2013.Data would need tobe collectedfor thispurpose. Therecommendedcalibration factorsor scenarioswill be consulted prior toitsfinalisation.Diversification Benefits23.UnderRBC, thetotalriskrequirementsareobtainedbysummingtheC1, C2 and C3 risk requirements.Withinthe C1or C2 risk requirements, theunderlying risk requirementsare alsoadded together, without allowingfor anydiversification effectswiththehelp of correlationmatrices.Some major jurisdictions such as the European Economic Area (underSolvency II), Australia and Bermuda have moved towards allowing fordiversification effects when combining various risk modules, and evenwithinsub-modules,using prescribedcorrelationmatrices.Thishastheeffectofreducingtheoverall regulatorycapitalrequirements.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  55. 55. 55Thelevel of sophistication of the correlation matricesvaries,and isbasedtosome degree, on judgment.24.MASlooked intothepossibility of recognisingdiversificationbenefitswhenaggregatingthe risk requirementsunder RBC 2.However,dependenciesbetween different riskswill vary asmarketconditionschangeand correlation hasbeen shown toincreasesignificantlyduringperiodsof stressor whenextreme eventsoccur.In the absenceof any conclusivestudiestoshowotherwise,MASproposesnot totake intoaccount diversificationeffectsfor theaggregation of risk requirementsunder RBC 2.This approach is consistent with the capital framework for banks, wherewedonot allowfor any diversificationbenefitswhenrisksare combined.Proposal 6MAS proposesnot toallowfor diversificationbenefitswhenaggregatingthecapital risk requirements.MASis, however, prepared toconsiderdiversification benefits if theindustry is be able tosubstantiate, withrobust studiesand research conducted on thelocalinsuranceindustry,that there are applicablecorrelationswhichcan relied on during normaland stressed times.Use of Internal Model25.MAS intendstoallowinsurerstousepartial or full internal modelstodeterminetheregulatory capital requirementsin thelonger run, in linewith international best practices.Theinternal modelswill have tobe calibratedat the same target criteriaasthe standardised approach, and be subject toMASapproval.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  56. 56. 562.26 The useof internal model will be looked at under thenext phaseofthereview, after thestandardised approachhasbeen rolledout.This will allowthe larger and more complex insurerstime to preparethemselvesfor a more sophisticated and tailoredapproach.MAS wouldalsobeabletocheckthereasonablenessoftheinternalmodelassumptionsand resultsagainst the experienceof the standardisedapproach.Proposal 7MAS proposestoallowtheuseof partial or internal model in thenextphaseof the RBC 2 review, after the implementationof the standardisedapproach.Theinternal model, whichwill be subject to approval by MAS, will havetobe calibratedat thesame level asthestandardised approach.COMPONENTSOF AVAILABLE CAPITAL3.1The amount of capital available tomeet the TRR is referred to as“financial resources” (“FR”) under the RBC framework.FR comprisesthreecomponents, namely Tier 1resources,Tier 2resourcesand the provision for non-guaranteedbenefits.- Tier 1resourcesarecapital resources of thehighest quality.Thesecapital instrumentsare ableto absorblosseson an on-goingbasis.Theyhavenomaturitydateand, if redeemable,can onlyberedeemedat the option of the insurer.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  57. 57. 57Theyshouldbeissuedandfullypaid-upandnon-cumulativein nature.Theyshould be ranked junior to policyholders, general creditors,andsubordinateddebt holdersof theinsurer.Tier 1resourcesshould neither besecurednor coveredby aguaranteeof the issuer or relatedentityor other arrangement that may legallyoreconomicallyenhancethe seniority of theclaimsvis-à-visthepolicyholders.Tier 1resourcesaregenerallyrepresentedby the aggregateof thesurplusesof an insurer’sinsurancefunds.Alocallyincorporatedinsurer may add toits Tier 1resources itspaid-upordinaryshare capital, its surplusesoutside of insurancefundsand irredeemableand noncumulativepreferenceshares.- Tier 2 resourcesare onlyapplicableto locallyincorporatedinsurersand consist of capital instrumentsthat are of a lowerqualitythanthatof Tier 1resourcesbut may be availabletoserveasa buffer againstlossesincurredby theinsurer.Examplesof theseinstrumentsincluderedeemableor cumulativepreferencesharesand certain subordinateddebt.Tier 2 resourcesin excessof 50% of Tier 1resourceswill not berecognisedasFR.- Theallowancefor provision for non-guaranteedbenefitsis applicableonlyto insurerswhomaintain a participatingfund.As the allowancefor provision for non-guaranteedbenefitsis onlyavailabletoabsorblossesof the participatingfund, theallowanceisadjustedto ensure that theunadjustedcapital ratio10of the insurer isnot greater than itsadjusted ratio.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  58. 58. 58Alignment with Basel III2.Asanintegratedsupervisoroverseeingbankingand insuranceentitiesinSingapore, MASseekstoensure a level playing field acrossthefinancialsectorsby havinga consistent regulatory and supervisoryframeworkfortheregulatedfinancial institutions.TheTier 1and Tier 2 capital componentsare largely aligned betweentheexistingRBC frameworkforinsurersandthecapitaladequacyframeworkforbanksunderBaselIII, withtheexceptionofsurplusesintheinsurancefundsor balancein the surplusaccount, whichare insurance-specific innature.However,Basel III hasstrengthened the“equity-like” characteristicsneeded for a hybrid capital instrument tobe included in Tier 1regulatorycapital (i.e. capital of the highest quality).Besides having to showgreater capacitytoabsorb losses,these hybridcapital instrumentsalsoneed to have featuresthat clearlyenabletheinstrument toundergoa principlewritedown or toconvert intocommonequityin the event of a bank stress.3.Toalign withthecapital adequacyframeworkfor banks, MAS proposestoincorporatethesameBaselIII features(i.e. equityconversion orwrite-downonbreachof regulatorycapitalrequirements)asconditionsfor acapital instrument tobe approved by MASasa Tier 1resource(“Approved Tier 1Resource”).Proposal 8MAS proposestoincorporate the same Basel III features(i.e. equityconversion or write-downon breach of regulatory capital requirements)for theApproved Tier 1resource.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  59. 59. 59This meansthat instrumentsthat qualifiesasApproved Tier 1resourcemust:(a)Automaticallyconvert toordinaryshare capital, asand whentheinsurerneedstoabsorblosses, andinanycase,whentheinsurer breachesitsregulatorycapital requirement;(b)Be subjecttowritedown aslong aslossespersist, asand whentheinsurer needstoabsorb losses,and in anycasewhentheinsurer breachesitsregulatorycapital requirement.Thelimitson the amount ofApproved Tier 1resource that can berecognised, asset out in the existingInsurance(Valuation and Capital)Regulations2004, will remain unchanged.Treatment of Negative Reserves4.For life business, policy liability isderived policy-by-policy bydiscountingthebest estimatecash flowsof future benefit payments,expensepaymentsand receipts,withallowancefor provision for adversedeviation.It is possiblefor the discountedvaluetobe negativewhen theexpectedpresent valueof thefuture receipts(like premium and charges) exceedtheexpected presentvalue of thefuture outgo(such asbenefit paymentsand expensepayments), resultingin a negative reserve.5.However, regulation 20(4) of the Insurance(Valuation and Capital)Regulations2004statesthat “Aregisteredinsurer shall not value theliability in respect of any liabilitytobe lessthan zero, unlessthere aremoneysduetotheinsurerwhenthepolicyisterminatedonvaluationdate,in whicheventhevalueof the liabilityin respect of that policymay benegativeto the extent of the amount due to the insurer.”Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  60. 60. 60Thismeansthat negativereservesarenotrecognisedunlessoneexpectsarecoveryof monies (for example, surrender penaltyin thecaseofinvestment-linkedpolicies).6.Practiceswithregards totreatment of negative reservesdifferinternationally.Under SolvencyII, theEuropean EconomicArea is consideringrecognisingnegative reservesasTier 1capital, whileCanadarecognisespart of thenegative reservesasTier 2capital.7.MAS current positionof not recognisingnegativereservesasaform ofcapital is a conservativeone becauseit isakin to assuminga 100%lapseon all thepolicies,such that future premium receiptsand chargesare notrecognised.In practice, thelapserate wouldnot be 100%. Therefore, there is scopetoreconsider the current position given that under RBC 2, an insurer’snetasset valuewill be shocked for insurancerisk, and specifically, lapserisk, at a 1-in-200year level.8.Hence, MAS wouldlike to consult on recognisinga part of thenegative reservesasfinancial resources.We propose for thistobe in the form of a positivefinancial resourceadjustment, rather than asTier 1or Tier 2capital.As the amount of negative reservesare currentlysizeablein some lifeinsurers,MASwill need tocarefullyreview and establish a frameworkforcalibratingthe level of negative reservesthat may be recognised.Proposal 9MAS proposestoallowa part of thenegativereservesto be recognisedasa form of positivefinancial resourceadjustment under FinancialResources.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  61. 61. 61MAS will consult further on the amount tobe recognised.Treatment of Aggregate of Allowancesfor Provision for Non-Guaranteed Benefits9.When assessingthe qualityof capital resources,insuranceregulatorsarerequiredunder international standardsto give consideration toitscharacteristics,including“theextent towhichtheresourceis availabletoabsorb losses,theextent of the permanent and/ or perpetual nature of thecapital and theexistenceof anymandatory servicingcostsin relationtothecapital”.10.Under the current RBC framework,ashighlightedin Paragraph3.1,an insurer maintainingany participatingfund isallowedto count asfinancial resources,the aggregate of allowancesfor provision fornon-guaranteedbenefits (“APNGB”), subject tothe unadjustedcapitalratio of the insurer remainingbelowtheadjusted ratio.However,astheseallowancesdo not meet the qualities requiredof acapital instrument, MAS will be reclassifyingAPNGB asa form ofpositivefinancial resource adjustment (“FRA”), instead of a capital item.Proposal 10MAS proposestoclassifyAggregate ofAllowancesfor Provision forNon-GuaranteedBenefits,whereapplicable, asa form of positivefinancial resource adjustment, rather than asa capital item.Thisappliestoaninsurermaintaininganyparticipatingfund, andsubjecttothe conditionthat theunadjusted capital ratioremainsbelow theadjustedcapital ratio, where:Adjusted capital ratio, in relation to theinsurer, meanstheratio of thefinancialresourcesof theinsurer (excludingthefinancialresourcesofanyparticipatingfund) tothetotal risk requirement (calibrated at 99.5% VaRBasel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  62. 62. 62overaone-yearperiod) oftheinsurer(excludingsuchrequirement arisingfrom anyparticipatingfund); andUnadjusted capital ratio, in relation to theinsurer, meansthe ratioof thefinancialresourcesof theinsurer(includingthefinancial resourcesof anyparticipatingfund) tothetotal risk requirement (calibrated at 99.5% VaRoveraone-year period) of theinsurer(includingsuchrequirement arisingfrom anyparticipatingfund).SOLVENCY INTERVENTION LEVELS1.Currently, under the Insurance(Valuation and Capital) Regulations2004, insurershave tomaintaina minimum CapitalAdequacy Ratio(“CAR”) of 100%.Registered insurersare alsorequired to notify MASabout theoccurrenceor potential occurrenceof any event that wouldresult in thefinancialresourcesof the insurer beinglessthan 120%, alsoknown asthe financialresourceswarningevent.In practice, wewouldexpect insurersto have capital management plansin placeand hold a target CAR of more than 120%. In fact, all insurersgenerallyhold at leasta CAR of 150%.2.InternationalstandardsoncapitaladequacyprescribedbytheIAIS setout twotransparent triggersfor supervisoryintervention whenassessingthecapital adequacyof an insurer:a) Prescribed Capital Requirement (“PCR”), which is the higher solvencycontrol level above which the insurance regulator would not intervene oncapital adequacygrounds.ThePCR iscalibratedsuch that the assetsof the insurer will exceed thepolicy liabilitiesand other liabilitieswitha specifiedlevel of safetyover adefinedtime horizon; andBasel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  63. 63. 63b) Minimum Capital Requirement (“MCR”), whichis thelowersolvencycontrol level at which, if breached, the insuranceregulator wouldinvokeitsstrongest actions,in the absenceof appropriatecorrectiveaction bytheinsurer.3.Globally, major jurisdictionsare moving towardsmeetingtheinternationalstandardsof having a PCR and a MCR.MAS believesthat havingsuch transparent and clearsolvencyintervention levelswouldbe most useful for insurersto better understandMAS expectationson the type of correctivecapital actionsrequired, andthe urgencywhichtheyshould be taken.Prescribed Capital Requirement4.Many insuranceregulatorsof major jurisdictionshavetargeted aconfidencelevel of 99.5% in settingregulatorycapital requirements.This correspondsto an implied credit ratingof at least an investmentgrade.MAS intendsto calibratethe PCR of a soloinsurer16tothe VaR of theinsurer’sfundstoa confidencelevel of 99.5% over a one year period.If an insurer’scapital fallsbelow its PCR, it will need to submit a plantorestore itscapital position within 3 months.As a countercyclical measure, MASwill havethe flexibilityand discretiontoallowinsurersmore timetorestore itscapital position, for example,during periodsof market stresses.For avoidanceof doubt, PCR needsto bemaintained at both thecompany level, aswell asat an insurancefund level.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  64. 64. 64Proposal 11PCR is thehigher supervisoryintervention level at whichthe insurer isrequiredto hold sufficient financial resourcestomeet the total riskrequirementswhichcorrespondstoa VaR of 99.5% confidencelevel overa one-year period.An insurer whichbreachesitsPCR will need to submit a plan on howtorestore itscapital position within 3 months.If the PCR ismet, MASwill not normally interveneon capital adequacygrounds.This doesnot precludeMASfrom requiring an insurer to maintainfinancialresourcesabovethePCR if thereare othersupervisoryconcerns.As a countercyclical measure, MASwill havetheflexibilityand discretiontoallowinsurersmore timetorestore itscapital position, forexample,during periodsof market stresses.PCR needstobe maintainedat both the company level, aswell asat aninsurancefund level.Minimum Capital Requirement4.5As for MCR, MASplansto calibratea soloentity MCR tothe VaR oftheinsurer’sfundstoa confidencelevel of 90% over a one year period.Thiscorrespondstoan implied credit ratingof B- and representsa 1in 10year event.During the calibration stage, the MCR may be expressed as a percentageof the total risk requirementsrequired under PCR for ease of computationand future monitoring.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  65. 65. 65For avoidanceof doubt, MCR needsto be maintainedat both thecompany level, aswell asat an insurancefund level.4.6 MAS intendsto take its strongest enforcement actionsif the MCR isbreached.Suchactionswouldincludestoppingnewbusiness,withdrawaloflicence,or directing a transfer of portfolio toanother insurer.Proposal 12MCR is the lowersupervisoryintervention level at whichthe insurer isrequiredto hold sufficient financial resourcestomeet the total riskrequirementswhichcorrespondstoa VaR of 90% confidencelevel over aone-year period.If an insurer breachesitsMCR, MAS may choose to invoke the strongestsupervisory action (such as stopping new business, withdrawal of licenceetc).MCR willbecalibratedasafixedpercentageof thePCR. Thispercentagewill be determinedafter quantitativeimpact studiesare done.MCR needsto be maintainedat both thecompanylevel, aswell asat aninsurancefund level.VALUATION OF ASSETSAND LIABILITIES5.1An insurerneedstodeterminethevalue of itsassetsand liabilitiesbeforecomputingitssolvencyrequirements.ValuationrulesfortheRBC frameworkarespecifiedwithintheInsurance(Valuation and Capital) Regulation 2004and the relevant Notices.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  66. 66. 662.Under current valuation rules,assetsare to bevaluedat themarketvalue, or the net realisablevalue, in the absenceof market value. Policyliabilitiesare tobe valuedbased on best estimateassumptions,withprovision for adverse deviation (“PAD”).Policy liabilitiesfor life insurance are computed using a prospectivediscountedcashflow method while that for general insurance consist ofthepremium liabilitiesand the claimsliabilities.3. We have identifiedtwoareasthat will be reviewedunder RBC 2.Risk Free Discount RateSingapore dollar-denominated liabilities4.Lifeinsurersare currentlyrequired tocalculatetheir policyliabilitiesusinga prospectivediscountedcash-flowmethod, with MASNotice 319prescribingtheuseof therisk-freediscount rate todeterminethevalueofpolicy liabilitiesfor non-participatingpolicies,non-unit reservesofinvestment-linkedpolicies,and theminimum condition liabilityofparticipatingfunds.5.For Singaporedollar (“SGD”)-denominatedliabilities, therisk freediscount rateis:(a)Where the duration of a liability is X years or less, the market yield ofthe Singapore Government Securities (“SGS”) of a matching duration asat valuation date;(b)Where the duration of a liabilityismore than X yearsbut lessthanYyears, a yield that isinterpolated from the market yield of theX year SGSand a stablelongterm risk free discount rate (“LTRFDR”); and(c) Where theduration of a liability isY years or more, a stableLTRFDR.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  67. 67. 67ThestableLTRFDR is to be calculatedaccordingtothe following:(a)Computetheaveragedailyclosingyield of the X-year SGSsinceitsinception;(b)Compute the averagedailyyield differential between theX-year andYyear SGSsincetheinceptionof theY-year SGS;(c)Derivean estimatelong-term yield bysumming the valuesobtainedunder subparagraphs(a) and (b);(d)Compute the prevailing averagedaily closingyield of theY-year SGSover thepast 6-month period;(e)Allocate 90% weight to theestimatedlong-term yield obtained insubparagraph(c), and 10% to the prevailingaverage yield undersubparagraph (d).(f)TheLTRFDR is then obtained by summingthetwovaluesin (e).Currently, X and Y are 10and 15 respectively.With effect from 1Jan2013,X andY will be 15and 2018.5.6 When RBC wasfirst introducedin 2005, the longest datedSGSavailablethen wasthe 15-year SGS(whichwasincepted in 2001).Recognisingthat the15-year SGSmight not be liquid enough and couldcauseunduevolatilityin therisk-freediscount rate aswell aspolicyliabilitiesat the longer end, the LTRFDR formula wasintroduced.Theuse of a weightedaverageformula haskept the LTRFDR “sticky”andvalue of policy liabilitiessteady.Whilst this isreflectiveof the underlying nature of long-term lifeinsuranceliabilities,it makesliabilityvalueslesssensitiveto marketBasel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  68. 68. 68movement in yields, resulting in short-term earningsvolatilityduetodifferencesin discountingof the assetsand liabilities.5.7 We now have 20-year (inceptedin 2007) and 30-year SGS(inceptedin2012) availablein themarket.With effect from 1January 2013, the 20-year SGS yield will be used in thederivation of the risk-free discount rate, that is, X and Y will be 15 and 20years respectivelyin the formula set out in Section5.5. MASintendsto further enhancethemarket consistencyof thediscount rateby incorporatingtheuseof 30-year SGSyield.Proposal 13MAS proposesthe followingtwoapproacheswithregardsto the risk-freediscount rate for SGD-denominated liabilities.(a) TokeeptothesameLTRFDR formulaassetout in paragraph5.5,butX and Y will now be20and 30respectively.This is on the expectationthat the 30-year SGSwill have adequateliquiditywhenRBC 2 is implemented. This means:-Durations0toyear 20: Use prevailingyields of SGS-Durations30 year and above:90% of historical averageyields (sinceinception) and 10% of latest6-month averageyield of 30-year SGS- Durations20 to year 30: Interpolated yields(b)Toremovethe LTRFDR formula altogether,ie.,- Durationsup to30Years:Use prevailing yieldsof SGS- Durations30year and above:Keep theyield flat at theprevailingyieldof 30-year SGSBasel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  69. 69. 69Consultation Question 3Whichof theaboveapproachesis more appropriate?Consultation Question 4Should MASallowfor some illiquiditypremium adjustment in therisk-freediscount rate for valuing certain portfoliossuch asannuitybusiness?8.We alsoconsideredthe feasibilityof using swaprates, instead of SGS,for discountingpurposes.Somejurisdictionshavemoved to usingswapratesfor valuing policyliabilities,and a few insurershaveasked MAS toconsider similarapproachesin Singapore.Theseinsurershave fed back that theswapcurve, extendingtolongerdurationswithratesdetermined by market forces,wouldprovidea moreaccuraterepresentation of risk-freemarket yields, withappropriateadjustmentsfor credit risk.9.MAS notesthat the useof swap ratesis typicallyallowedin certainjurisdictionsbecauseof insufficient supplyof sovereign governmentbonds.In some countries, the bond market maynot be asdeveloped or liquid astheswapmarket.In fact, it is noted that whereswapsdonot exist or are not sufficientlyliquidand reliable, the risk-freediscount rate used for valuation shouldhavereferencetothegovernment yield curve in that currency.In Singapore, giventhat the government securitiesmarket is still moreliquidand deep than theswapmarket.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  70. 70. 70MAS proposestoretain theuseof SGSyields.10.It is currentlyprovidedin MAS319that wherean insurer implementsan effectivecash flow hedge or fair valuehedge asdefinedunder FRS39of theAccounting Standard, the insurermay elect to usethe market yieldoftheSGSofamatchingdurationasat thevaluationdateforvaluingsuchhedgedSingaporedollar policy liabilities.For thehedged policyliabilitiesthat have a duration exceedingthemaximum duration availableon theSGSyield curve, themarket yield forthemaximum duration SGSavailableshall be used.Where an insurer haselected touse themarket yield of theSGSof amatchingduration, it shall continueto dosoaslong asthedesignatedliabilitiesremain a hedged liabilityasdefined under FRS39.MAS may at any timerequire theinsurer to produceall necessarydocumentary evidenceon the hedgingof such policyliabilitieswithinsuch time asmay be specified by MAS.For theavoidance of doubt, MASwill be retainingthisflexibilityunderRBC 2.Non-SGD denominated liabilities11.For liabilitiesdenominated in a currency other thanSGD, MAS319statesthat the risk-freediscount rate tobe used is the market yield of theforeign government securitiesof similar duration at thevaluation date.Unlike for SGD-denominated liabilities,thereis nosimilar concept of aLTRFDR here.12.In thecaseof non-SGD denominated liabilities, MASproposestorequireinsurersto followtheregulatoryrequirementspertainingtodiscountingasprescribed by the insurancesupervisoryauthority in thejurisdictionissuingthecurrency.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  71. 71. 71For example, for US-dollar denominatedliabilities,the insurer willdiscount itsliabilitiesaccordingtothe discountingrequirementsset bytheNationalAssociation of InsuranceSupervisors(“NAIC”) in US.For liabilitiesdenominated in currenciesof European EconomicAreamember states,theinsurer will discount itsliabilitiesaccordingto thediscountingrequirementsset by the European Commission underSolvencyII.This proposal is premised on the fact that the insuranceregulator in thejurisdictionissuingthecurrency will be best placed toset thediscountrate for itshome currency.Proposal 14MAS proposesthat insurersfollowtheregulatoryrequirementspertainingtodiscountingasprescribedbytheinsurancesupervisoryauthorityin thejurisdictionissuingthe currency, for valuingnon-Singaporedollardenominatedliabilitiesfor both life and general business.Consultation Question 5If the relevant foreign supervisoryauthorityhasnot prescribed any basisfor discountingtheliabilitiesdenominatedin that home currency, whatshould be the approach taken?Should the risk-freediscount ratebe themarket yield of theforeigngovernment securitiesof similar duration, and the yield kept flat forliabilitiesextendingbeyond the longest availablegovernment securities?General insurance policy liabilities5.13MAS319 is currentlyapplicabletoinsurerswritinglife businessonly.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  72. 72. 72For general business, it is stated in guidelinesID 01/04that discountingofliabilitiesshouldbecarriedout wheretheimpact ofsuchdiscountingismaterial.Where discountingof liabilitiesis used, thediscount rate adoptedshouldbethegrossredemption yield asat thevaluation date of a portfolio ofgovernment bonds(where applicable) withitscurrencyand expectedpayment profile (or duration) similar to the insuranceliabilitiesbeingvalued.14.MASproposestoextend thediscountingrequirementsfor lifebusiness(asset out in thepreviousproposals)to general business.However,thiswouldapply onlyto liabilitieswithdurationsabove 1year.Proposal 15MAS proposestoextend the discount rate requirementsfor life businesstogeneral businessaswell, for liability durationsabove1year.For liabilitydurationof 1year and less, nodiscountingwouldberequired.Provision for Adverse Deviation15.Under the current RBC framework,policy liabilitiesfor both life andgeneralinsurancebusinessaretobedeterminedusingbest estimatesanda provision for adversedeviation (“PAD”) (commonlyknownasa riskmargin).- For general business, the PAD for both claims liability and unexpiredrisk reserves are to be calculated at the 75% level of sufficiency, as setout in the Insurance(Valuation and Capital) Regulations2004.- For life business, MAS319 requires thePAD to be determinedusingmore conservativeassumptionssoasto buffer against fluctuationsofthebest estimateexperience.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  73. 73. 73Thedetermination of the level of PAD is left tothe professionaljudgment of the appointedactuaries,whoare bound by theguidancenoteissued by the SingaporeActuarial Society(“SAS”).Acommon methodadoptedbytheappointedactuariesisfortheloadingsfor policy liabilitieswith PAD tobe calculatedashalf of theprescribedloadingsfor modified policyliabilitiesand modified minimum conditionliabilitiesfor the participatingpolicies.Put simply, the PAD is roughlyhalf of the C1risk requirements.16.Internationally, there are a number of methodsbeingused forderivingPAD or risk margin.Onemethod whichisgainingprominence(asprescribedin SolvencyIIandtheSwissSolvencyTest) is thecost-of-capitalmethod.This method reflectsthereturn on the capital a buyer wouldneed tosupport the liabilitiesacquired from theholder over thewholerun-offperiod.This method involvesapplying a cost-of-capital rate toprojectedriskchargesandthendiscountingthecalculatedcost ofcapitalat therisk-freerate of interest, to obtain theapplicablerisk margin.Both SolvencyII and the SwissSolvencyTest adopt a cost-of-capital rateof 6% per annum.This rate correspondsto the spread above the risk-freeinterest rate thatan investment gradeinsurer wouldbe charged to raisecapital for theportfolio, and is alsoconsistent withwhat is assumed in theVaRassumptionsunder risk calibration.17.Althoughit ishardertocompute,thecost-of-capitalmethodhasbeenassessed asthemost market consistent in practiceby some studies.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  74. 74. 74As such, MASwouldlike toseektheindustry’sviewson using thecost-of-capital method in determiningPAD.Consultation Question 6Do you agree that the cost-of-capital approach, for computing theprovision for adverse deviation for both life and general insuranceliabilities,is appropriate?If so, do you agreethat it is appropriatetoadopt a cost-of-capital rateof6% per annum?Asthereisnoevidencetosuggestthat thecost ofprovidingtheamount ofavailablecapital to support the policyliabilitieswouldbe substantiallydifferent for life and general insurers,a uniform ratehasbeenproposedfor all types of insurers.ENTERPRISE RISK MANAGEMENT1.TheRBC 2 review is not solely limitedto thequantitativeelementsoftheRBC framework;it alsofocusesonMAScontinuingeffortstoimproveindustrystandardson governance, controlsand in particular, riskmanagement practices.2.MAS hasalreadyissued a set of comprehensiveguidelineson riskmanagement practicesthat appliesboth toa financial institution ingeneral, aswell asto an insurer specifically.Theguidelinescover board and senior management, internalcontrol, credit risk, market risk, technology risk, operational risk(businesscontinuitymanagement and outsourcing), insurancecoreactivitiesand insurancefraud.MAS is lookingat further enhancingtherisk management guidelinestoadopt a more holisticand enterprise-wide risk management framework,Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  75. 75. 75in linewith evolving international standardson EnterpriseRiskManagement (“ERM”) and best practices.3.The ERM requirements, which we will consult on and expect to issueby the end of this year, will go beyond addressing risks in each activity orfunction.Thenew requirementswill set out MASexpectationson how insurersidentify and manage the interdependenciesbetweenkeyrisks, and howthiswill be translatedintostrategic management actionsand capitalplanning.4.Theinternational standardon ERM advocatesERM systemstohavecloselinkagesbetweenongoingoperational management of risk,longer-term businessgoalsand strategy, and economiccapitalmanagement soastoensure optimal financial efficiency, and sufficientlevelsof solvencyto ensure adequateprotection of policyholders.An insurer will be expected to carryout itsownrisk and solvencyassessment (“ORSA”).TheORSAis a self-drivenprocessby the insurer to assessthe adequacyof itsrisk management practices,and both current and future solvencypositions.TheBoard and senior management of the insurer are expectedtotakeownership of theprocess, whichshould be well-documented.In assessingitsoverall solvencyneeds,all identifiedrelevant andmaterialrisksare to be subjectedto rigorousstressand scenariotesting.5.We expect insurersto undertake itsORSAregularly and effectively,givingdue consideration to thedynamic interactionsbetweenrisks, andthelink betweenrisk management, businessstrategyand capitalmanagement.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  76. 76. 76Thesophistication of an insurer’sERM frameworkshould becommensuratewiththenature, scaleand complexityof the risksthat itbears.Proposal 16MAS proposestointroduceEnterpriseRisk Managementrequirements,includingthoserelatingto Own Risk and SolvencyAssessment, to insurers.Wewill consult industryontheERMrequirementsandtarget toissuea final document by end of 2012.PROPOSED TIMELINE1.MAS‟ proposedtimelinefor thevariousreviewsoutlined in Sections2to5 of thispaper are asfollows:- Finalisethe calibrationfactorsby 1Q 2013. During thecalibrationstage, insurerswouldbe involved in a few roundsof quantitativeimpact studies;- Finalisethe changestothe Insurance(Valuation and Capital)Regulations2004and Insurance(Accountsand Statements)Regulations2005by2Q 2013;- Implement the RBC 2 requirements(with the exceptionof theinsurancecatastropherisk chargeswhichmay need more time) foraccountingyear ending31Dec 2013.There will be at least 2years of parallel run withthe existingRBCframework,wherethetotal risk requirementsunderRBC 2frameworkwouldbe subject toa floorof a specified percentage of the total riskrequirementsunder the existingRBC framework.This is toprevent anysudden releasein capital requirements;Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  77. 77. 77- Commenceworkon the internal model approachwiththe industryafter the implementationof RBC 2.Proposal 17MAS proposestoimplement the RBC 2 requirementsfor theaccountingyear ending 31December 2013.There will be at least 2years of parallel run withthe existingRBCframeworkand appropriate floorsimposed to prevent sudden release incapital requirements.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  78. 78. 78Basel III – CRD 4: Impact and stakesIntroductoryspeechbyMr ChristianNoyer,Governorof the Bank of France andChairmanof theBoard of Directorsof theBank for International Settlements,at theAutoritéde contrôleprudentiel (ACP)conference, Paris, 27June 2012.Ladies and gentlemen,I am delightedtowelcomeyou todaytothisnew conferenceorganisedby theAutorité decontrôleprudentiel (ACP).This morning, the conference will be dedicated to the impact and stakesof the Basel III reform and, this afternoon, to the supervision of businesspracticesin bankingand insurance.I wouldlike tothank all theparticipantsfor the interesttheyhave shownin thesecrucial exchangesbetweenregulators,supervisorsand marketparticipants.This conferenceisbeingheld against thebackdrop of an economicandfinancial environment that remainsvery difficult, characterisedinparticular in Europe by the ongoingsovereigndebt crisis.Many questionssurround thefuture of the European banking system,whichhasalreadyundergonemajor transformationsin the recent periodwhile significant changesin itsprudential frameworkand theorganisationof its supervision are currentlybeingreviewed.Far from puttingon theback burner questionsconcerningBasel III anditsapplicationin Europe, that is tosay CRD IV and itsproject to createa“singlerulebook” for European banks, I believe, on the contrary, thesedevelopmentsunderscore the importanceof better understandingtheBasel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  79. 79. 79current reform and takingtime toreflect, in order toensurethat thenewframeworkfor banking regulationand thedistributionof supervisoryresponsibilitiesin Europe will deliver all their expected benefits.Beforeleavingyou todiscussingreaterdetail theimpactandstakesoftheBasel III reform, I wouldlike tomake a few remarkson thistopic inrelationtothecurrent environment.1. Basel III and CRD IV represent a quantitative and qualitativeleap aimed at addressing the shortcomingshighlighted by thecurrent financial crisisFirst, I believethat it wouldbeuseful torapidlyplacetheBasel III reformin itscontext, in order tofullyunderstand its scope.BaselIII isfirstandforemost aresponsetothefinancialcrisisthat startedin 2007.Thiscrisisandthesubsequent waveofshockstothebankingsystem havenot merely resulted in a temporary lossof output for themajor advancedeconomies.Theyhave alsohad a lastingimpact on employment, industrialproduction, the confidenceof investorsand households, and needlesstosayon public finances,whichmake crisisexit evenmore difficult.In responsetothesedevelopments, the international communityadoptedin 2009, under the impetusof theG20, an ambitiousreform programmeincludingBasel III, whichis a keyelement for the banking sector.Indeed, a banking system that ismore robust asa wholeand capableofabsorbingmajor shocksis vital to avoid therepetition of such chainreactionsin the future.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  80. 80. 80In thisrespect,despitethedelayinthereform agendaintheUnitedStates,Europe must clearlypressforward: the credibilityof our banksand oureconomiesis at stake.Basel III is naturallybased on BaselII which establishesthecurrentcapital adequacyrules.However,Basel III goesfurther than merelychangingand updatingtheexistingrules.–Basel III indeed considerablystrengthensthe capital requirementsthatbanksmust meet, but this reform ismore extensivein that it significantlyenhancestheprudential framework:in additiontocapital requirements,itestablishesliquidityrequirements, and a leverageratiois set tobeintroduced in the medium term.From this point of view, Basel III is a far-reachingreform of bankingregulation.–Furthermore, and most importantly, I believethat Basel III is a majorstepforwardinthat it leadstoamuchcloserinteractionthanhasbeenthecasetodatebetweenthe individual supervisionof banks, known asmicroprudential supervision, and the overall supervision of thebankingand financial system, or macroprudential supervision.Thisbroader view of banking supervision, takingaccount of all its facets,translatesintoa number of provisionsand notablyintroducesadditionalcapital buffers(a capital conservation buffer, a countercyclical buffer anda buffer for systemically important financial institutions) in excessof theregulatoryminimum.Basel III thereforerepresentsa quantitativeand alsoa qualitativeleap.Given the magnitudeof the changestobe made, Basel III hasmajorrepercussionson market participants,whomust adapt to thisnewenvironment.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  81. 81. 81Theserepercussionsareboth anticipatedand desirable, but thepotentiallynegativeconsequencesof thisreform must be kept toaminimum.In thisrespect, manyassociatedriskswerehighlightedduringitsdraftingand even more sorecently, due to the current economicand financialdifficulties.Theseincludedtherisk of arise in thecost of credit or of a credit crunch.Hence, the impact and stakesof Basel III must be carefullyanalysed andaddressed.2. The difficult economic environment stressesthe importanceof implementing Basel III in an appropriate manner but doesnot call into question the rationale of the reformWithout playing down thepotential risksassociatedwith theimplementationof BaselIII, to whichtheACP pays close attention, Ibelievethat this reform can be successfullyimplemented.Allow me to mention some reasonsfor this conviction and offer someavenuesfor actions:– First, French banks, whichhave complied withBasel 2.5 rulessinceDecember 2011, are in a strongpositiontomeet thenewcapital adequacyrequirementswhen theycome intoforce.Moreover,French banksare ahead of the Basel III schedule.CurrentlywithCore Tier 1capital ratiosof over 9%, the main Frenchgroupsdemonstratetheir abilitytomeet theEuropeanBankingAuthoritydeadlineof 30 June 2012.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
  82. 82. 82Theyshould alsofullycomplywith thenew Basel III requirementsby2013.–TheACP iscloselymonitoringcredit institutions‟preparationsforBaselIII. By doingso, anyproblemscan be identified at anearlystage andissuesrelatingto itsimplementation can be addressed, whichI believe isessential for a smooth transition.Moregenerally, in addition to theindividual monitoring of banks‟preparation, coordinationbetweensupervisorsand theplayersconcernedis alsoimportant toensure a clearunderstandingof the rulesand identifyanyquestionsrelatingto the reform and their potential consequences.TheACP liaiseson a regular basiswiththeprofession on all prudentialmatters.Indeed, today‟sconferenceis a prime illustrationof this.–It isalsoessentialtocloselymonitorandtakeintoaccount theimpact ofthenew regulationson the financial system and theeconomy and toassessthe different interactionsin order, if necessary, to deal with theunforeseen consequencesof Basel III.In this respect, theACP, whichmaintainsclose linksto theBanque deFrance and operatesunder itsaegis, is naturallyparticularlyattentivetoand involved in all these matters.This is whyweare accompanying the prudential reform withmoregeneral and macroeconomic reflectionson thefinancingof theeconomy, and in particular on credit developmentsand the relationshipbetweenbankingregulation and monetary policy.Thenew liquidityratiosthereforecannot be applied astheystand astheydonot takeintoaccount all their consequencesand interactionsbeyondtheprudential objectivesthemselves,whichincludein particular theBasel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com

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