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Monday October 29, 2012 - Top 10 Risk Management News
 

Monday October 29, 2012 - Top 10 Risk Management News

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Monday October 29, 2012 - Top 10 Risk Management News

Monday October 29, 2012 - Top 10 Risk Management News

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    Monday October 29, 2012 - Top 10 Risk Management News Monday October 29, 2012 - Top 10 Risk Management News Document Transcript

    • Page |1 International Association of Risk and Compliance Professionals (IARCP) 1200 G Street NW Suite 800 Washington, DC 20005-6705 USA Tel: 202-449-9750 www.risk-compliance-association.com Top 10 risk and compliance management related news stories and world events that (for better or for worse) shaped the weeks agenda, and what is nextDear Member,This week I will start from a reallyinteresting approach to risk management:“There are essential parts of the valuationframework still under political discussions”What? Politicians in actuarial roles? Who said that?The European Insurance and Occupational Pensions Authority (EIOPA)that was established in consequence of the reforms to the structure ofsupervision of the financial sector in the European Union.This phrase is at the top of the "I wish I had the guts to say it" list for asupervisor. Congratulations EIOPA.Read more at Number 4 below.Welcome to the Top 10 list. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • Page |2Chairman Ben S. BernankeU.S. Monetary Policy and InternationalImplicationsAt the "Challenges of the Global Financial System:Risks and Governance under Evolving Globalization,"A High-Level Seminar sponsored by Bank of Japan-InternationalMonetary Fund, Tokyo, JapanThe new UK Regulator:The Financial ConductAuthorityThe Financial ConductAuthority (FCA) will be the newregulator whose vision it is tomake markets work well soconsumers get a fair deal.It will be responsible forrequiring firms to put thewell-being of their customers atthe heart of how they run theirbusiness, promoting effectivecompetition and ensuring thatmarkets operate with integrity.The FCA will start work in 2013,when it will receive new powersfrom the Financial Services Bill that is currently going throughparliament. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • Page |3Cyber Experts Engage on DARPA’s Plan XProposers’ Day dialogue cements program approachWhen the team behind DARPA’s Plan X mapped out where it wanted togo with research in the development of cyber capabilities and platforms, itknew the DARPA approach to problem solving included soliciting inputfrom the leading experts in the field.Technical Specifications for theSolvency II valuation and SolvencyCapital Requirements calculations(Part I)This technical specification is a working document proposed by EIOPAto be used by insurance and reinsurance undertakings participating inany quantitative assessment to be undertaken until new update isavailable.International Association of Insurance SupervisorsIAIS Releases Proposed Policy Measures forGlobal Systemically Important InsurersPublic consultation to continue through 16 December 2012Basel – The International Association of Insurance Supervisors (IAIS)today released its proposed policy measures for global systemicallyimportant insurers, or G-SIIs. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • Page |4Presidents Summary ofOutcomes from the Experts’meeting on CorruptionThe Financial Action Task Force (FATF) convened, in collaboration withthe G20 Anti-Corruption Working Group, an Experts Meeting onCorruption.Lim Hng Kiang: What’s next for hedgefunds?Keynote address by Mr Lim Hng Kiang,Minister for Trade and Industry and DeputyChairman of the Monetary Authority ofSingapore, at the SkyBridge Alternative (SALT)Conference, Marina Bay SandsGill Marcus: Why education is important tothe South African ReserveBankAddress by Ms Gill Marcus, Governor of theSouth African Reserve Bank, at the Partners inPerformance 2012 Celebration Lunch at theMaths Centre, Braamfontein _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • Page |5Andrew G Haldane: The Bank and thebanksSpeech by Mr Andrew G Haldane, ExecutiveDirector, Financial Stability, Bank ofEngland, at Queen’s University, BelfastProposal for a Directive of theEuropean Parliament and of theCouncil on criminal sanctions forinsider dealing and marketmanipulation (MAD)State of play and orientation debate _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • Page |6Chairman Ben S. BernankeAt the "Challenges of the Global Financial System:Risks and Governance under Evolving Globalization,"A High-Level Seminar sponsored by Bank ofJapan-International Monetary Fund, Tokyo, JapanU.S. Monetary Policy and InternationalImplicationsThank you. It is a pleasure to be here. This morning I will first brieflyreview the U.S. and global economic outlook.I will then discuss the basic rationale underlying the Federal Reservesrecent policy decisions and place these actions in an internationalcontext.U.S. and Global Outlook The U.S. economy has faced significant headwinds, and, although theeconomy has been expanding since mid-2009, the pace of our recoveryhas been frustratingly slow.The headwinds include the effects of deleveraging by households, thestill-weak U.S. housing market, tight credit conditions in some sectors,spillovers from the situation in Europe, fiscal contraction at all levels ofgovernment, and concerns about the medium-term U.S. fiscal outlook.In this environment, households and businesses have been quite cautiousin increasing spending.Accordingly, the pace of economic growth has been insufficient tosupport significant improvement in the job market; indeed, theunemployment rate, at 7.8 percent, is well above what we judge to be itslong-run normal level. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • Page |7With large and persistent margins of resource slack, U.S. inflation hasgenerally been subdued despite periodic fluctuations in commodityprices.Consumer price inflation is running somewhat below the FederalReserves 2 percent longer-run objective, and survey- and market-basedmeasures of longer-term inflation expectations have remained wellanchored.The global economic outlook also presents many challenges, as youknow.Fiscal and financial strains have pushed Europe back into recession.Japans economy is recovering from last years tragic earthquake andtsunami, and it continues to struggle with deflation and persistent weakdemand.And in the emerging market economies, the rapid snap-back from theglobal financial crisis has given way to slower growth in the face of weakexport demand from the advanced economies.The soft tone of global activity is yet another headwind for the U.S.economy.Looking ahead, economic projections of Federal Open MarketCommittee (FOMC) participants prepared for the CommitteesSeptember meeting called for the economic recovery to proceed at amoderate pace in coming quarters, with the unemployment rate decliningonly gradually.FOMC participants generally expected that inflation was likely to run ator below the Committees inflation goal of 2 percent over the next fewyears.The Committee also judged that there were significant downside risks tothis outlook, importantly including the potential for an intensification ofstrains in Europe and an associated slowing in global growth. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • Page |8Federal Reserves Recent Policy ActionsAll of the Federal Reserves monetary policy decisions are guided by ourdual mandate to promote maximum employment and stable prices.With the disappointing progress in job markets and with inflationpressures remaining subdued, the FOMC has taken several importantsteps this year to provide additional policy accommodation.In January, the Committee noted that it anticipated that economicconditions were likely to warrant exceptionally low levels of the federalfunds rate at least through late 2014--a year and a half later than inprevious statements.In June, policymakers decided to continue through year-end the maturityextension program (MEP), under which the Federal Reserve purchaseslong-term Treasury securities and sells short-term ones to help depresslong-term yields. At its September meeting, with the data continuing to signal weak labormarkets and no signs of significant inflation pressures, the FOMCdecided to take several additional steps to provide policyaccommodation.It extended the period over which it expects to maintain exceptionally lowlevels of the federal funds rate from late 2014 to mid-2015.Moreover, the Committee clarified that it expects to maintain a highlyaccommodative stance of monetary policy for a considerable period afterthe economic recovery strengthens.The FOMC coupled these changes in forward guidance with additionalasset purchases, announcing that it will purchase agencymortgage-backed securities (MBS) at a pace of $40 billion per month, ontop of the $45 billion in monthly purchases of long-term Treasurysecurities planned for the remainder of this year under the MEP. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • Page |9The FOMC also indicated that it would continue to purchase agencyMBS, undertake additional asset purchases, and employ other tools asappropriate until the outlook for the labor market improves substantiallyin a context of price stability.The open-ended nature of these new asset purchases, together with theirexplicit conditioning on improvements in labor market conditions, willprovide the Committee with flexibility in responding to economicdevelopments and instill greater public confidence that the FederalReserve will take the actions necessary to foster a stronger economicrecovery in a context of price stability.An easing in financial conditions and greater public confidence shouldhelp promote more rapid economic growth and faster job gains overcoming quarters.As I have said many times, however, monetary policy is not a panacea.Although we expect our policies to provide meaningful help to theeconomy, the most effective approach would combine a range ofeconomic policies and tackle longer-term fiscal and structural issues aswell as the near-term shortfall in aggregate demand.Moreover, we recognize that unconventional monetary policies comewith possible risks and costs; accordingly, the Federal Reserve hasgenerally employed a high hurdle for using these tools and carefullyweighs the costs and benefits of any proposed policy action.International Aspects of Federal Reserve Asset Purchases Although the monetary accommodation we are providing is playing acritical role in supporting the U.S. economy, concerns have been raisedabout the spillover effects of our policies on our trading partners.In particular, some critics have argued that the Feds asset purchases, andaccommodative monetary policy more generally, encourage capital flowsto emerging market economies. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 10These capital flows are said to cause undesirable currency appreciation,too much liquidity leading to asset bubbles or inflation, or economicdisruptions as capital inflows quickly give way to outflows.I am sympathetic to the challenges faced by many economies in a worldof volatile international capital flows.And, to be sure, highly accommodative monetary policies in the UnitedStates, as well as in other advanced economies, shift interest ratedifferentials in favor of emerging markets and thus probably contribute toprivate capital flows to these markets.I would argue, though, that it is not at all clear that accommodativepolicies in advanced economies impose net costs on emerging marketeconomies, for several reasons. First, the linkage between advanced-economy monetary policies andinternational capital flows is looser than is sometimes asserted.Even in normal times, differences in growth prospects amongcountries--and the resulting differences in expected returns--are the mostimportant determinant of capital flows.The rebound in emerging market economies from the global financialcrisis, even as the advanced economies remained weak, provided stillgreater encouragement to these flows.Another important determinant of capital flows is the appetite for risk byglobal investors.Over the past few years, swings in investor sentiment between "risk-on"and "risk-off," often in response to developments in Europe, have led tocorresponding swings in capital flows.All told, recent research, including studies by the International MonetaryFund, does not support the view that advanced-economy monetarypolicies are the dominant factor behind emerging market capital flows. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 11Consistent with such findings, these flows have diminished in the pastcouple of years or so, even as monetary policies in advanced economieshave continued to ease and longer-term interest rates in those economieshave continued to decline.Second, the effects of capital inflows, whatever their cause, on emergingmarket economies are not predetermined, but instead depend greatly onthe choices made by policymakers in those economies.In some emerging markets, policymakers have chosen to systematicallyresist currency appreciation as a means of promoting exports anddomestic growth.However, the perceived benefits of currency management inevitablycome with costs, including reduced monetary independence and theconsequent susceptibility to imported inflation.In other words, the perceived advantages of undervaluation and theproblem of unwanted capital inflows must be understood as apackage--you cant have one without the other. Of course, an alternative strategy--one consistent with classicalprinciples of international adjustment--is to refrain from intervening inforeign exchange markets, thereby allowing the currency to rise andhelping insulate the financial system from external pressures.Under a flexible exchange-rate regime, a fully independent monetarypolicy, together with fiscal policy as needed, would be available to helpcounteract any adverse effects of currency appreciation on growth.The resultant rebalancing from external to domestic demand would notonly preserve near-term growth in the emerging market economies whilesupporting recovery in the advanced economies, it would redound toeveryones benefit in the long run by putting the global economy on amore stable and sustainable path. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 12Finally, any costs for emerging market economies of monetary easing inadvanced economies should be set against the very real benefits of thosepolicies.The slowing of growth in the emerging market economies this year inlarge part reflects their decelerating exports to the United States, Europe,and other advanced economies.Therefore, monetary easing that supports the recovery in the advancedeconomies should stimulate trade and boost growth in emerging marketeconomies as well.In principle, depreciation of the dollar and other advanced-economycurrencies could reduce (although not eliminate) the positive effect ontrade and growth in emerging markets.However, since mid-2008, in fact, before the intensification of thefinancial crisis triggered wide swings in the dollar, the real multilateralvalue of the dollar has changed little, and it has fallen just a bit against thecurrencies of the emerging market economies.Conclusion To conclude, the Federal Reserve is providing additional monetaryaccommodation to achieve its dual mandate of maximum employmentand price stability.This policy not only helps strengthen the U.S. economic recovery, but byboosting U.S. spending and growth, it has the effect of helping supportthe global economy as well. Assessments of the international impact ofU.S. monetary policies should give appropriate weight to their beneficialeffects on global growth and stability. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 13The new UK Regulator:The Financial ConductAuthorityThe Financial Conduct Authority (FCA) will be the new regulator whosevision it is to make markets work well so consumers get a fair deal.It will be responsible forrequiring firms to put thewell-being of their customers atthe heart of how they run theirbusiness, promoting effectivecompetition and ensuring thatmarkets operate with integrity.The FCA will start work in 2013,when it will receive new powersfrom the Financial Services Billthat is currently going throughparliament.The Journey to the FCA sets outhow we will approach ourregulatory objectives, how weintend to achieve a fair deal infinancial services for consumersand where we are on thisjourney.Changes to authorisationsThe UK regulatory structure will be changing in 2013, when the FSA willsplit into two regulatory bodies the Financial Conduct Authority (FCA)and the Prudential Regulation Authority (PRA). _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 14In April 2012, Supervision adopted the internal-twin peaks structure, andnow Authorisations are implementing a similar structure, withassessments carried out by both the Prudential Business Unit (PBU) andthe Conduct Business Unit (CBU).This change will only affect firms that will be dual regulated in future.The application submission process will not change and we will continueto seek to meet our statutory deadlines.What will change is how the application is processed internally.There will be a CBU case officer and a PBU supervisor responsible foreach application and they will coordinate to minimise duplication or theimpact on applicant firms and individuals.The final decision will need to be agreed by both the PBU and the CBU toensure a single FSA decision during transition to the new regulatorystructure.These changes will allow us to start to deliver, as far as possible, a modelthat will mirror the future authorisation procedures in the PRA and theFCA.What is happening to the FSA Handbook?At legal cutover, the FSA Handbook will be split between the FCA andthe PRA to form two new Handbooks, one for the PRA and one for theFCA.Most provisions in the FSA Handbook will be incorporated into thePRA’s Handbook, the FCA’s Handbook, or both, in line with each newregulator’s set of responsibilities and objectives.Users of the Handbook will be able to access the following online: 1. The PRA Handbook, displaying provisions which apply to PRA-regulated firms _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 15 2. The FCA Handbook, displaying all provisions which apply to FCA-regulated firms; and 3. To support the transition, a central version which will show the provisions of both Handbooks, with clear labels indicating which regulator applies a provision to firms.The new Handbooks will reflect the new regulatory regime (for example,references to the FSA will be replaced with the appropriate regulator), andin some areas more substantive changes will be made to reflect theexistence of the two regulators, their roles and powers.(This is likely to include such aspects as the future processes forpermissions, passporting, controlled functions, threshold conditions andenforcement powers.)The more substantive changes will be consulted on before the PRA andthe FCA acquire their legal powers.Changes to the FSA Handbook as a result of EU legislation and FSApolicy initiatives will continue throughout this work.After acquiring their powers, the FCA and the PRA will amend their ownsuites of policy material as independent bodies in accordance with theprocesses laid down in the Financial Services Bill, including cooperationbetween them and external consultation.What does this mean for firms?This approach to the Handbooks for the FCA and the PRA has beenplanned to ensure a safe transition for firms and the new regulators as thenew regime is introduced.Firms will have a new regulator or regulators, and will consequently needto assess how the new Handbooks of these bodies will apply to them.Dual regulated firms will need to look to both the PRA and the FCAHandbooks, and FCA regulated firms to the FCA Handbook. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 16When will the changes be in the Handbook?We expect to publish the new Handbooks before legal cutover.This will allow firms and others time to adjust to the application of thenew Handbooks before the FCA and the PRA are fully operational.The new Handbooks will not be available in detail before this.Alongside the publication, we will publish material on how to interpretthe application of the Handbooks, where this is not dealt with in theHandbooks themselves.The FSA will continue to make changes to its Handbook in accordancewith the normal procedure, until the new bodies acquire their legalpowers.The FSA Handbook will remain in force until the FCA and PRA acquiretheir legal powers. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 17Launch of the Journey to the FCASpeech by Martin Wheatley - Managing Director,FSA, and CEO Designate, FCA at the Launch ofthe Journey to the FCA eventGood morning. I would like to thank the MinisterGreg Clark for joining us today, for his supportivewords – and for demonstrating the Government’scommitment to working alongside us to deliver better conduct regulation.I would also like to thank Thomson-Reuters for hosting this morning.Today is a big step forward on the road to becoming the new regulator,and I am glad that you are all here to join us as we launch the Journey tothe FCA.The FCA offers a huge opportunity for the regulator and firms to startafresh, and work in partnership to reset how we deal with conduct infinancial services.We see it as the role of the regulator to not only make the relevant marketswork well but also to help firms get back to putting their customers at theheart of how they do business.Regulation has a huge impact on the people and businesses that rely onfinancial services, and we should never forget this.We have approached the creation of the FCA in a thoughtful andconsidered way, as the document we are sharing with you today shows.We will regulate one of our most successful industries, central to thehealth of our economy and a provider of two million UK jobs.This makes our job an important one, and it will mean that we carry outour work in a way that is as open and accountable as possible.We spent the summer engaging with consumer organisations, and 500firms from all areas of financial services, as we developed our thinking onthe FCA.This allowed us to gather useful feedback and we will continue this openworking in the FCA. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 18We aim in the Journey to the FCA to demonstrate what our neworganisation will mean for the firms we regulate and the consumers weare here to help protect.I encourage you all to read it, and to give us your views.We are clear about the type of regulator we want to become, and we wantto work with all of our stakeholders to get there and deliver regulation thatworks better.You have not yet had a chance to read the document, so let me explain abit more about what the FCA is going to be about.The FCA has been set up to work with firms to ensure they put consumersat the heart of their business.Underlining this are three outcomes:1. Consumers get financial services and products that meet their needsfrom firms they can trust.2. Firms compete effectively with the interests of their customers and theintegrity of the market at the heart of how they run their business.3. Markets and financial systems are sound, stable and resilient withtransparent pricing information.Reforming regulation is not just good for consumers, it will also be goodfor firms. The industry’s standing has suffered as the mis-selling scandalsand other problems have taken their toll.This has damaged the reputation of firms across the industry, whetherdirectly involved or not. We need to work with you to put that right.While much of what we will do is new, we will also build on what hasworked well under the FSA.We will keep up our policy of credible deterrence, pursuing enforcementcases to punish wrongdoing.And our markets regulation will continue to promote integrity and carryon the FSA’s fight against insider dealing, which has secured 20 criminalconvictions since 2009. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 19We will continue to keep unauthorised firms from trying to takeadvantage of consumers.We will set high expectations for those firms that want to enter financialservices, while still allowing innovation and good ideas to flourish.And we will take forward a strong interest in the fair treatment ofcustomers – an agenda that has been around for many years, but is stillkey to the FCA.There will, however, be important changes, and our approach will bemore forward-looking, better informed, and we will have a greaterappetite to get things done.A new department will act as the radar of our new organisation –combining better research into what is happening in the market, andanalysis of the risks to our objectives.This will then feed into our policymaking and our supervision of firms.We want to really understand what is happening to your customers, thedeal they are getting and the issues they face.This will include getting a better understanding of why consumers act inthe way they do, so we can adapt our regulation to their commonbehavioural traits.Fewer firms will have regular direct contact with supervisors, as we shiftresources to allow us to deal more quickly and effectively with emergingissues, and run more cross-industry projects to get to the root cause ofproblems.We will have new partners to work with and our relationship with the newPrudential Regulation Authority will be crucial, and driven by a culture ofcooperation.We will aim to bring our expertise to international debates, so that EUand international policymaking works for UK consumers and firms.All of this will be delivered by a new culture in the FCA. We willencourage our staff to be more confident in making bold, firm andpredictable decisions. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 20To help us do our job, the Government intends to give the FCA new toolsto ensure that consumers get products that meet their needs.This builds on one of the key lessons from past problems, which is thatregulation is often more effective if it steps in early to pre-empt andprevent widespread harm.We will reflect this in our supervision work when we look at how firmsdesign and sell their products.But a key new power will mean that we can step in and ban the sale ofproducts that pose unacceptable risks to consumers for up to 12 months,without consulting first.We will also be able to ban misleading advertising.We will use these new tools in a measured way – and while we will actsooner, and more decisively, our approach will be based on a properunderstanding of the issues and a full consideration of the potentialsolutions.So whilst there may be times when we have to act rapidly, this is notsomething that firms should be afraid of.Firms selling the right products, in the right way, to the right consumershave little to fear.Our new approach will mean that we will take competition into account inall our work.We will weigh up the impact on competition of new measures wepropose.We will also consider whether competition could lead to better resultsthan other action we could take.In our work here, and in other areas, I am very conscious that we have towork with firms.Making regulation work better for us is also about allowing firms room totry new ideas and develop their business.Promoting competition will play an important part in this. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 21We are not here to stand in the way of progress that will be of benefit toconsumers.Our goals as the FCA are clear: we will work for an industry that is betterat serving the needs of its customers.I see this as an opportunity – not just for us but for the industry.We can do our job better if we work with you, and I am pleased that somany of the chief executives that I speak to are talking the same languageand have committed to rebuilding confidence and trust, and reconnectingwith their customers.It is great hearing about these good intentions, but the difficult bit for usall is to make sure this change actually happens.There are challenges and opportunities for both us the regulator, and youthe industry.It is a journey we have to walk together, as we put consumers back at theheart of what we do. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 22Cyber Experts Engage on DARPA’s Plan XProposers’ Day dialogue cements program approachWhen the team behind DARPA’s Plan X mapped out where it wanted togo with research in the development of cyber capabilities and platforms, itknew the DARPA approach to problem solving included soliciting inputfrom the leading experts in the field.On October 15 and 16, DARPA outlined its plans for Plan X to a packedhouse of potential developers and performers and solicited theirfeedback.More than 350 software engineers, cyber researchers and human-machineinterface experts attended the event.DARPA officials presented the goals of Plan X in preparation for releaseof the program’s Broad Agency Announcement (BAA)—anticipatedwithin the next month.Plan X, announced in May 2012, is the first DARPA program of its kind.It will attempt to create revolutionary technologies for understanding,planning and managing DoD cyber missions in real-time, large-scale anddynamic network environments.Plan X will conduct novel research on the cyber domain.The Plan X program is explicitly not funding research and developmentefforts in vulnerability analysis or generation of cyberweapons.“Insights obtained from discussions with government partners andpotential performers during the Proposers’ Day workshop will help usfinalize our approach to the Plan X program,” said Dan Roelker, DARPAprogram manager. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 23“The program covers largely unchartered territory as we attempt toformalize cyber mission command and control for the DoD.”It is anticipated that the BAA for this effort will be posted to www.fbo.govwithin the next month. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 24Technical Specifications for theSolvency II valuation and SolvencyCapital Requirements calculations(Part I)NoteThis technical specification is a working document proposed by EIOPAto be used by insurance and reinsurance undertakings participating inany quantitative assessment to be undertaken until new update isavailable.As there are essential parts of the valuation framework still under politicaldiscussions, i.e. the discount rates for the technical provisionscalculations, this document is not intended to be a complete set oftechnical specifications for the Solvency 2 balance sheet valuation nor forthe Solvency Capital Requirements calculations.Howsoever these essential parts are not included at this stage but willfollow in due course.Not even when the specification of discount rates for TP calculations arefinally added, the resulting technical specifications should be seen as acomplete implementation of the Solvency II framework, since for thepurpose of feasibility of testing exercises, shortcuts and ad hocsimplifications have been included.In particular, relevant parts of the SCR calculation such as internalmodels section, undertaking specific parameters section and within thegroup section: the combination method, the treatment of Participations,Ring Fenced funds and internal model for group calculation have beendeliberately not included in the current technical specifications, as thesewere not considered by EIOPA as providing key information for thepurposes of the quantitative tests that may be launched in the comingmonths. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 25However, this should not be interpreted as an EIOPA speculation on itsinclusion in the final Solvency II framework.This technical specification is inspired by the knowledge that EIOPA hason the current status of the negotiations on Omnibus 2 Directive, theworking documents on implementing measures and its own work in thedevelopment of Technical Standards and Guidelines.EIOPA plans to incorporate the relevant elements of the technicalprovisions valuation, once the outcome of the OMDII negotiations isstabilised.Important partsIAS 39 Financial Instruments: Recognition and MeasurementIAS 39 establishes principles for recognising and measuring financialassets, financial liabilities and some contracts to buy or sell non-financialitems.For the purpose of measuring a financial asset after initial recognition,this Standard classifies financial assets into the following four categoriesdefined in paragraph 9:(a) Financial assets at fair value through profit or loss;(b) Held-to-maturity investments;(c) Loans and receivables; and(d) Available-for-sale financial assets.These categories apply to measurement and profit or loss recognitionunder this Standard.The entity may use other descriptors for these categories or othercategorisations when presenting information in the financial statements. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 26After initial recognition, an entity shall measure financial assets,including derivatives that are assets, at their fair values, without anydeduction for transaction costs it may incur on sale or other disposal,except for the following financial assets:(a) Loans and receivables, which shall be measured at amortised costusing the effective interest method(b) Held-to-maturity investments, which shall be measured at amortisedcost using the effective interest method(c) Investments in equity instruments that do not have a quoted marketprice in an active market and whose fair value cannot be reliablymeasured and derivatives that are linked to and must be settled bydelivery of such unquoted equity instruments, which shall be measured atcost.Solvency II framework: Fair value measurement principles are consideredto be consistent with article 75 of Directive 2009/138/EC, except forsubsequent adjustments to take account of the change in own creditstanding of the insurance or reinsurance undertaking after initialrecognition in the measurement of financial liabilities.Technical ProvisionsIntroductionTP.1.1. The reporting date to be used by all participants should be 30June.TP.1.2. Solvency II requires undertakings to set up technical provisionswhich correspond to the current amount undertakings would have to payif they were to transfer their (re)insurance obligations immediately toanother undertaking.The value of technical provisions should be equal to the sum of a bestestimate and a risk margin. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 27However, under certain conditions that relate to the replicability of thecash flows underlying the (re)insurance obligations, best estimate andrisk margin should not be valued separately but technical provisionsshould be calculated as a whole.TP.1.3. Undertakings should segment their (re)insurance obligations intohomogeneous risk groups, and as a minimum by line of business, whencalculating technical provisionsTP.1.4. The best estimate should be calculated gross, without deductionof the amounts recoverable from reinsurance contracts and SPVs. Thoseamounts should be calculated separately.TP.1.5. The calculation of the technical provisions should take account ofthe time value of money by using the relevant risk-free interest rate termstructure.TP.1.6. The actuarial and statistical methods to calculate technicalprovisions should be proportionate to the nature, scale and complexity ofthe risks supported by the undertaking.V.2.1. SegmentationGeneral principlesTP.1.7. Insurance and reinsurance obligations should be segmented as aminimum by line of business (LoB) in order to calculate technicalprovisions.TP.1.8. The purpose of segmentation of (re)insurance obligations is toachieve an accurate valuation of technical provisions.For example, in order to ensure that appropriate assumptions are used, itis important that the assumptions are based on homogenous data to avoidintroducing distortions which might arise from combining dissimilarbusiness. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 28Therefore, business is usually managed in more granular homogeneousrisk groups than the proposed minimum segmentation by lines ofbusiness where it allows for a more accurate valuation of technicalprovisions.TP.1.9. Undertakings in different Member States and even undertakingsin the same Member State offer insurance products covering different setsof risks.Therefore it is appropriate for each undertaking to define thehomogenous risk group and the level of granularity most appropriate fortheir business and in the manner needed to derive appropriateassumptions for the calculation of the best estimate.TP.1.10. (Re)insurance obligations should be allocated to the line ofbusiness that best reflects the nature of the risks relating to the obligation.In particular, the principle of substance over form should be followed forthe allocation.In other words, the segmentation should reflect the nature of the risksunderlying the contract (substance), rather than the legal form of thecontract (form).TP.1.11. The segmentation into lines of business distinguishes betweenlife and non-life insurance obligations.This distinction does not coincide with the legal distinction between lifeand non-life insurance activities or the legal distinction between life andnon-life insurance contracts.Instead, the distinction between life and non-life insurance obligationsshould be based on the nature of the underlying risk:- Insurance obligations of business that is pursued on a similar technical basis to that of life insurance should be considered as life insurance obligations, even if they are non-life insurance from a legal perspective.- Insurance obligations of business that is not pursued on a similar technical basis to that of life insurance should be considered as non-life insurance obligations, even if they are life insurance from a legal perspective. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 29TP.1.12. In particular, annuities stemming from non-life insurancecontracts (for example for motor vehicle liability insurance) are lifeinsurance obligations.TP.1.13. The segmentation should be applied to both components of thetechnical provisions (best estimate and risk margin). It should also beapplied where technical provisions are calculated as a whole.Segmentation of non-life insurance and reinsurance obligationsTP.1.14. Non-life insurance obligations should be segmented into thefollowing 12 lines of business:Medical expenses insuranceThis line of business includes obligations which cover the provision ofpreventive or curative medical treatment or care including medicaltreatment or care due to illness, accident, disability and infirmity, orfinancial compensation for such treatment or care, where the underlyingbusiness is not pursued on a similar technical basis to that of lifeinsurance, other than obligations considered as workers compensationinsurance;Income protection insuranceThis line of business includes obligations which cover financialcompensation in consequence of illness, accident, disability or infirmitywhere the underlying business is not pursued on a similar technical basisto that of life insurance, other than obligations considered as medicalexpenses or workers compensation insurance;Workers’ compensation insuranceThis line of business includes health insurance obligations which relate toaccidents at work, industrial injury and occupational diseases and wherethe underlying business is not pursued on a similar technical basis to thatof life insurance covering: _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 30- the provision of preventive or curative medical treatment or care relating to accident at work, industrial injury or occupational diseases; or- financial compensation for such treatment;- or financial compensation for accident at work, industrial injury or occupational diseases;Motor vehicle liability insuranceThis line of business includes obligations which cover all liabilitiesarising out of the use of motor vehicles operating on land (includingcarrier’s liability);Other motor insuranceThis line of business includes obligations which cover all damage to orloss of land vehicles, (including railway rolling stock);Marine, aviation and transport insuranceThis line of business includes obligations which cover all damage or lossto river, canal, lake and sea vessels, aircraft, and damage to or loss ofgoods in transit or baggage irrespective of the form of transport.This line of business also includes all liabilities arising out of use ofaircraft, ships, vessels or boats on the sea, lakes, rivers or canals(including carrier’s liability).Fire and other damage to property insuranceThis line of business includes obligations which cover all damage to orloss of property other than motor, marine aviation and transport due tofire, explosion, natural forces including storm, hail or frost, nuclearenergy, land subsidence and any event such as theft; _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 31General liability insuranceThis line of business includes obligations which cover all liabilities otherthan those included in motor vehicle liability and marine, aviation andtransport;Credit and suretyship insuranceThis line of business includes obligations which cover insolvency, exportcredit, instalment credit, mortgages, agricultural credit and direct andindirect suretyship;Legal expenses insuranceThis line of business includes obligations which cover legal expenses andcost of litigation;Assistance insuranceThis line of business includes obligations which cover assistance forpersons who get into difficulties while travelling, while away from homeor while away from their habitual residence;Miscellaneous financial loss insuranceThis line of business includes obligations which cover employment risk,insufficiency of income, bad weather, loss of benefits, continuing generalexpenses, unforeseen trading expenses, loss of market value, loss of rentor revenue, indirect trading losses other than those mentioned before,other financial loss (not-trading) as well as any other risk of non-lifeinsurance business not covered by the lines of business alreadymentioned.TP.1.15. Obligations relating to accepted proportional reinsurance shouldbe segmented into 12 lines of business in the same way as non-lifeinsurance obligations are segmented. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 32TP.1.16. Obligations relating to accepted non-proportional reinsurance innon-life should be segmented into 4 lines of business as follows:- Health: non-proportional reinsurance obligations relating to insurance obligations included in the following lines: medical expenses, income protection and workers’ compensation.- Property: non-proportional reinsurance obligations relating to insurance obligations included in the following lines: other motor insurance, fire and other damage to property, credit and suretyship, legal expenses, assistance, miscellaneous financial loss. Casualty: non-proportional reinsurance obligations relating to insurance obligations included in the following lines: motor vehicle liability and general liability.- Marine, aviation and transport: non-proportional reinsurance obligations relating to insurance obligations included in the line marine, aviation and transport insuranceSegmentation of life insurance and reinsurance obligationsTP.1.17. Life insurance obligations should be segmented into 6 lines ofbusiness.Health insuranceHealth insurance obligations where the underlying business is pursuedon a similar technical basis to that of life insurance, other than thoseincluded in the following line of business “Annuities stemming fromnon-life insurance contracts and relating to health insurance obligations”.Life insurance with profit participationInsurance obligations with profit participation other than thoseobligations included in the annuities stemming from non-life insurancecontracts. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 33Index-linked and unit-linked insuranceInsurance obligations with index-linked and unit-linked benefits otherthan those included in the annuities stemming from non-life insurance.Other life insuranceobligations other than obligations included in any of the other life lines ofbusiness.Annuities stemming from non-life insurance contracts and relating tohealth insurance obligations (annuities stemming from non-life contractsand NSLT health insurance).Annuities stemming from non-life insurance contracts and relating toinsurance obligations other than health insurance obligationsTP.1.18. Obligations relating to accepted reinsurance in life should besegmented into 4 lines of business as follows:Health reinsuranceReinsurance obligations which relate to the obligations included in linesof business health insurance and “Annuities stemming from non-lifeinsurance contracts and relating to health insurance obligations”.Life reinsuranceReinsurance obligations which relate to the obligations included in linesof business “Life Insurance with profit participation”, “Index-linked andunit-linked insurance”, “Other life insurance” and “Annuities stemmingfrom non-life insurance contracts and relating to insurance obligationsother than health insurance obligations”.TP.1.19. There could be circumstances where, for a particular line ofbusiness in the segment "life insurance with profit participation" _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 34(participating business), the insurance liabilities can, from the outset, notbe calculated in isolation from those of the rest of the business.For example, an undertaking may have management rules such thatbonus rates on one line of business can be reduced to recoup guaranteedcosts on another line of business and/or where bonus rates depend on theoverall solvency position of the undertaking.However, even in this case undertakings should assign a technicalprovision to each line of business in a practicable manner.Health insurance obligationsTP.1.20. Health insurance covers one or both of the following:- The provision of preventive or curative medical treatment or care including medical treatment or care due to illness, accident, disability and infirmity, or financial compensation for such treatment or care;- Financial compensation in consequence of illness, accident, disability or infirmity.TP.1.21. In relation to their technical nature two types of health insurancecan be distinguished:- Health insurance which is pursued on a similar technical basis to that of life insurance (SLT Health)- Health insurance which is not pursued on a similar technical basis to that of life insurance (Non-SLT Health)TP.1.22. Health insurance obligations pursued on a similar technicalbasis to that of life insurance (SLT Health) are the health insuranceobligations for which it is appropriate to use life insurance techniques forthe calculation of the best estimate.Health insurance obligations should be assigned to life insurance lines ofbusiness where such obligations are exposed to biometrical risks (i.e. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 35mortality, longevity or disability/morbidity) and where the commontechniques used to assess such obligations explicitly take intoconsideration the behaviour of the variables underlying these risks.Where insurance or reinsurance health obligations are calculatedaccording to the conditions set out in Article 206 of Directive2009/138/EPC they should be assigned to SLT health insurance lines ofbusiness.TP.1.23. SLT health insurance obligations should be allocated to one ofthe four following lines of business for life insurance obligations definedin subsection V .2.1:- Insurance contracts with profit participation where the main risk driver is disability/morbidity risk- Index-linked and unit-linked life insurance contracts where the main risk driver is disability/morbidity risk- Other insurance contracts where the main risk driver is disability/morbidity risk- Annuities stemming from non-life contracts.TP.1.24. With regard to the line of business for annuities stemming fromnon-life contracts or health insurance includes only annuities stemmingfrom Non-SLT health contracts (for example workers compensation andincome protection insurance).Insurance or reinsurance obligations that, although stemming fromNon-Life or NSLT health insurance, and originally segmented intoNon-Life or NSLT health lines of business, as a result of the trigger of anevent are pursued on a similar technical basis to that of life insurance,should be assigned to the relevant life lines of business as soon as there issufficient information to assess those obligations using life techniques.TP.1.25. Non-SLT health obligations should be allocated to one of thethree following lines of business for non-life insurance obligations: _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 36- Medical expense- Income protection- Workers compensationTP.1.26. The definition of health insurance applied in the QuantitativeAssessment may not coincide with national definitions of healthinsurance used for authorisation or accounting purposes.TP.1.27. The granularity of the segmentation of insurance or reinsuranceobligations should allow for an adequate reflection of the nature of therisks.For the purpose of calculation of the technical provisions, thesegmentation should consider the policyholder’s right to profitparticipation, options and guarantees embedded in the contracts and therelevant risk drivers of the obligations.Unbundling of insurance and reinsurance contractsTP.1.28. Where a contract includes life and non-life (re)insuranceobligations, it should be unbundled into its life and non-life parts.TP.1.29. Where a contract covers risks across the different lines ofbusiness for non-life (re)insurance obligations, these contracts should beunbundled into the appropriate lines of business.TP.1.30. A contract covering life insurance risks should always beunbundled according to the following lines of business- SLT- Life insurance with profit participation- Index-linked and unit-linked life insurance- Other life insurance _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 37TP.1.31. Where a contract gives rise to SLT health insurance obligations,it should be unbundled into a health part and a non-health part where it istechnically feasible and where both parts are material.Notwithstanding the above, unbundling may not be required where onlyone of the risks covered by a contract is material.In this case, the contract may be allocated according to the main risk.Best estimateV.2.2.1. Methodology for the calculation of the best estimateAppropriate methodologies for the calculation of the bestestimateTP.2.1. The best estimate should correspond to the probability weightedaverage of future cash-flows taking account of the time value of money.TP.2.2. Therefore, the best estimate calculation should allow for theuncertainty in the future cash-flows.The calculation should consider the variability of the cash flows in orderto ensure that the best estimate represents the mean of the distribution ofcash flow values.Allowance for uncertainty does not suggest that additional marginsshould be included within the best estimate.TP.2.3. The best estimate is the average of the outcomes of all possiblescenarios, weighted according to their respective probabilities.Although, in principle, all possible scenarios should be considered, it maynot be necessary, or even possible, to explicitly incorporate all possiblescenarios in the valuation of the liability, nor to develop explicitprobability distributions in all cases, depending on the type of risksinvolved and the materiality of the expected financial effect of thescenarios under consideration. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 38Moreover, it is sometimes possible to implicitly allow for all possiblescenarios, for example in closed form solutions in life insurance or thechain-ladder technique in non-life insurance.TP.2.4. Cash-flow characteristics that should, in principle and whererelevant, be taken into consideration in the application of the valuationtechnique include the following:a) Uncertainty in the timing, frequency and severity of claim events.b) Uncertainty in claims amounts, including uncertainty in claimsinflation, and in the period needed to settle and pay claims.c) Uncertainty in the amount of expenses.d) Uncertainty in the expected future developments that will have amaterial impact on the cash in- and out-flows required to settle theinsurance and reinsurance obligations thereof (e.g. the value of anindex/market values used to determine claim amounts).For this purpose future developments shall include demographic, legal,medical, technological, social, environmental and economicdevelopments including inflation.e) Uncertainty in policyholder behaviour.f) Path dependency, where the cash-flows depend not only oncircumstances such as economic conditions on the cash-flow date, butalso on those circumstances at previous dates.A cash-flow having no path dependency can be valued by, for example,using an assumed value of the equity market at a future point in time.However, a cash-flow with path-dependency would need additionalassumptions as to how the level of the equity market evolved (the equitymarkets path) over time in order to be valued.g) Interdependency between two or more causes of uncertainty.Some risk-drivers may be heavily influenced by or even determined byseveral other risk-drivers (interdependence). _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 39For example, a fall in market values may influence the (re)insuranceundertaking’s exercise of discretion in future participation, which in turnaffects policyholder behaviour.Another example would be a change in the legal environment or the onsetof a recession which could increase the frequency or severity of non-lifeclaims.TP.2.5. Undertakings should use actuarial and statistical techniques forthe calculation of the best estimate which appropriately reflect the risksthat affect the cash-flows.This may include simulation methods, deterministic techniques andanalytical techniques.TP.2.6. For certain life insurance liabilities, in particular the futurediscretionary benefits relating to participating contracts or othercontracts with embedded options and guarantees, simulation may lead toa more appropriate and robust valuation of the best estimate liability.TP.2.7. For the estimation of non-life best estimate liabilities as well aslife insurance liabilities that do not need simulation techniques,deterministic and analytical techniques can be more appropriate.Cash-flow projectionsTP.2.8. The best estimate should be calculated gross, without deductionof the amounts recoverable from reinsurance contracts and specialpurpose vehicles.Recoverables from reinsurance and Special Purpose Vehicles should becalculated separately.In the case of co-insurance the cash-flows of each co-insurer should becalculated as their proportion of the expected cash-flows withoutdeduction of the amounts recoverable from reinsurance and specialpurpose vehicles.TP.2.9. Cash-flow projections should reflect expected realistic futuredemographic, legal, medical, technological, social or economicdevelopments. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 40TP.2.10. Appropriate assumptions for future inflation should be built intothe cash-flow projection.Care should be taken to identify the type of inflation to which particularcash-flows are exposed (i.e. consumer price index, salary inflation).TP.2.11. The cash-flow projections, in particular for health insurancebusiness, should take account of claims inflation and any premiumadjustment clauses.It may be assumed that the effects of claims inflation and premiumadjustment clauses cancel each other out in the cash flow projection,provided this approach undervalues neither the best estimate, nor the riskinvolved with the higher cash flows after claims inflation and premiumadjustment.Recognition and derecognition of (re)insurance contracts forsolvency purposesTP.2.12. The calculation of the best estimate should only include futurecash-flows associated with obligations within the boundary of thecontract.TP.2.13. A reinsurance or insurance obligation should be initiallyrecognised by insurance or reinsurance undertakings at whichever is theearlier of the date the undertaking becomes a party to the contract thatgives rise to the obligation or the date the insurance or reinsurance coverbegins.TP.2.14. A contract should be derecognised as an existing contract onlywhen the obligation specified in the contract is extinguished, dischargedor cancelled or expires.The boundary of an existing (re)insurance contractTP.2.15. The definition of the contract boundary should be applied inparticular to decide whether options to renew the contract, to extend theinsurance coverage to another person, to extend the insurance period, toincrease the insurance cover or to establish additional insurance covergives rise to a new contract or belongs to the existing contract. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 41Where the option belongs to the existing contract the provisions forpolicyholder options should be taken into account.TP.2.16. For the purpose of determining which insurance or reinsuranceobligations arise in relation to an insurance or reinsurance contract, theboundaries of the contract shall be defined in the following manner:(a) Where the insurance or reinsurance undertaking has at a future date:(i) A unilateral right to terminate the contract,(ii) A unilateral right to reject premiums payable under the contract, or(iii) A unilateral right to amend the premiums or the benefits payableunder the contract in such a way that the premiums fully reflect the risks,any obligations which relate to insurance or reinsurance cover whichmight be provided by the undertaking after that date do not belong to thecontract, unless the undertaking can compel the policy holder to pay thepremium for those obligations;(b) Where the insurance or reinsurance undertaking has a unilateral rightas referred to in point (a) that relates only to a part of the contract, thesame principle as defined in point (a) shall be applied to this part;(c) Notwithstanding points (a) and (b), where an insurance orreinsurance contract:(i) Does not provide compensation for a specified uncertain event thatadversely affects the insured person,(ii) Does not include a financial guarantee of benefits, any obligationsthat do not relate to premiums which have already been paid do notbelong to the contract, unless the undertaking can compel the policyholder to pay the future premium;(d) Notwithstanding points (a) and (b), where an insurance orreinsurance contract can be unbundled into two parts and where one ofthese parts meets the requirements set out in points (c)(i) and (ii), anyobligations that do not relate to the premiums of that part and which havealready been paid do not belong to the contract, unless the undertakingcan compel the policy holder to pay future premium of that part;(e) All other obligations relating to the contract, including obligationsrelating to unilateral rights of the insurance or reinsurance undertaking to _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 42renew or extend the scope of the contract and obligations that relate topaid premiums, belong to the contract.TP.2.17. Where an insurance or reinsurance undertaking has theunilateral right to amend the premiums or benefits of a portfolio ofinsurance or reinsurance obligations in such a way that the premiums ofthe portfolio fully reflect the risks covered by the portfolio, theundertakings unilateral right to amend the premiums or benefits of thoseobligations shall be regarded as complying with the condition set out inparagraph TP.2.16(a).TP.2.18. Premiums shall be regarded as fully reflecting the risks coveredby a portfolio of insurance or reinsurance obligations, only where there isno scenario under which the amount of the benefits and expenses payableunder the portfolio exceeds the amount of the premiums payable underthe portfolio;TP.2.19. Notwithstanding paragraph TP.2.17, in the case of life insuranceobligations where an individual risk assessment of the obligationsrelating to the insured person of the contract is carried out at theinception of the contract and that assessment cannot be repeated beforeamending the premiums or benefits, the assessment of whether thepremiums fully reflect the risk in accordance with the condition set out inparagraph 1(a) shall be made at the level of the contract.TP.2.20. For the purpose of points (a) and (b) of paragraph TP.2.16,restrictions of the unilateral right and limitations of the extent by whichpremiums and benefits can be amended that have no discernible effect onthe economics of the contract, shall be ignored.TP.2.21. For the purpose of points (c) and (d) of paragraph TP.2.16,coverage of events and guarantees that have no discernible effect on theeconomics of the contract, shall be ignored.TP.2.22. Annex D includes several examples that illustrate the applicationof the definition of the contract boundary.Time horizonTP.2.23. The projection horizon used in the calculation of best estimateshould cover the full lifetime of all the cash in- and out-flows required to _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 43settle the obligations related to existing insurance and reinsurancecontracts on the date of the valuation, unless an accurate valuation can beachieved otherwise.TP.2.24. The determination of the lifetime of insurance and reinsuranceobligations should be based on up-to-date and credible information andrealistic assumptions about when the existing insurance and reinsuranceobligations will be discharged or cancelled or expired.Gross cash in-flowsTP.2.25. To determine the best estimate the following non-exhaustive listof cash in-flows should be included:- Future premiums; and- Receivables for salvage and subrogation.TP.2.26. The cash in-flows should not take into account investmentreturns (i.e. interests earned, dividends…).Gross cash out-flowsTP.2.27. The cash out-flows could be divided between benefits to thepolicyholders or beneficiaries, expenses that will be incurred in servicinginsurance and reinsurance obligations, and other cash-flow items such astaxation payments which are charged to policyholders.BenefitsTP.2.28. The benefit cash out-flows (non-exhaustive list) should include:- Claims payments- Maturity benefits- Death benefits- Disability benefits- Surrender benefits- Annuity payments- Profit sharing bonuses _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 44ExpensesTP.2.29. In determining the best estimate, the undertaking should takeinto account all cash-flows arising from expenses that will be incurred inservicing all recognised insurance and reinsurance obligations over thelifetime thereof. This should include (non-exhaustive list):- Administrative expenses- Investment management expenses- Claims management expenses / handling expensesTP.2.30. Expenses that are pertinent to the valuation of technicalprovisions would usually include both allocated and overhead expenses.Allocated expenses are those expenses which could be directly assignableto the source of expense that will be incurred in servicing insurance andreinsurance obligations.Overhead expenses comprise all other expenses which the undertakingincurs in servicing insurance and reinsurance obligations.TP.2.31. Overhead expenses include, for example, expenses which arerelated to general management and service departments which are notdirectly involved in new business or policy maintenance activities andwhich are insensitive to either the volume of new business or the level ofin-force business.The allocation of overhead expenses to homogeneous risk groups or thepremium provisions and the provisions for claims outstanding shall bedone in a realistic and objective manner and on a consistent basis overtime.The same requirements shall apply to the allocation of overhead expensesto existing and future business.TP.2.32. Administrative expenses are expenses which are connected withpolicy administration including expenses in respect of reinsurancecontracts and special purpose vehicles. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 45Some administrative expenses relate directly to insurance contract orcontract activity (e.g. maintenance cost) such as cost of premium billing,cost of sending regular information to policyholders and cost of handlingpolicy changes (e.g. conversions and reinstatements).Other administrative expenses relate directly to insurance contracts orcontract activity but are a result of activities that cover more than onepolicy such as salaries of staff responsible for policy administration.TP.2.33. Investment management expenses are usually not allocated on apolicy by policy basis but at the level of a portfolio of insurance contracts.Investment management expenses could include expenses ofrecordkeeping of the investments’ portfolio, salaries of staff responsiblefor investment, remunerations of external advisers, expenses connectedwith investment trading activity (i.e. buying and selling of the portfoliosecurities) and in some cases also remuneration for custodial services.Investment management expenses have to be based on a portfolio ofassets appropriate to cover their portfolio of obligations.In case the future discretionary benefits depend on the assets held by theundertaking and for unit-linked contracts the undertaking should ensurethat the future investment management expenses allow for the expectedchanges to the future aforementioned portfolio of assets.In particular, a dynamic expense allowance should be used to reflect adynamic asset strategy.TP.2.34. Usually investment management expenses differ regardingdifferent assets classes.To ensure that investment management expenses will properly reflect thecharacteristics of the portfolio, investment management expenses inrelation to different assets will be based on existing and predicted futuresplit of assets. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 46TP.2.35. Investment management expenses are considered as cashout-flow in the calculation of the best estimate since discounting is madewith a yield curve gross of investment expenses.TP.2.36. Claims management expenses are expenses that will be incurredin processing and resolving claims, including legal and adjuster’s feesand internal costs of processing claims payments. Some of these expensescould be assignable to individual claim (e.g. legal and adjuster’s fees),others are a result of activities that cover more than one claim (e.g.salaries of staff of claims handling department).TP.2.37. Acquisition expenses include expenses which can be identifiedat the level of individual insurance contract and have been incurredbecause the undertaking has issued that particular contract.These are commission costs, costs of selling, underwriting and initiatingan insurance contract that has been issued.TP.2.38. Overhead expenses include salaries to general managers,auditing costs and regular day-to-day costs i.e. electricity bill, rent foraccommodations, IT costs.These overhead expenses also include expenses related to thedevelopment of new insurance and reinsurance business, advertisinginsurance products, improvement of the internal processes such asinvestment in system required to support insurance and reinsurancebusiness (e.g. buying new IT system and developing new software).TP.2.39. Expenses connected with activities which are not linked withservicing insurance and reinsurance obligations are not taken intoaccount when calculating technical provisions.Such expenses could be for example company pension scheme deficits,holding companies’ operational expenses connected with expenseslinked to entities which are not insurance or reinsurance undertakings. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 47TP.2.40. Undertakings should value and take into account charges forembedded options in the valuation of the technical provisions wherepossible.For life insurance contracts with embedded options it is rather commonthat for the cost of the embedded option only a minor charge is made upfront and that the remainder is due in an extended period of time.This does not necessarily have to be the total time until maturity and is ingeneral not necessary fixed or known exactly in advance.Charges from embedded options are taken into account in the bestestimate valuation of technical provisions and they are kept separatelyfrom expense loadings.For example a surrender charge could possibly be seen as a charge tooffset the uncollected charges in average, but could also be seen as a wayto force the policyholder to continue the contract and hence it would notdirectly be related to the cost of embedded options.TP.2.41. To the extent that future premiums from existing insurance andreinsurance contracts are taken into account in the valuation of the bestestimate, expenses relating to these future premiums should be taken intoconsideration.TP.2.42. Undertaking should consider their own analysis of expenses andany relevant data from external sources such as average industry ormarket data.Undertakings should assess the availability of market data on expensesby considering the representativeness of the market data relative to theportfolio and the credibility and reliability of the data.TP.2.43. Where average market information is used, consideration needsto be given as to the representativeness of the data used to form thataverage. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 48For example, market information is not deemed to be sufficientlyrepresentative where the market information has material dispersion inrepresentativeness of the portfolios whose data have been used tocalculate such market information.The assessment of credibility considers the volume of data underlying themarket information.TP.2.44. Assumptions with respect to future expenses arising fromcommitments made on or prior to the date of valuation have to beappropriate and take into account the type of expenses involved.Undertakings should ensure that expense assumptions allow for futurechanges in expenses and such an allowance for inflation is consistent withthe economic assumptions made.Future expense cash flows are usually assumed to vary with assumedrates of general level of expense inflation in a reasonable manner.TP.2.45. Relevant market data needs to be used to determine expenseassumptions which include an allowance for future cost increase.The correlation between inflation rates and interest rates are taken intoaccount.An undertaking needs to ensure that the allowance for inflation isconsistent with the economic assumptions made, which could beachieved if the probabilities for each inflation scenario are consistent withprobabilities implied by market interest rates.Furthermore, expense inflation must be consistent with the types ofexpenses being considered (e.g. different levels of inflation would beexpected regarding office space rents, salaries of different types of staff,IT systems, medical expenses, etc.).TP.2.46. Any assumptions about the expected cost reduction should berealistic, objective and based on verifiable data and information. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 49TP.2.47. For the assessment of the future expenses, undertakings shouldtake into account all the expenses that are directly related to the on-goingadministration of obligations related to existing insurance andreinsurance contracts, together with a share of the relevant overheadexpenses.The share of overheads should be assessed on the basis that theundertaking continues to write further new business.Overhead expenses have to be apportioned between existing and futurebusiness based on recent analyses of the operations of the business andthe identification of appropriate expense drivers and relevant expenseapportionment ratios.Cash flow projections should include, as cash out-flows, the recurrentoverheads attributable to the existing business at the calculation date ofthe best estimate.TP.2.48. In order to determine which expenses best reflect thecharacteristics of the underlying portfolio and to ensure that the technicalprovisions are calculated in a prudent, reliable and objective manner,insurance and reinsurance undertakings should consider theappropriateness of both market consistent expenses and undertakingspecific expenses.If sufficiently reliable, market consistent expenses are not availableparticipants should use undertaking-specific information to determineexpenses that will be incurred in servicing insurance and reinsuranceobligations provided that the undertaking-specific information isassessed to be appropriate.TP.2.49. Expenses, that are determined by contracts between theundertaking and third parties have to be taken into account based on theterms of the contract.In particular, commissions arising from insurance contracts have to beconsidered based on the terms of the contracts between the undertakingsand the sales persons, and expenses in respect of reinsurance are taken _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 50into account based on the contracts between the undertaking and itsreinsurers.Tax paymentsTP.2.50. In determining the best estimate, undertakings should take intoaccount taxation payments which are charged to policyholders.Only those taxation payments which are settled by the undertaking needto be taken into account.A gross calculation of the amounts due to policyholders suffices where taxpayments are settled by the policyholders;TP.2.51. Different taxation regimes exist across Member States giving riseto a broad variety of tax rules in relation to insurance contracts.The assessment of the expected cash-flows underlying the technicalprovisions should take into account any taxation payments which arecharged to policyholders, or which would be required to be made by theundertaking to settle the insurance obligations.All other tax payments should be taken into account under other balancesheet items.TP.2.52. The following tax payments should be included in the bestestimate: transaction-based taxes (such as premium taxes, value addedtaxes and goods and services taxes) and levies (such as fire service leviesand guarantee fund assessments) that arise directly from existinginsurance contracts, or that can be attributed to the contracts on areasonable and consistent basis.Contributions which were already included in companies’ expenseassumptions (i.e. levies paid by insurance companies to industryprotection schemes) should not be included.TP.2.53. The allowance for tax payments in the best estimate should beconsistent with the amount and timing of the taxable profits and lossesthat are expected to be incurred in the future. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 51In cases where changes to taxation requirements are substantiallyenacted, the pending adjustments should be reflected.TP.2.54. Homogeneous risk groups of life insurance obligationsThe cash-flow projections used in the calculation of best estimates for lifeinsurance obligations shall be made separately for each policy.Where the separate calculation for each policy would be an undue burdenon the insurance or reinsurance undertaking, it may carry out theprojection by grouping policies, provided that the grouping complieswith the following requirements:(1) There are no significant differences in the nature and complexity ofthe risks underlying the policies that belong to the same group;(2) The grouping of policies does not misrepresent the risk underlying thepolicies and does not misstate their expenses;(3) The grouping of policies is likely to give approximately the sameresults for the best estimate calculation as a calculation on a per policybasis, in particular in relation to financial guarantees and contractualoptions included in the policies.TP.2.55. In certain specific circumstances, the best estimate element oftechnical provisions may be negative (e.g. for some individual contracts).This is acceptable and undertakings should not set to zero the value of thebest estimate with respect to those individual contracts.TP.2.56. No implicit or explicit surrender value floor should be assumedfor the amount of the market consistent value of liabilities for a contract.This means that if the sum of a best estimate and a risk margin of acontract is lower than the surrender value of that contract there is no needto increase the value of insurance liabilities to the surrender value of thecontract. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 52Non-life insurance obligationsTP.2.57. The valuation of the best estimate for provisions for claimsoutstanding and for premium provisions should be carried out separately.With respect to the best estimate for premium provisions, the cash-flowprojections relate to claim events occurring after the valuation date andduring the remaining in-force period (coverage period) of the policiesheld by the undertaking (existing policies).The cash-flow projections should comprise all future claim payments andclaims administration expenses arising from these events, cash-flowsarising from the ongoing administration of the in-force policies andexpected future premiums stemming from existing policies.TP.2.58. The best estimate of premium provisions from existinginsurance and reinsurance contracts should be given as the expectedpresent value of future in- and out-going cash-flows, being a combinationof, inter alia:- cash-flows from future premiums;- cash-flows resulting from future claims events;- cash-flows arising from allocated and unallocated claims administration expenses;- cash-flows arising from ongoing administration of the in-force policies.There is no need for the listed items to be calculated separately.TP.2.59. With regard to premium provisions, the cash in-flows couldexceed the cash out-flows leading to a negative best estimate.This is acceptable and undertakings are not required to set to zero thevalue of the best estimate. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 53The valuation should take account of the time value of money where risksin the remaining period would give rise to claims settlements into thefuture.TP.2.60. Additionally, the valuation of premium provisions should takeaccount of future policyholder behaviour such as likelihood of policylapse during the remaining period.TP.2.61. With respect to the best estimate for provisions for claimsoutstanding, the cash-flow projections relate to claim events havingoccurred before or at the valuation date – whether the claims arising fromthese events have been reported or not (i.e. all incurred but not settledclaims).The cash-flow projections should comprise all future claim payments aswell as claims administration expenses arising from these events.TP.2.62. Where non-life insurance policies give rise to the payment ofannuities, the approach laid down in the following subsection onsubstance over form should be followed.Consistent with this, for premium provisions, its assessment shouldinclude an appropriate calculation of annuity obligations if a materialamount of incurred claims is expected to give rise to the payment ofannuities.Principle of substance over formTP.2.63. When discussing valuation techniques for calculating technicalprovisions, it is common to refer to a distinction between a valuationbased on life techniques and a valuation based on non-life techniques.The distinctions between life and non-life techniques are aimed towardsthe nature of the liabilities (substance), which may not necessarily matchthe legal form (form) of the contract that originated the liability. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 54The choice between life or non-life actuarial methodologies should bebased on the nature of the liabilities being valued and from theidentification of risks which materially affect the underlying cash-flows.This is the essence of the principle of substance over form.TP.2.64. Traditional life actuarial techniques to calculate the bestestimate can be described as techniques that are based on discountedcash-flow models, generally applied on a policy-by-policy basis, whichtake into account in an explicit manner risk factors such as mortality,survival and changes in the health status of the insured person(s).TP.2.65. On the other hand, traditional non-life actuarial techniquesinclude a number of different approaches.For example some of the most common being:- Methodologies based on the projection of run-off triangles, usually constructed on an aggregate basis;- Frequency/severity models, where the number of claims and the severity of each claim is assessed separately;- Methodologies based on the estimation of the expected loss ratio or other relevant ratios;- Combinations of the previous methodologies;TP.2.66. There is one key difference between life and non-life actuarialmethodologies: life actuarial methodologies consider explicitly theprobabilities of death, survival, disability and/or morbidity of the insuredpersons as key parameters in the model, while non-life actuarialmethodologies do not.TP.2.67. The choice between life or non-life actuarial methodologiesshould be based on the nature of the liabilities valued and on theidentification of risks which materially affect the underlying cash-flows. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 55TP.2.68. In practice, in the majority of cases the form will correspond tothe substance.However, for example for certain supplementary covers included in lifecontracts (e.g. accident) may be better suited for an estimation based onnon-life actuarial methodologies.TP.2.69. The following provides additional guidance for the treatment ofannuities arising in non-life insurance.The application of the principle of substance over form implies that suchliabilities should be valued using methodologies usually applicable to thevaluation of life technical provisions,Specifically, guidance is provided in relation to:- the recognition and segmentation of insurance obligations for the purpose of calculating technical provisions (i.e. the allocation of obligations to the individual lines of business);- the valuation of technical provisions for such annuities; and- possible methods for the valuation of technical provisions for the remaining non-life obligationsTP.2.70. The treatment proposed in these specifications for annuitiesshould be extended to other types of liabilities stemming from non-lifeand health insurance whose nature is deemed similar to life liabilities(such as life assistance benefits), taking into consideration the principlementioned in the previous paragraph.Allocation to the individual lines of businessTP.2.71. Where non-life and Non-SLT health insurance policies give riseto the payment of annuities such liabilities should be valued usingtechniques commonly used to value life insurance obligations. Suchliabilities should be assigned to the lines of business for annuitiesstemming from non-life contracts. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 56Valuation of annuities arising from non-life and Non-SLT healthinsurance contractsTP.2.72. Undertakings should value the technical provisions related tosuch annuities separately from the technical provisions related to theremaining non-life and health obligations.They should apply appropriate life insurance valuation techniques.The valuation should be consistent with the valuation of life insuranceannuities with comparable technical features.Valuation of the remaining non-life and health insuranceobligationsTP.2.73. The remaining obligations in the undertaking’s non-life andNon-SLT health business (which are similar in nature to non-lifeinsurance obligations) have to be valued separately from the relevantblock of annuities.TP.2.74. Where provisions for claims outstanding according to nationalaccounting rules are compared to provisions for claims outstanding ascalculated above, it should be taken into account that the latter do notinclude the annuity obligations.TP.2.75. Undertakings may use, where appropriate, one of the followingapproaches to determine the best estimate of claims provisions for theremaining non-life or health obligations in a given non-life or Non-SLThealth insurance line of business where annuities are valued separately.Separate calculation of non-life liabilitiesTP.2.76. Under this approach, the run-off triangle which is used as a basisfor the determination of the technical provisions should not include anycash-flows relating to the annuities. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 57An additional estimate of the amount of annuities not yet reported and forreported but not yet agreed annuities needs to be added.Allowance of agreed annuities as single lump-sum payments inthe run-off triangleTP.2.77. This approach also foresees a separate calculation of the bestestimate, where the split is between annuities in payment and theremaining obligations.TP.2.78. Under this approach, the run-off triangle which is used as a basisfor the determination of the technical provisions of the remaining non-lifeor health obligations in a line of business does not include any cash-flowsrelating to the annuities in payment.This means that claims payments for annuities in payment are excludedfrom the run-off triangle.TP.2.79. However, payments on claims before annuitisation1 andpayments at the time of annuitisation remain included in the run-offtriangle.At the time of annuitisation, the best estimate of the annuity (valuedseparately according to life principles) is shown as a single lump-sumpayment in the run-off triangle, calculated as at the date of theannuitisation.Where proportionate, approximations of the lump sums could be used.TP.2.80. Where the analysis is based on run-off triangles of incurredclaims, the lump sum payment should reduce the case reserves at the dateof annuitisation.TP.2.81. On basis of run-off triangles adjusted as described above, theparticipant may apply an appropriate actuarial reserving method to derivea best estimate of the claims provision of the portfolio. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 58Due to the construction of the run-off triangle, this best estimate wouldnot include the best estimate related to the annuities in payment whichwould be valued separately using life principles (i.e. there would be no“double counting” in relation to the separate life insurance valuation),but it includes a best estimate for not yet reported and for reported but notyet agreed annuities.Expert judgementTP.2.82. Insurance and reinsurance undertakings shall chooseassumptions based on the expertise of persons with relevant knowledge,experience and understanding of the risks inherent in the insurance orreinsurance business thereof (expert judgment).In certain circumstances expert judgement may be necessary whencalculating the best estimate, among other:- in selecting the data to use, correcting its errors and deciding the treatment of outliers or extreme events,- in adjusting the data to reflect current or future conditions, and adjusting external data to reflect the undertaking’s features or the characteristics of the relevant portfolio,- in selecting the time period of the data- in selecting realistic assumptions- in selecting the valuation technique or choosing the most appropriate alternatives existing in each methodology- in incorporating appropriately to the calculations the environment under which the undertakings have to run its business.TP.2.83. In the case of non-life insurance and non-life reinsuranceobligations, participants should allocate the expenses into homogenousrisk groups, as a minimum by line of business according to the _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 59segmentation of their obligations used in the calculation of technicalprovisions.Undertakings should allocate the expenses of non-life insurance andreinsurance obligations to premium provisions and to provisions forclaims outstanding.Obligations in different currenciesTP.2.84. The probability-weighted average cash-flows should take intoaccount the time value of money.The time value of money of future cash-flows in different currencies iscalculated using risk-free term structure for relevant currency.Therefore the best estimate should be calculated separately forobligations of different currencies.Valuation of options and guarantees embedded in insurancecontractsTP.2.85. When calculating the best estimate, insurance and reinsuranceundertakings shall identify and take into account:1. All financial guarantees and contractual options included in theirinsurance and reinsurance policies;2. All factors which may materially affect the likelihood that policy holderswill exercise contractual options or the value of the option or guarantee.Definition of contractual options and financial guaranteesTP.2.86. A contractual option is defined as a right to change the benefits2,to be taken at the choice of its holder (generally the policyholder), onterms that are established in advance.Thus, in order to trigger an option, a deliberate decision of its holder isnecessary. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 60TP.2.87. Some (non-exhaustive) examples of contractual options whichare pre-determined in contract and do not require again the consent of theparties to renew or modify the contract include the following:- Surrender value option, where the policyholder has the right to fully or partially surrender the policy and receive a pre-defined lump sum amount;- Paid-up policy option, where the policyholder has the right to stop paying premiums and change the policy to a paid-up status;- Annuity conversion option, where the policyholder has the right to convert a lump survival benefit into an annuity at a pre-defined minimum rate of conversion;- Policy conversion option, where the policyholder has the right to convert from one policy to another at pre-specific terms and conditions;- Extended coverage option, where the policyholder has the right to extend the coverage period at the expiry of the original contract without producing further evidence of health.TP.2.88. A financial guarantee is present when there is the possibility topass losses to the undertaking or to receive additional benefits as a resultof the evolution of financial variables (solely or in conjunction withnon-financial variables) (e.g. investment return of the underlying assetportfolio, performance of indices, etc.).In the case of guarantees, the trigger is generally automatic (themechanism would be set in the policy’s terms and conditions) and thusnot dependent on a deliberate decision of the policyholder / beneficiary.In financial terms, a guarantee is linked to option valuation.TP.2.89. The following is a non-exhaustive list of examples of commonfinancial guarantees embedded in life insurance contracts: _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 61- Guaranteed invested capital- Guaranteed minimum investment return- Profit sharingTP.2.90. There are also non-financial guarantees, where the benefitsprovided would be driven by the evolution of non-financial variables, suchas reinstatement premiums in reinsurance, experience adjustments tofuture premiums following a favourable underwriting history (e.g.guaranteed no-claims discount).Where these guarantees are material, the calculation of technicalprovisions should also take into account their value.Valuation requirementsTP.2.91. For each type of contractual option insurers are required toidentify the risk drivers which have the potential to materially affect(directly or indirectly) the frequency of option take-up rates considering asufficiently large range of scenarios, including adverse ones.TP.2.92. The best estimate of contractual options and financialguarantees must capture the uncertainty of cash-flows, taking intoaccount the likelihood and severity of outcomes from multiple scenarioscombining the relevant risk drivers.TP.2.93. The best estimate of contractual options and financialguarantees should reflect both the intrinsic value and the time value.TP.2.94. The best estimate of contractual options and financialguarantees may be valued by using one or more of the followingmethodologies:- A stochastic approach using for instance a market-consistent asset model (includes both closed form and stochastic simulation approaches); _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 62- A series of deterministic projections with attributed probabilities; and- A deterministic valuation based on expected cash-flows in cases where this delivers a market-consistent valuation of the technical provision, including the cost of options and guarantees.TP.2.95. For the purposes of valuing the best estimate of contractualoptions and financial guarantees, a stochastic simulation approach wouldconsist of an appropriate market-consistent asset model for projections ofasset prices and returns (such as equity prices, fixed interest rate andproperty returns), together with a dynamic model incorporating thecorresponding value of liabilities (incorporating the stochastic nature ofany relevant non-financial risk drivers) and the impact of any foreseeableactions to be taken by management.TP.2.96. For the purposes of the deterministic approach, a range ofscenarios or outcomes appropriate to both valuing the options orguarantees and the underlying asset mix, together with the associatedprobability of occurrence should be set.These probabilities of occurrence should be weighted towards adversescenarios to reflect market pricing for risk.The series of deterministic projections should be numerous enough tocapture a wide range of possible out-comes (and, in particular, it shouldinclude very adverse yet possible scenarios) and take into account theprobability of each outcomes likelihood (which may, in practice, need toincorporate judgement).The costs will be understated if only relatively benign or limited economicscenarios are considered.TP.2.97. When the valuation of the best estimate of contractual optionsand financial guarantees is not being done on a policy-by-policy basis, thesegmentation considered should not distort the valuation of technicalprovisions by, for example, forming groups containing policies which are"in the money" and policies which are "out of the money". _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 63TP.2.98. Regarding contractual options, the assumptions on policyholderbehaviour should be appropriately founded in statistical and empiricalevidence, to the extent that it is deemed representative of the futureexpected behaviour.However, when assessing the experience of policyholders’ behaviourappropriate attention based on expert judgements should be given to thefact that when an option is out of or barely in the money, the behaviour ofpolicyholders should not be considered to be a reliable indication of likelypolicyholders’ behaviour when the options are heavily in-the-money.TP.2.99. Appropriate consideration should also be given to an increasingfuture awareness of policy options as well as policyholders’ possiblereactions to a changed financial position of an undertaking.In general, policyholders’ behaviour should not be assumed to beindependent of financial markets, a firm’s treatment of customers orpublicly available information unless proper evidence to support theassumption can be observed.TP.2.100. Where material, non-financial guarantees should be treated likefinancial guarantees.Valuation of future discretionary benefitsTP.2.101. In calculating the best estimate, undertakings should take intoaccount future discretionary benefits which are expected to be made,whether or not those payments are contractually guaranteed.Undertakings should not take into account payments that relate tosurplus funds which possess the characteristics of Tier 1 basic own funds.Surplus funds are accumulated profits which have not been madeavailable for distribution to policyholders and beneficiaries. (Cf. Article 91of the Solvency II Framework Directive.)TP.2.102. When undertakings calculate the best estimate of technicalprovisions, the value of future discretionary benefits should be calculatedseparately. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 64TP.2.103. Future discretionary benefits means benefits of insurance orreinsurance contracts which have one of the following characteristics:- The benefits are legally or contractually based on one or several of the following results:- The performance of a specified pool of contracts or a specified type of contract or a single contract;- Realised or unrealised investment return on a specified pool of assets held by the insurance or reinsurance undertaking;- The profit or loss of the insurance or reinsurance undertaking or fund that issues the contract that gives rise to the benefits;- The benefits are based on a declaration of the insurance or reinsurance undertaking and the timing or the amount of the benefits is at its discretion.TP.2.104. Index-linked and unit-linked benefits should not be consideredas discretionary benefits.TP.2.105. The distribution of future discretionary benefits is amanagement action and assumptions about it should be objective,realistic and verifiable.In particular assumptions about the distribution of future discretionarybenefits should take the relevant and material characteristics of themechanism for their distribution into account.TP.2.106. Some examples of characteristics of mechanisms fordistributing discretionary benefits are the following.Undertakings should consider whether they are relevant and material forthe valuation of future discretionary benefits and take them into accountaccordingly, applying the principle of proportionality. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 65- What constitutes a homogenous group of policyholders and what are the key drivers for the grouping?- How is a profit divided between owners of the undertaking and the policyholders and furthermore between different policyholders?- How is a deficit divided between owners of the undertaking and the policyholders and furthermore between different policyholders?- How will the mechanism for discretionary benefits be affected by a large profit or loss?- How will policyholders be affected by profits and losses from other activities?- What is the target return level set by the firm’s owners on their invested capital?- What are the key drivers affecting the level of discretionary benefits?- What is an expected level (inclusive of any distribution of excess capital, unrealised gains etc.) of discretionary benefits?- How are the discretionary benefits made available for policyholders and what are the key drivers affecting for example the split between reversionary and terminal discretionary benefits, conditionality, changes in smoothing practice, level of discretionary by the undertaking, etc.- How will the experience from current and previous years affect the level of discretionary benefits?- When is an undertakings solvency position so weak that declaring discretionary benefits is considered by the undertaking to jeopardize a shareholder’s or/and policyholders’ interest?- What other restrictions are in place for determining the level of discretionary benefits? _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 66- What is an undertakings investment strategy?- What is the asset mix driving the investment return?- What is the smoothing mechanism if used and what is the interplay with a large profit or loss?- What kind of restrictions are in place in smoothing extra benefits?- Under what circumstances would one expect significant changes in the crediting mechanism for discretionary benefits?- To what extent is the crediting mechanism for discretionary benefits sensitive to policyholders’ actions?TP.2.107. Where the future discretionary benefits depend on the assetsheld by the undertaking, the calculation of the best estimate should bebased on the current assets held by the undertaking.Future changes of the asset allocation should be taken into accountaccording to the requirements on future management actions.TP.2.108. The assumptions on the future returns of these assets, valuedaccording to the subsection V.1, should be consistent with the relevantrisk-free interest term structure for the Quantitative Assessment.Where a risk neutral approach for the valuation is used, the set ofassumptions on returns of future investments underlying the valuation ofdiscretionary benefits should be consistent with the principle that theyshould not exceed the level given by the forward rates derived from therisk-free interest rates. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 67Assumptions underlying the calculation of the best estimateAssumptions consistent with information provided by financialmarketsTP.2.109. Assumptions consistent with information about or provided byfinancial markets include (non-exhaustive list):- relevant risk-free interest rate term structure,- currency exchange rates,- market inflation rates (consumer price index or sector inflation) and- economic scenario files (ESF).TP.2.110. When undertakings derive assumptions on future financialmarket parameters or scenarios, they should be able to demonstrate thatthe choice of the assumptions is appropriate and consistent with thevaluation principles set out in subsection V.1;TP.2.111. Where the undertaking uses a model to produce futureprojections of market parameters (market consistent asset model, e.g. aneconomic scenario file), such model should comply with the followingrequirements:i. It generates asset prices that are consistent with deep, liquid andtransparent financial markets 4;ii. It assumes no arbitrage opportunity;TP.2.112. The following principles should be taken into account indetermining the appropriate calibration of a market consistent assetmodel: _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 68a) The asset model should be calibrated to reflect the nature and term ofthe liabilities, in particular of those liabilities giving rise to significantguarantee and option costs.b) The asset model should be calibrated to the current risk-free termstructure used to discount the cash flows.c) The asset model should be calibrated to a properly calibrated volatilitymeasure.TP.2.113. In principle, the calibration process should use market pricesonly from financial markets that are deep, liquid and transparent.If the derivation of a parameter is not possible by means of prices fromdeep, liquid and transparent markets, other market prices may be used.In this case, particular attention should be paid to any distortions of themarket prices.Corrections for the distortions should be made in a deliberate, objectiveand reliable manner.TP.2.114. A financial market is deep, liquid and transparent, if it meets therequirements specified in the subsection of these specifications regardingcircumstances in which technical provisions should be calculated as awhole.TP.2.115. The calibration of the above mentioned assets models may alsobe based on adequate actuarial and statistical analysis of economicvariables provided they produce market consistent results.For example:a) To inform the appropriate correlations between different asset returns.b) To determine probabilities of transitions between rating classes anddefault of corporate bonds. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 69c) To determine property volatilities.As there is virtually no market in property derivatives, it is difficult toderive property implied volatility. Thus the volatility of a property indexmay often be used instead of property implied volatility.Assumptions consistent with generally available data oninsurance and reinsurance technical risksTP.2.116. Generally available data refers to a combination of:- Internal data- External data sources such as industry or market data.TP.2.117. Internal data refers to all data which is available from internalsources.Internal data may be either:- Undertaking-specific data:- Portfolio-specific data:TP.2.118. All relevant available data whether external or internal data,should be taken into account in order to arrive at the assumption whichbest reflects the characteristics of the underlying insurance portfolio.In the case of using external data, only that which the undertaking canreasonably be expected to have access too should be considered.The extent to which internal data is taken into account should be basedon:- The availability, quality and relevance of external data.- The amount and quality of internal data. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 70TP.2.119. Where insurance and reinsurance undertakings use data froman external source, they should derive assumptions on underwriting risksthat are based on that data according to the following requirements:(a) Undertakings are able to demonstrate that the sole use of data whichare available from an internal source are not more suitable than externaldata; and(b) The origin of the data and assumptions or methodologies used toprocess them is known to the undertaking and the undertaking is able todemonstrate that these assumptions and methodologies appropriatelyreflect the characteristics of the portfolio.Policyholders’ behaviourTP.2.120. Undertakings are required to identify policyholders’ behaviour.TP.2.121. Any assumptions made by insurance and reinsuranceundertakings with respect to the likelihood that policyholders willexercise contractual options, including lapses and surrenders, should berealistic and based on current and credible information.The assumptions should take account, either explicitly or implicitly, ofthe impact that future changes in financial and non-financial conditionsmay have on the exercise of those options.TP.2.122. Assumptions about the likelihood that policy holders willexercise contractual options should be based on analysis of pastpolicyholder behaviour.The analysis should take into account the following:(a) How beneficial the exercise of the options was or would have been tothe policyholders under past circumstances (whether the option is out ofor barely in the money or is in the money),(b) The influence of past economic conditions, _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 71(c) The impact of past management actions,(d) Where relevant, how past projections compared to the actual outcome,(e) Any other circumstances that are likely to influence a decision whetherto exercise the option.TP.2.123. The likelihood that policyholders will exercise contractualoptions, including lapses and surrenders, should not be assumed to beindependent of the elements mentioned in points (a) to (e) in the previousparagraph, unless proper evidence to support such an assumption can beobserved or where the impact would not be material.TP.2.124. In general policyholders’ behaviour should not be assumed tobe independent of financial markets, of undertaking’s treatment ofcustomers or publicly available information unless proper evidence tosupport the assumption can be observed.TP.2.125. Policyholder options to surrender are often dependent onfinancial markets and undertaking-specific information, in particular thefinancial position of the undertaking.TP.2.126. Policyholders’ option to lapse and also in certain cases tosurrender are mainly dependent on the change of policyholders’ statussuch as the ability to further pay the premium, employment, divorce, etc.Management actionsTP.2.127. The methods and techniques for the estimation of futurecash-flows, and hence the assessment of the provisions for insuranceliabilities, should take account of potential future actions by themanagement of the undertaking.TP.2.128. As examples, the following should be considered:- changes in asset allocation, as management of gains/losses for differentasset classes in order to gain the target segregated fund return;management of cash balance and equity backing ratio with the aim of _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 72maintaining a defined target asset mix in the projection period;management of liquidity according to the asset mix and durationstrategy; actions to maintain a stable allocation of the portfolio assets interm of duration and product type, actions for the dynamic rebalancing ofthe assets portfolio according to movements in liabilities and changes inmarket conditions;- changes in bonus rates or product changes, for example on policies withprofit participation to mitigate market risks;- changes in expense charge, for example related to guarantee charge, orrelated to an increased charging on unit-linked or index-linked business;TP.2.129. The assumptions on future management actions used in thecalculation of the technical provisions should be determined in anobjective manner.TP.2.130. Assumed future management actions should be realistic andconsistent with the insurance or reinsurance undertaking’s currentbusiness practice and business strategy unless there is sufficient currentevidence that the undertaking will change its practices.TP.2.131. Assumed future management actions should be consistent witheach other.TP.2.132. Insurance and reinsurance undertakings should not assumethat future management actions would be taken that would be contrary totheir obligations towards policyholders and beneficiaries or to legalprovisions applicable to the insurance and reinsurance undertakings.The assumed future management actions should take account of anypublic indications by the insurance or reinsurance undertaking as to theactions that it would expect to take, or not take in the circumstancesbeing considered.TP.2.133. Assumptions about future management actions should takeaccount of the time needed to implement the management actions andany expenses caused by them. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 73TP.2.134. Insurance and reinsurance undertakings should be able toverify that assumptions about future management actions are realisticthrough a comparison of assumed future management actions withmanagement actions actually taken previously by the insurance orreinsurance undertaking. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 74International Association of Insurance SupervisorsIAIS Releases Proposed Policy Measures forGlobal Systemically Important InsurersPublic consultation to continue through 16 December 2012Basel – The International Association of Insurance Supervisors (IAIS)today released its proposed policy measures for global systemicallyimportant insurers, or G-SIIs.The paper was endorsed for consultation by the Financial Stability Board(FSB), which is coordinating the overall project to reduce the moralhazard posed by global systemically important financial institutions.Supervisors, insurers and other interested parties are encouraged tosubmit comments on the proposed policy measures through 16December.“These proposed policy measures are intended to reduce moral hazardand the negative externalities stemming from the potential disorderlyfailure posed by a G-SII,” said Peter Braumüller, Chair of the IAISExecutive Committee.“Each of the proposed policy measures has also been designed to takeaccount of the specific nature of the insurance business model and is theresult of intensive and thorough discussion at the IAIS.”The IAIS has proposed a framework of policy measures for G-SIIs basedupon the general framework published by the FSB with adjustments that,as with the proposed assessment methodology, reflect the factors thatmake insurers different from other financial institutions.The proposal consists of three main types of measures:1. Enhanced Supervision. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 75These measures build on the IAIS Insurance Core Principles and theFSB’s Supervisory Intensity and Effectiveness recommendations andinclude the development of a Systemic Risk Reduction Plan andenhanced liquidity planning and management.2. Effective Resolution.Based on the FSB’s Key Attributes of Effective Resolution Regimes forFinancial Institutions, which include the establishment of CrisisManagement Groups, the elaboration of recovery and resolution plans,the conduct of resolvability assessments, and the adoption ofinstitution-specific cross-border cooperation agreements.The IAIS proposals take account of the specificities of insurance throughthe inclusion of plans for separating non-traditional, non-insurance(NTNI) activities from traditional insurance activities, the potential useof portfolio transfers and run-off arrangements, and the recognition ofexisting policyholder protection and guarantee schemes.3. Higher Loss Absorption (HLA) Capacity.This proposal utilises a cascading approach.In the first step if, and to the extent to which, the G-SII has demonstratedeffective separation of NTNI activities from traditional insuranceactivities, targeted HLA will be applied to the separate entities.Under the second step, whether or not NTNI activities have beenseparated, an overall assessment of group-wide HLA needed will beundertaken and the group wide supervisor will determine whether theHLA capacity held at the NTNI entities is sufficient or needs to befurther increased.About the IAIS:The IAIS is a global standard setting body whose objectives are topromote effective and globally consistent regulation and supervision ofthe insurance industry in order to develop and maintain fair, safe and _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 76stable insurance markets for the benefit and protection of policyholders;and to contribute to global financial stability.Its membership includes insurance regulators and supervisors from over190 jurisdictions in some 140 countries.More than 120 organisations and individuals representing professionalassociations, insurance and reinsurance companies, internationalfinancial institutions, consultants and other professionals are Observers.Global Systemically Important Insurers:Proposed Policy MeasuresPublic Consultation DocumentComments due by 16 December 2012Cover noteThe global financial crisis underscored the interconnected nature offinancial firms and the severe financial and economic costs associatedwith public sector interventions for those that were distressed or expectedto fail.It also underscored the need to act promptly and proactively to identifyfirms that are systemically important and to take measures to lessen theimpact and reduce the moral hazard associated with the failure of suchfirms.As such, the International Association of Insurance Supervisors (IAIS) isparticipating in a global initiative, along with other standard setters,central banks and financial sector supervisors, and under the purview ofthe Financial Stability Board (FSB) and G20, to identify globalsystemically important financial institutions (G-SIFIs).The focus of IAIS analysis is in relation to potential global systemicallyimportant insurers (G-SIIs). _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 77Earlier this year, the IAIS developed an assessment methodology toidentify any insurers whose distress or disorderly failure, because of theirsize, complexity and interconnectedness, would cause significantdisruption to the global financial system and economic activity.The IAIS has now developed a framework of policy measures that shouldbe applied to insurers that are determined to be G-SIIs.Interested parties may wish to consult relevant background papers whichare available on the IAIS, FSB and Basel Committee on BankingSupervision (Basel Committee) websites, including the IAIS’ reportInsurance and Financial Stability.Other key papers include:• The IMF/FSB/Bank for International Settlements (BIS) staff reportsubmitted to the G20 Finance Ministers and Central Bank Governorsentitled Guidance to Assess the Systemic Importance of FinancialInstitutions, Markets and Instruments (October 2009);• The FSB’s recommendations on Reducing the moral hazard posed bysystemically important financial institutions (SIFIs) (October 2010);• The Basel Committee framework for identifying global systemicallyimportant banks (G-SIBs) and requirements for additional lossabsorbency for G-SIBs (November 2011); and• The determination of the first cohort of G-SIBs (November 2011).All comments will be published on the IAIS website, unless a specificrequest is made for comments to remain confidential.Glossary of abbreviationsBCBS Basel Committee on Banking Supervision (also Basel Committee)BIS Bank for International Settlements _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 78CDS Credit Default SwapComFrame IAIS Common Framework for the Supervision ofInternationally Active Insurance GroupsCMGs Crisis Management GroupsFSB Financial Stability BoardG-SIBs Global Systemically Important BanksG-SIFIs Global Systemically Important Financial InstitutionsG-SIIs Global Systemically Important InsurersG20 Group of Twenty CountriesHLA Higher Loss Absorbency or Higher Loss Absorption capacityIAIGs Internationally Active Insurance GroupsIAIS International Association of Insurance SupervisorsICPs IAIS Insurance Core PrinciplesIGT Intra-group TransactionsISDA International Swaps and Derivatives AssociationKey Attributes FSB’s Key Attributes for Effective Resolution RegimesMCR Minimum Capital RequirementNTNI Non-traditional Insurance and Non-insurance activitiesPCR Prescribed Capital RequirementRRPs Recovery and Resolution Plans _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 79SIFIs Systemically Important Financial InstitutionsSRRP Systemic Risk Reduction PlanExecutive SummaryFSB framework for G-SIFIsThe Financial Stability Board (FSB) framework for reducing the moralhazard and risk to the global financial system posed by systemicallyimportant financial institutions (SIFIs) recommends several policieswhich should combine to:• Apply more intensive and co-ordinated supervision of SIFIs,• Improve the authorities’ ability to resolve SIFIs in an orderly mannerwithout destabilising the financial system and exposing the taxpayer tothe risk of loss,• Require higher loss absorption (HLA) capacity for SIFIs to reflect thegreater risks that these institutions pose to the global financial system,• Provide other supplementary prudential and other requirements asdetermined by the national authorities.Policy measures proposed by IAISThe IAIS proposes a framework of policy measures for G-SIIs in line withthe FSB recommendations.Measures will often require strong cooperation among authorities,including authorities with responsibility for non-insurance entities.i) Enhanced supervisionThe foundation for G-SII policy measures is the existing IAIS InsuranceCore Principles (ICPs). _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 80The FSB’s “Supervisory Intensity and Effectiveness” recommendations(SIE recommendations) would form the basis of the IAIS’ approach toenhanced supervision.In addition, the IAIS Common Framework for the Supervision ofInternationally Active Insurance Groups (ComFrame) will aim to fosterglobal convergence of regulatory and supervisory measures andapproaches for Internationally Active Insurance Groups (IAIGs), whetheror not they are identified as G-SIIs, although ComFrame is not expectedto directly focus on addressing systemic risk.For G-SIIs, the supervisor should have direct powers over holdingcompanies to ensure that a direct approach to consolidated group-widesupervision can be applied.Special attention should be paid to group-wide supervision since G-SIIsare most likely to take the form of a group and NTNI (non-traditional andnon-insurance) activities are often carried out by separate entities withina group and/or the group may have significant interconnections to otherparts of the financial system.The supervisor should require G-SIIs to have, in particular, adequatearrangements in place to deal with liquidity risk management for thewhole group, primarily for the NTNI business, but secondarily also forthe remainder of the G-SII.The authorities should analyse activities that cause systemic importanceof G-SIIs and take necessary measures to reduce that systemicimportance.The authorities should oversee the development of a Systemic RiskReduction Plan (SRRP) by each G-SII (in addition to recovery andresolution plans (RRPs)) to reduce that systemic importance and monitorimplementation of the plan.Where feasible and appropriate, the SRRP may include effectiveseparation of systemically important NTNI activities from traditional _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 81insurance business and/or restrictions or prohibitions of specifiedsystemically important activities or any other measures.Where separation of NTNI activities is contemplated, the SRRP shouldseek to ensure it achieves self-sufficiency in terms of structure andfinancial condition of the separated entities.Structural aspects of self-sufficiency will likely involve a combination ofrestructuring measures and the restriction or prohibition of parentalguarantees and cross-default clauses to ensure that any separation intolegal entities is not undermined by contractual obligations.Self-sufficiency in terms of financial condition means there should be nocapital or funding subsidies or multiple-gearing.The authorities should avoid the creation by the G-SII of non-regulatedentities through the separation of NTNI activities.Any entities used to separate NTNI activities should be effectivelyregulated under direct consolidated group-wide supervision includingcoordination with other involved supervisors, as discussed above.ii) Effective resolutionIn 2011, the FSB published an international standard for resolution – “KeyAttributes of Effective Resolution Regimes for Financial Institutions”(Key Attributes).This standard sets out a range of specific requirements that should applyto any financial institution that could be systemically significant orcritical if it fail.The requirements applied to at least G-SIFIs include(i) The establishment of Crisis Management Groups (CMGs);(ii) The elaboration of recovery and resolution plans (RRPs); _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 82(iii) The conduct of resolvability assessments(iv) The adoption of institution-specific cross-border cooperationagreementsFor G-SIIs, effective resolution will take account of the specificities ofinsurance including:• Plans and steps needed for separating NTNI activities from traditionalinsurance activities,• The possible use of portfolio transfers and run off arrangements as partof the resolution of entities conducting traditional insurance activities,and• The existence of policyholder protection and guarantee schemes (orsimilar arrangements) in many jurisdictions.iii) Higher loss absorption (HLA) capacityMandating a higher loss absorption capacity for a G-SII will help toreduce its probability of failure.This is important given the greater risks that the failure of G-SIIs poses tothe global financial system.The IAIS proposes that the following cascading approach to achieveHLA capacity should apply.This is in line with the principle for HLA is to be targeted, where possible,at activities that have the potential to generate or aggravate systemic risk.• Step 1 – if, and to the extent to which, the G-SII has demonstratedeffective separation of NTNI activities from traditional insuranceactivities, targeted HLA will be applied to the separate entitiesconducting NTNI activities. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 83• Step 2 – whether or not NTNI activities have been separated, an overallassessment of group-wide HLA needed is required.In the case where Step 1 has been applied, this should take into accountthe HLA in the separate entities and the fact that separation exists, butonly where that HLA was not created by multiple-gearing through downstreaming capital within the G-SII.The group-wide supervisor determines (in consultation with involvedsupervisors) whether the HLA capacity held at the NTNI entities issufficient or needs to be further increased at the group level.As an alternative to Step 2, there is on-going discussion within the IAISon whether there is a need for group-wide HLA if targeted HLA, andother measures (such as restrictions and prohibitions), are effective inreducing the level of systemic importance to an acceptable level.Instruments comprising the highest quality capital – that is permanentcapital that is fully available to cover losses of the insurer at all times on agoing-concern basis – are the appropriate instruments to meet HLAcapacity requirements.The HLA assessment will take into account any capital charges imposedto mitigate the systemic risk of an insurer that are in place under nationallegislation.Regarding the proposed policy measures on HLA, the IAIS will elaborateand develop a concrete plan by the end of 2013.Implementation time frameIt is planned that the first cohort of G-SIIs will be designated andsubsequently published in the first half of 2013.G-SII measures on enhanced supervision (including development of theSRRP) and effective resolution should begin to be implementedimmediately afterwards. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 84The SRRP and measures on effective resolution should be completedwithin 18 months after designation.The implementation of the SRRP should be assessed by the authorities in2016.Measures on HLA capacity should begin to be implemented in 2019 forthe G-SIIs designated in 2017 allowing for the assessment ofimplementation of structural measures in the SRRP.The IAIS expects national authorities to prepare a framework in whichinsurers will be able to provide high quality data for the indicators.To ensure the transparency of the methodology (for the benefit of marketparticipants and to promote market discipline) and the efficientidentification of G-SIIs, the IAIS expects all participating insurers todisclose relevant data when the G-SII policy is implemented and the IAISwill provide reporting guidance.Implementation of G-SII policy measures should be monitored by anIAIS peer review process in order to ensure international consistency.The full implementation timeframe is: _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 85 _____________________________________________________________International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 861 Introduction1. The IAIS is participating in a global initiative, along with otherstandard setters, central banks and financial sector supervisors, andunder the purview of the Financial Stability Board (FSB) and G20, toidentify global systemically important financial institutions (G-SIFIs).The focus of IAIS analysis is in relation to potential Global SystemicallyImportant Insurers (G-SIIs).To this end, the IAIS has developed a public consultation document“Global Systemically Important Insurers (G-SIIs): Proposed AssessmentMethodology”, explaining the proposed assessment methodology toidentify any insurers whose distress or disorderly failure, would causesignificant disruption to the global financial system and economicactivity.Any such insurers should be regarded as systemically important on aglobal basis.2. The IAIS has now also developed a proposed framework of policymeasures for G-SIIs.The proposed framework is based upon the general framework publishedby the FSB with adjustments.As with the assessment methodology, these adjustments reflect thefactors that make insurers, and the reasons why they might besystemically important, different to other financial institutions.3. At the Summit meeting in Seoul, November 2010, the G20 leadersendorsed the FSB’s framework for reducing the moral hazard posed bysystemically important financial institutions.The framework recommends several policies which should combine to: _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 87• Improve the authorities’ ability to resolve SIFIs in an orderly mannerwithout destabilising the financial system and exposing the taxpayer tothe risk of loss,• Require higher loss absorbency for SIFIs to reflect the greater risks thatthese institutions pose to the global financial system,• Apply more intensive and co-ordinated supervision of SIFIs,• Strengthen core financial infrastructures, and• Provide other supplementary prudential and other requirements asdetermined by the national authorities.4. As discussed in the IAIS’ report, Insurance and Financial Stability, thetwo most important factors for assessing the systemic importance ofinsurers are non-traditional insurance and non-insurance activities andinterconnectedness.Non-traditional and non-insurance (NTNI) activities are importantbecause, among other matters, the longer timeframe over whichinsurance liabilities can normally be managed may not be present, andinterconnectedness is important because there can be strong connectionsbetween the insurance and banking sectors that can amplify the impact ofstress events.Therefore, the policy measures need to address these causes of systemicimportance.5. The purpose of this consultation document is to seek views fromsupervisors, industry and the public on the proposed policy measuresframework for G-SIIs. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 882 Overview2.1 The supervisory challenges in relation to G-SIIs6. G-SIIs are a risk to financial stability because their scope, the nature oftheir business and their position in the financial system is such that, ifthey fail, they may cause disruption to the rest of the financial system andthe real economy.7. G-SIIs are different to Global Systemically Important Banks (G-SIBs),in part because the traditional insurance business model is not inherentlysystemically important.Insurers vary widely from banks in their structures and activities andconsequently in the nature and degree of risks they pose to the globalfinancial system.The activities or variations on the traditional insurance business modelthat would make an insurer a G-SII can vary greatly from one insurer toanother.This requires a policy response designed to address the specific natureand source of systemic importance and the different drivers of possiblenegative externalities.2.2 Objectives of G-SII policy measures8. The proposed G-SII policy measures should reduce moral hazard andthe negative externalities stemming from the potential disorderly failureposed by a G-SII.These policy measures should:• Reduce the probability and impact of distress or failure of G-SIIs andthus reduce the expected systemic impacts which disorderly failure maycause. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 89• Incentivise G-SIIs to become less systemically important, and givenon-G-SIIs strong disincentives from becoming G-SIIs, and• Be linked to the drivers of the G-SII status of each individual insurer.9. G-SIIs may be regarded as a safe haven by policyholders andinstitutional investors, either because of a perceived implicit stateguarantee or maybe more so because the policy measures are understoodto bring an additional level of security.Within the financial market place, this might have substantial distortionalconsequences.For example, the G-SII designation of insurers could result in givingG-SIIs access to lower funding costs.The financial strength rating assessment by credit rating agencies and thebespoke ratings assigned by investment banks and repo dealers today donot assume any implicit state guarantee for insurers.During implementation of the policy measures for G-SIIs, potentialunintended consequences should be considered and avoided wherepossible.3 The G-SII policy measures3.1 Overview10. The IAIS proposes a framework of policy measures for G-SIIs in linewith the FSB recommendations.• Enhanced supervision:Enhanced supervision applies immediately to all G-SIIs to ensure thatthey rapidly achieve the higher standards of risk management their G-SIIstatus demands.The Insurance Core Principles (ICPs), the common framework forsupervision of internationally active insurance groups (ComFrame), and _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 90the FSB’s “Supervisory Intensity and Effectiveness” (SIE)recommendations would form the basis of the IAIS’s approach toenhanced supervision while special emphasis would be placed ongroup-wide supervision and liquidity planning, as described below.The authorities should also analyse activities that cause systemicimportance of G-SIIs and take necessary measures to reduce thatsystemic importance.This includes development and implementation of a Systemic RiskReduction Plan (SRRP) which could include measures such as separationof NTNI activities from traditional insurance business and/or restrictionor prohibition of systemically important NTNI activities).• Increased resolvability:The FSB’s “Key Attributes for Effective Resolution Regimes” (KeyAttributes) would be the basis for improved resolvability and would helpreduce the impact of a G-SII failing. Under the Key Attributes, all G-SIIswill be required to produce recovery and resolution plans (RRPs) withtheir supervisor.The G-SII authorities will also be required to establish a crisismanagement group (CMG), conduct resolvability assessments and havecooperation agreements with other involved supervisors.• Higher loss absorption (HLA) capacity:This will entail the supervisor requiring the G-SII to hold more regulatorycapital or to increase loss absorption capacity by other means.Higher capital will be targeted at those NTNI activities the G-SIIundertakes which generate systemic risk if, and to the extent to which,the G-SII has demonstrated effective separation of NTNI activities fromtraditional insurance activities.It is noted that some national supervisory frameworks are expected toprovide for capital surcharges that account for the systemic risk profile of _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 91an insurance group and these additional capital requirements would betaken into consideration in assessing whether the G-SII has anappropriate level of HLA capacity.11. When applying policy measures authorities should keep the followingpoints in mind:• Measures should be proportionate and should avoid unintended adverseconsequences, where practicable• Measures should be directed at the source of systemic importance andlinked to the assessment methodology• Measures will often require strong cooperation among authorities,including authorities with responsibility for non-insurance entities withinthe insurance group.3.2 Enhanced supervision3.2.1 General description12. Enhanced supervision of G-SIIs will generally mean, in line with theSIE recommendations, specifically tailored regulation, greatersupervisory resources and bolder use of existing supervisory toolscompared to the supervision of non-systemically important insurers.The enhanced supervision of G-SIIs should include a direct approach toconsolidated group-wide supervision and should especially focus on theunique risk profile and possible risk concentrations of G-SIIs in order tolessen the probability and impact of failure.In doing so, involved supervisors should take into account the reasons forthe systemic importance of the G-SII suggested by the results of G-SIIassessment methodology.13. The desired outcomes of enhanced supervision are: _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 92• The supervisor determines a set of measures to reduce the risks posedby the G-SII and establishes timelines and indicators to adequatelymonitor the effectiveness of the measures.• There is a group-wide supervisory framework that applies to the groupas a whole with a particular focus on its systemic risks and the need forcooperation among supervisors, including supervisors with responsibilityfor non-insurance entities within the insurance group.Obstacles that could hinder effective group-wide supervision areidentified and removed.For G-SIIs, the supervisor has direct powers over holding companies toensure that a direct approach to consolidated group-wide supervision canbe applied.• The supervisor has clear visibility of internal control systems and riskmanagement and solvency assessment procedures within the insurancegroup.This includes requiring the G-SII to have the ability to aggregate andidentify risk exposures and concentrations quickly and accurately at thegroup-wide level, across business lines and legal entities, and to otherfirms.• The G-SII has internal controls and limits that are appropriate,investments and reinsurance arrangements that are appropriatelydiversified, increased disclosure and additional stress testing.• Enhanced supervisory co-ordination is achieved via supervisory colleges(cross-sector and cross-jurisdictions).14. The IAIS approach to enhanced supervision builds on:• The IAIS ICPs, which are applicable to all insurers and will be thefoundation for the G-SII policy measures. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 93• The IAIS ComFrame, which will aim to foster global convergence ofregulatory and supervisory measures and approaches for InternationallyActive Insurance Groups (IAIGs), whether or not they are identified asG-SIIs, although ComFrame is not expected to directly focus onaddressing systemic risk.• Special attention should be paid to group-wide supervision since G-SIIsare most likely to take the form of a group and NTNI activities are oftencarried out by separate entities within a group.• The FSB’s recommendations for “Intensity and Effectiveness of SIFISupervision”, (SIE recommendations), especially in relation to:– Unambiguous mandates, independence and appropriate resourcesMandates geared toward active early intervention can facilitate a culturewhere supervisors have the will to act early.The mandate should convey the point that the supervisory authority’s riskview of a firm will always reflect a higher degree of conservatism and willtherefore often be a source of conflict when viewed against the respectiverisk appetites of senior management, board and shareholders.Reinforcing the operational independence and resources of supervisoryagencies is critical to ensuring supervisory effectiveness and credibility ingeneral.Supervisor independence is of particular importance as the mandates ofagencies is broadened to include authority to take countercyclical actionssuch as imposing more conservative underwriting standards in boomtimes, or raising capital requirements, which may run contrary to publicperceptions of risk and be politically unpopular.– Full suite of supervisory powersSince the crisis, the need for tools such as increased liquidityrequirements, large exposure limits, imposing dividend cuts, requiringadditional capital etc. have come to the forefront. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 94Given that a full suite of powers is critical to a supervisor executing theirrole, the inventory of required tools should be updated. Supervisors needto ensure that the stress testing undertaken is comprehensive andcommensurate with the risks and complexities of these institutions.– Improved standards and methodsIncreased focus on outcomes of governance and business processes andgreater use of horizontal reviews are desirable.Supervisors need to evaluate whether their approach to and methods ofsupervision remain effective or have, for example, moved too far towardfocusing on adequacy of capital and control systems, and away fromdetailed assessments of sources of profits and financial data.Supervisory interactions with Boards and senior management should bestepped up, in terms of frequency, level of seniority, and assessment oftheir effectiveness.Consideration should be given to developing expanded guidance tosupervisors on how to assess a board with the goal of being better armedwith tools and techniques which enable better determination of boardeffectiveness.Supervisors should adopt proactive approaches to deal with successionplanning and performance expectations for key positions within G-SIIs(e.g. CEOs, CROs, Internal Auditors), elements that should no longer beregarded as only internal matters for institutions.– Stricter assessment regimeSupervisors should consider how their supervisory frameworks setinternal control expectations (including risk management frameworks)for G-SIIs, and they should be confident that the assessment criteria forthe control environment at G-SIIs set a “higher bar” for these firms toachieve in the areas of internal controls given the potential systemicimpact that they pose. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 95Supervisors should further explore ways to formally assess risk culture,particularly at G-SIIs. Establishing a strong risk culture at financialinstitutions is an essential element of good governance.– Group-wide and consolidated supervisionGroup-wide supervisory work can be impaired when supervisors do nothave the legal right or ability to review the group entities includingnon-regulated entities (including parents and/or affiliates), yet thoseentities have the potential to pose risks to the regulated entity.Consolidated supervisory blind spots can be created when there areentities within the regulated firm that the consolidated supervisor doesnot have access to or influence over.In some cases this is caused by business lines that have a primarysupervisor that is different from the primary supervisor of theconsolidated entity.Competing mandates and approaches of these supervisors can fragmentthe overall supervisory effort.– Risk aggregationSupervisors should study their data needs and data processingcapabilities in the context of the higher requirements for G-SIIsupervision.Where there are deficiencies in any or all ofi) The type of data collected,ii) The authority’s ability to process the data in a timely and fulsome way,oriii) Their ability to collect ad-hoc data in a timely manner, these should beaddressed as soon as possible. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 96Supervisors need to consider putting in place additional datamanagement and analysis processes for the information available from arange of sources, such as that collected by trade repositories and othercentralised sources of financial data, so that key players in markets andmarket anomalies are identified.3.2.2 Enhanced liquidity planning and management15. The supervisor should require the G-SII to have adequatearrangements in place to manage liquidity risk for the whole group,primarily in relation to NTNI activities and key channels ofinterconnectedness and secondarily also for the remainder of the group.These arrangements should include written strategies and policies forliquidity risk management during normal and stressed conditions subjectto clearly documented governance requirements.Adjustments for expected behavior of market participants and customersduring stressed conditions (especially in relation to acceleration ofliabilities) should be considered.Liquidity risk management policies should include all relevant issues.Relevant issues may include: the basis for managing liquidity (forexample, regional or central); the degree of concentrations, potentiallyaffecting liquidity risk, that are acceptable to the firm; a policy formanaging the liability side of liquidity risk and potential effects ofdowngrades on rating triggers; the role of marketable, or otherwiserealisable, assets; ways of managing both the firms aggregate foreigncurrency liquidity needs and its needs in each individual currency; waysof managing market access; the use of derivatives to minimise liquidityrisk (including potential for collateral calls and margin calls); and, ifNTNI activities exist, the management of intra-day liquidity. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 973.2.3 Structural measures and the Systemic Risk Reduction Plan(SRRP)16. The authorities should analyse activities that cause systemicimportance of G-SIIs and take necessary measures to reduce thatsystemic importance.The authorities should select the most effective policy measures toachieve this goal.The authorities should oversee the development of a SRRP by each G-SII(in addition to the recovery and resolution plans (RRPs)) to reduce thatsystemic importance and monitor implementation of the plan.Where feasible and appropriate, the SRRP may include effectiveseparation (so as to achieve self-sufficiency) of systemically importantNTNI activities from traditional insurance business (in combination withtargeted HLA) and/or restrictions or prohibitions of specifiedsystemically important activities or any other measures.3.2.3.1 Separation of non-traditional and non-insurance (NTNI)activities17. Separation of NTNI activities is an ex-ante policy measure aiming forgreater transparency, self-sufficiency and resolvability of G-SIIs bytargeting the structure of G-SIIs.The desired outcomes of implementing this measure are:• Traditional insurance business is more strongly shielded from NTNIbusiness and vice versa. The qualities and resilience of traditionalinsurance business can be largely preserved20, even in G-SIIs with lesstraditional operations.• The resolvability of G-SIIs is structurally improved ex-ante, unlike RRPswhich are conceived ex-ante but executed ex-post. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 98The resolvability of traditional insurance business can be largelypreserved, even in G-SIIs with less traditional operations, and theresolvability of NTNI business is addressed. (see 3.3 EffectiveResolution)• (In combination with targeted HLA) the expected impact of the distressor failure of the NTNI entities is reduced to non-systemic level.18. The aforementioned outcomes are supported by the followingcombination of specific measures:• NTNI business is conducted in separate legal entities that arestructurally and financially self-sufficient– Structural self-sufficiency means that it should be possible to ring-fence(and liquidate) self-sufficient legal entities without impacting theremaining legal entities of a group.As well as legal entity separation, it requires that problematic NTNIintra-group transactions such as guarantees (especially any unlimitedguarantees, upward and peer guarantees and intra-group transactionsaimed at capital gearing) as well as cross-default clauses are prohibited orat a minimum adequately monitored and restricted.– Financial self-sufficiency requires economically adequate capitalisationof legal entities that account for their systemic importance and hence ofthe G-SII; avoiding certain structures designed to allow forundercapitalisation and subsidies of selected legal entities.• Subsidies in the form of capital and/or funding to the benefit of NTNIentities should not be allowed• Self-sufficiency in terms of structure and financial condition is to bemonitored and verified by the authorities during the process ofimplementation of the SRRP. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 9919. Company structures exist in such a variety of forms that it isimpossible to capture the structural measures in a set of all-encompassingrules.The structure of G-SIIs becomes more transparent and hence tractablewith their businesses separated according to the business segmentsproposed in Insurance and Financial Stability.This allows supervisors to target their supervisory actions and measuresmore effectively and efficiently to the nature and risks of the respectivebusiness segments.In terms of tractability and transparency, the organisational structure ofG-SIIs would be simpler to understand if different types of activities andbusinesses were compartmentalised.The financial statements would also be simpler to understand if segmentreporting is aligned accordingly.20. The authorities should avoid the creation by the G-SII ofnon-regulated entities through the separation of NTNI activities.Any entities used to separate NTNI activities should be effectivelyregulated under direct consolidated group-wide supervision includingcoordination with other involved supervisors, as discussed above.3.2.3.2 Restrictions and prohibitions21. The supervisor could choose to apply restrictions and prohibitionswith the following goals in mind:- to reduce the probability and impact of failure resulting from systemically important activities within G-SIIs- to eliminate or limit systemically important activities based on the nature of the activity _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 100- to discourage such activities and thereby encourage G-SIIs to reduce or eliminate their systemically important activities and discourage other insurers from undertaking potentially systemically important activities.22. Restrictions and prohibitions are most effectively applied to NTNIand interconnectedness activities and could be applied on a stand-alonebasis or in combination with other policy measures.Restrictions and prohibitions could be targeted to specific legal entitieswithin the G-SII or they could be tailored to specific systemic NTNIactivities or those activities that make a company more interconnected.23. Restrictions and prohibitions cover a broad range of options thatinclude both direct prohibitions, limitations and restrictions on activitiesas well as measures that provide strong disincentives and/or internalisethe costs for engaging in systemically important activities.These include:• Direct prohibition or limitation of the systemically important activity• Requirements for prior approval of transactions that fund or supportsystemically important activities• Requirements for spreading or dispersing risks relating to systemicallyimportant activities.• Limiting or restricting diversification benefits between traditionalinsurance business and other businesses.This measure improves the overall capital position and hence providesHLA capacity.In practical terms, it could either be applied at ultimate parent level or atthe NTNI sub-holding or entity level _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 10124. Given the premise that insurers are not likely to inherently generatesystemic risk other than through NTNI and interconnectedness,prohibitions or strict limitations of an activity can be applied to G-SIIswhere the goal is to eliminate the activity or severely curtail the riskyactivity.When a systemically important activity is conducted by a non-insuranceentity within a group and joint banking and insurance make it moredesirable to contain the risk rather than remove the activity, restrictionmay play a lesser role when compared with structural measures (e.g.segregation or separation) and HLA capacity.3.3 Effective Resolution25. The desired outcomes of effective resolution are:- to ensure the resolution of G-SIIs can take place without severe systemic disruption and without exposing taxpayers to loss,- to protect vital economic functions through mechanisms which make it possible for shareholders and unsecured creditors to absorb losses in a manner that respects the hierarchy of claims in liquidation,- to ensure that policyholder protection arrangements remain as effective as possible,- to avoid unnecessary destruction of value and ensure that non-viable G-SIIs can exit the market in an orderly way, and- to identify and remove impediments to smooth resolution.3.3.1 Resolution regimes and tools for G-SIIs26. In 2011, the FSB published an international standard for resolution –“Key Attributes of Effective Resolution Regimes for FinancialInstitutions” (Key Attributes). _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 102This standard sets out a range of specific requirements for institutionsthat should apply at a minimum to all G-SIFIs including G-SIIs.They include(i) The establishment of Crisis Management Groups (CMGs);(ii) The elaboration of recovery and resolution plans (RRPs);(iii) The conduct of resolvability assessments; and(iv) The adoption of institution-specific cross-border cooperationagreements.27. To carry out an effective resolution, authorities need to have at theirdisposal a broad range of tools that enable them to intervene safely andquickly to protect policyholders and avoid destabilisation of financialmarkets.At present, many IAIS jurisdictions have a fourfold power in connectionwith the trigger points of a recovery system to require a solvency plan ifthe “prescribed capital requirement” (PCR) is breached, a financing planif the “minimum capital requirement” (MCR) is breached, a recoveryplan if the asset/liability ratio is breached and a liquidation plan if boththe asset/liability ratio and the MCR are breached.These powers should be considered for RRPs of G-SIIs when they are ingood health.The FSB Key Attributes should serve as a point of reference for the reformof national resolution regimes, setting out the responsibilities,instruments and powers that all national resolution regimes should haveto enable authorities to resolve failing G-SIIs in an orderly manner andwithout exposing the taxpayer to the risk of loss.28. It needs to be further examined whether a mainly traditional insurancegroup with a large derivatives portfolio may experience a disorderly _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 103run-off and, if so, whether there needs to be adjustments to themethodology or policy measures as a result.29. Authorities will consider and take all necessary actions to ensureeffective resolution including removing obstacles to the separability ofnon-traditional and non-insurance (NTNI) activities from traditionalinsurance activities during a stressed event.The resolvability assessment will include assessing whether, and theextent to which, effective ex ante separation of activities is in place. (See3.2.3 Structural measures and the SRRP).30. The FSB Key Attributes provide guidance to assist authorities inimplementing the requirements for G-SIFIs.The IAIS concurs that these requirements are also relevant for G-SIIs,although insurance specificities need to be taken into account inimplementing them.The FSB is currently developing an assessment methodology whichshould be used for assessments by the IMF and World Bank of nationalresolution regimes for financial institutions.The IAIS considers that the methodology should containinsurance-specific elements and hence is working closely with the FSB toensure that the methodology addresses insurance specificities.Where necessary, the IAIS will explore with its members the need todevelop further guidance for inclusion in the assessment methodology.Insurance specificities which need to be taken into account, include:• Plans and steps for separating NTNI activities from traditionalinsurance activities,• The possible use of portfolio transfers and run off arrangements as partof the resolution of entities conducting traditional insurance activities,and _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 104• The existence of policyholder protection and guarantee schemes (orsimilar arrangements) in many jurisdictions.31. The IAIS will also consider whether to develop a template forassessing resolvability of G-SIIs.This template could assist authorities in identifying structural measuresthat would better prepare G-SIIs for resolution if the G-SII needs to beresolved.The issues discussed under the previous section 3.2.3.1 on separationshould also be considered in this context.3.4 Higher Loss Absorption (HLA) capacity3.4.1 General description and purpose32. All G-SIIs should have higher loss absorption (HLA) capacity toreflect the greater risks that G-SIFIs pose to the global financial system.The desired outcomes of HLA capacity, all of which work to reduce theprobability or failure of distress and thus expected impact, include:• The G-SII is more resilient to low probability but high impact events.• Supervisors intervene earlier than they would for non-G-SIIs givingthem more time to address emerging risks to the soundness of the G-SII.• Any implicit or explicit funding subsidy linked to G-SII status is offset.33. HLA can be applied as an instrument at the group level or as atargeted instrument at the legal entity level if, and to the extent to which,the G-SII has demonstrated effective separation of NTNI activities fromtraditional insurance activities.34. The application of HLA to G-SIIs is complicated by the fact that thereis no global solvency standard for insurers. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 105By requiring group-wide HLA, it might further aggravate differencesbetween jurisdictions which might result in further regulatory arbitragepossibilities.Furthermore, the international differences in accounting and regulatoryrequirements would need to be considered when deciding the basis forany calculations, with IFRS, US GAAP or Japan GAAP with bridges toIFRS as the basis.35. Mandating a higher loss absorption capacity for a G-SII will help toreduce its probability of failure.This is important given the greater risks that the failure of G-SIIs poses tothe global financial system. The IAIS proposes that the followingcascading approach to achieve HLA capacity should apply.This is in line with the principle for HLA is to be targeted, where possible,at activities that have the potential to generate or aggravate systemic risk.• Step 1 – if, and to the extent to which, the G-SII has demonstratedeffective separation (so as to achieve self-sufficiency) of NTNI activitiesfrom traditional insurance activities, targeted HLA will be applied to theseparate entities conducting NTNI activities.• Step 2 – whether or not NTNI activities have been separated, an overallassessment of the HLA needed at the group level is required.In the case where Step 1 has been applied, this should take into accountthe HLA in the separate entities and the fact that separation exists, butonly where that HLA was not created by multiple-gearing through downstreaming capital within the G-SII.The group-wide supervisor determines (in consultation with involvedsupervisors) whether the HLA capacity held at the NTNI entities issufficient or needs to be further increased at the group level.• As an alternative to Step 2, there is on-going discussion within the IAISon whether there is a need for group-wide HLA if targeted HLA, and _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 106other measures (such as restrictions and prohibitions), are effective inreducing the level of systemic importance to an acceptable level.36. The HLA assessment will take into account any capital chargesimposed to mitigate the systemic risk of an insurer that are in place undernational legislation.37. The structural measures required to achieve self-sufficiency arediscussed in the previous section 3.2.3.1 on separation.3.4.2 Methodology for applying group HLA capacity38. There is currently no global solvency standard for insurance groupsupon which to build HLA capacity requirements to apply consistentlyacross jurisdictions.Nevertheless, the IAIS has decided in November 2011 that the capitalcomponent of the solvency assessment in ComFrame should have,among other items, a partly harmonised set of standards and parametersthat sets out a narrow range of target criteria and time horizons formeasurement purposes.39. Currently, ICPs 17.3, 17.4 and 17.5 describe the concept of solvencycontrol levels which could be used as the basis for applying HLAcapacity.These ICPs specify a “prescribed capital requirement” (PCR), abovewhich level the supervisor does not intervene on capital adequacygrounds.The PCR should be set such that, in adversity, an insurer’s obligations topolicyholders will continue to be met as they fall due, that is, at a levelsuch that the insurer is able to absorb the losses from adverse events thatmay occur over a defined period while technical provisions remaincovered.HLA capacity would essentially be setting a higher PCR that accounts forthe fact that the failure or distress of a G-SII is associated with negative _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 107externalities towards the global financial system and the economy, notjust the policyholders and other direct stakeholders of the G-SII.40. HLA capacity could be applied to the current national/regionalsolvency regime, as an HLA uplift to the closest conceptual equivalent tothe PCR that is required under each country’s regulation.This approach should fit with most solvency regimes provided there is anequivalent of a PCR.Because it would be an add-on to the existing baseline solvencyrequirements in each jurisdiction, the large part of the overall solvencyrequirement should still be risk sensitive (to the extent that the existingregime is risk sensitive).This approach would also not impede the convergence of solvencystandards over time.Step 1 – Targeted HLA capacity41. If, and to the extent to which, the G-SII has demonstrated effectiveseparation (so as to achieve self-sufficiency in terms of structure andfinancial condition) of NTNI activities from traditional insuranceactivities, targeted HLA will be applied to the separate entitiesconducting NTNI activities.Thus it sits where it is most needed in situations of stress.Targeted HLA capacity establishes an additional capital buffer and alsomakes it more expensive to carry out systemic activities. It is specificallyaimed at the systemic NTNI business of insurers and is a disincentive asG-SIIs would require more capital.42. Targeted HLA could directly affect the activities that pose systemicrisk within the insurance business and also provides incentives toundertake any activities that pose systemic risk to a lesser extent. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 10843. For any banking or bank-like activities, whether carried out in a banksubsidiary or a non-insurance financial entity, the targeted HLA capacitycould be set according to Basel III rules (eg HLA of at least 1% ofrisk-weighted assets).Where Basel III can be used, it should be carefully designed to avoidregulatory arbitrage by applying the same rule to the same activity.Moreover, the same standards should apply to the same business indifferent jurisdictions to ensure a level playing field.44. For other NTNI activities, the supervisor would need to determinesuitable rules based on the nature of the activities and the principles inthe ICPs and other relevant regulatory frameworks.The IAIS will provide guidance for supervisors as part of the proposedconcrete policy measures on HLA, by the end of 2013.Step 2 – Group-wide HLA capacity45. Under Step 2, an overall assessment of the HLA needed at the grouplevel is required.In the case where Step 1 has been applied, this should take into accountthe HLA in the separate entities and the fact that separation exists, butonly where that HLA was not created by multiple-gearing through downstreaming capital within the G-SII.Possible add-ons should also be considered. Ideally, the level ofgroup-wide HLA capacity should reduce the expected impact of a G-SIIfailing to an agreed benchmark.One way to set the appropriate level of group-wide HLA capacity wouldbe so that the probability of failure is reduced to the point that theexpected impact of a G-SII failing equals the expected impact of othersimilar insurance groups that _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 109are not G-SIIs failing. This approach is not considered feasible in theshort term, as there is not sufficient data available to make a properassessment.Application of the HLA uplift46. Deciding a basis to calculate the HLA uplift is complicated bydifferent solvency regimes and accounting requirements acrossjurisdictions.Two options on which the HLA uplift could be based are to use a capitalmeasure or a balance sheet measure:i) Capital measure based on existing local solvency regimesThe capital measure could be the nearest equivalent solvency standard tothe PCR and the HLA uplift would be a percentage of the PCR (possiblyin the range of 10% to 30%).Advantages:• Simple to handle.• Consistent with the concept of PCR which is the baseline of HLA uplift.Disadvantages:• As the baseline of group-wide HLA capacity is different, distortionscould occur, depending on what business is being taken into accountunder local regimes and whether the major part of the business lies injurisdictions with higher or lower regulatory capital requirements.• Aggregation of local regimes may not create a sufficient capital measureor, conversely, may provide an excessive capital measure.• Most local regimes will have little or no regard for specific treatment ofNTNI activities. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 110ii) Total balance sheet (including off-balance sheet positions)The balance sheet measure could be based on the total balance sheet(excluding capital but including off balance sheet items) and the HLAuplift would be a percentage of that amount (possibly in the range of 0.5%to 1.5%).It should be considered whether and how to deduct insurance assets andinsurance liabilities in an appropriate manner in order to dis-incentivisereductions in insurance technical reserves and related assets.Advantages:• More global approach• Improves comparability between G-SIIs provided IFRS, US GAAP orJapan GAAP with bridges to IFRS are used as a basis• Independent from the levels of regulatory capital, and hence mayprovide more consistency between jurisdictions than the previousapproach.Disadvantages:• Not as precise as a fully-fledged economic capital regime.• Not risk-sensitive, and could be inconsistent with an insurers riskmanagement framework.• Accounting differences across jurisdictions in the calculation ofinsurance liabilities mean this approach could also yield considerableinconsistency of HLA uplift.• This approach penalises insurers with healthier balance sheets withinjurisdictions, including those insurers that maintain more conservativetechnical provisions.• It is technically difficult to define off-balance sheet items. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 1113.4.3 Acceptable instruments47. Currently, there is no common global definition of capital in theinsurance sector.The ICP 17.11.34 provides an example of broad categorisation of capital asfollows.a. Highest quality capital: permanent capital that is fully available tocover losses of the insurer at all times on a going-concern and a wind-upbasis;b. Medium quality capital: capital that lacks some of the characteristics ofhighest quality capital, but which provides a degree of loss absorptionduring on-going operations and is subordinated to the rights (andreasonable expectations) of policyholders;c. Lowest quality capital: capital that provides loss absorption ininsolvency/ winding-up only.48. The FSB report, endorsed at the G20 Seoul Summit in November 2010,states that G-SIFIs should have greater loss absorption capacity wherebya higher share of their balance sheets is funded by capital and/or by otherinstruments which increase the resilience of the institution as a goingconcern.49. In line with the FSB recommendation, given the going-concernobjective of the HLA capacity requirement, the HLA capacity should bemet by the highest quality capital as defined in the above-mentioned ICP17.11.34.Instruments comprising the highest quality capital – that is permanentcapital that is fully available to cover losses of the insurer at all times on agoing-concern basis – are the appropriate instruments to meet a HLAcapacity requirement for the time being.50. The supervisor should judge whether an instrument which exists in itsjurisdiction constitutes the highest quality of capital or not. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 112It should also be noted that the IAIS has decided that a commondefinition of capital resources is to be established by 2013.51. Attention should be paid to the fact that the additional capital shouldsit in the place where it is most needed (e.g. in separate NTNIbusinesses).Otherwise, particularly if sitting in non-regulated entities (e.g. holdingcompanies), issues relating to supervisory powers as well as transferimpediments might arise.3.4.4 Refining the HLA capacity requirement52. The IAIS will elaborate the above-mentioned HLA capacity measureand develop a concrete proposal by the end of 2013 taking into accountthat a sufficient transitional period of the introduction of this measure hasbeen proposed as implementation is scheduled to begin from 2019 (seesection 4).4 Implementation4.1 Implementation timeframe53. The starting point for the implementation of G-SII policy measures isthe public determination by the FSB and national supervisory authoritiesthat a particular insurer is found to be a G-SII.For each G-SII, the group-wide supervisor would contact the G-SII tocommence the process of implementing required policy measures.The key dates and timeframes are expected to be: _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 11354. Discussions with the G-SII would focus first on the particular driversof G-SII status.The authority would immediately begin to implement measures withregards to enhanced supervision (including development of the SRRP)and effective resolution.The SRRP and resolution measures should be completed within 18months after G-SII designation. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 114The implementation of the SRRP should be assessed by the authorities 3years after G-SII designation.Implementation of the SRRP is a prerequisite for application of thetargeted HLA capacity requirements.55. Regarding the proposed policy measures on HLA, the IAIS willelaborate and develop a concrete plan by the end of 2013.56. The HLA capacity requirements will apply from 2019 for those G-SIIsdesignated in 2017 and will be based on the status of implementation ofthe SRRP in 2017.The list of designated G-SIIs will be updated every year.After the first designation in 2017, a newly designated G-SII will beallowed to have the same period to meet the HLA capacity requirement.57. The IAIS expects national authorities to prepare a framework in whichinsurers will be able to provide high quality data for the indicators.To ensure the transparency of the methodology (for the benefit of marketparticipants and to promote market discipline) and the efficientidentification of G-SIIs, the IAIS expects all participating insurers todisclose relevant data when the G-SII policy is implemented and the IAISwill provide reporting guidance.58. Implementation of G-SII policy measures should be monitored by anIAIS peer review process in order to ensure international consistency. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 115Presidents Summary ofOutcomes from the Experts’meeting on Corruption1. The Financial Action Task Force(FATF) convened, in collaboration with the G20 Anti-CorruptionWorking Group, an Experts Meeting on Corruption.In this meeting, 88 delegates from 28 jurisdictions and 14 organisationsparticipated including: the FATF, G20 Anti-Corruption Working Group,Asia Pacific Group (APG), Intergovernmental Action Group againstMoney Laundering in Africa (GIABA), Middle East &North AfricaFinancial Action Task Force (MENAFATF), Commonwealth Secretariat,Group of States Against Corruption (GRECO), InternationalAnti-Corruption Academy (IACA), International Association of InsuranceSupervisors (IAIS), International Monetary Fund (IMF), Organisation forEconomic Co-operation and Development (OECD), United NationsOffice on Drugs and Crime (UNODC), World Customs Organisation,and World Bank.The meeting was chaired by the President of the FATF, Mr Bjørn S.Aamo (Norway), at facilities in Paris offered by the World Bank.The FATF continues to emphasise the anti-corruption agenda, whileavoiding duplication of the role of mandated anti-corruption bodies.Part of that work is focused on bringing together anti-money launderingand counter-terrorist financing (AML/CFT) experts and anti-corruption(AC) experts for the purpose of discussing issues of mutual interest.2. This is the second time that the FATF has held such an event.The first FATF Experts Meeting was held in February 2011 under theMexican FATF Presidency, and was the first international platform forexchanging views between operational-level AML/CFT andanticorruption experts, policy makers from both developing and _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 116developed countries, and international standard setters andassessment/monitoring bodies.3. This meeting has been focused on the experience of countries,particularly in relation to asset recovery issues, and taking into accountthe domestic dimension.The timing of this meeting is significant, as it occurs at a critical stageduring the FATF’s work to develop a new assessment methodology, newmutual evaluation procedures, and new guidance which will assistcountries in their implementation of the new FATF standards.It is particularly important for the FATF to have input fromanti-corruption practitioners at this point in time when it is in the processof making the revised FATF Recommendations operational.4. This meeting has also been an important opportunity for the expertswho are present to provide input to the FATF’s work.The information gathered during this meeting will be reported back tothe FATF membership at the FATF Plenary which is being held in Parisnext week, and will provide useful input into the development of the newassessment methodology and procedures, and guidance papers.5. The key objectives for this meeting were:- To identify key challenges and possible solutions for facilitating international cooperation by exploiting the synergies between AML/CFT measures and AC measures- To have an in-depth discussion of key issues concerning international co-operation in the context of investigating and prosecuting corruption, bribery and related money laundering offences- To identify and discuss key AML/CFT tools that asset recovery practitioners should be aware of and use _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 117- To use the results of the discussions as input into FATF’s and anti-corruption standard setters’ ongoing and future work on corruption- To identify those FATF Recommendations that are particularly useful for AC experts and that should be included in FATF best practices on corruption6. Experts heard presentations on the following issues:i) Asset tracing and financial investigationsii) Provisional measures (freezing and seizing)iii) Confiscationiv) Asset recovery and international cooperation.Participants discussed the issues outlined below.Additionally, there was a recognition of the important synergies betweenthe work of the FATF and the work of the G20 Anti-Corruption WorkingGroup.Asset tracing and financial investigations7. The FATF Recommendations require countries to implementdomestic AML/CFT measures that provide valuable tools for tracingassets, conducting financial investigations, and facilitating theconfiscation of the proceeds of corruption and bribery offences.These tools can add value to a corruption case, even where it may not bepossible to pursue related money laundering charges.In practice, suspicious transaction reports (STR) have uncoveredcorruption activity, triggered corruption investigations, and been used tosupport ongoing financial investigations of corrupt activity. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 118STRs can provide a valuable source of financial intelligence forinvestigators in both the identification and tracing of the proceeds ofcorruption.Unfortunately, adequate feedback on the value of STR reporting is notalways transmitted back to reporting entities.The rigorous and effective prosecution of corruption and bribery casesalso provides an important source of information for money launderingcases.It is useful to preserve the closed files of such cases, as these may bereopened and used as a source of information for future investigations.8. Customer due diligence (CDD), enhanced CDD for politically exposedpersons (PEPs), and record keeping measures are also important tools.Where financial institutions and designated non-financial businesses andprofessions (DNFBP) hold accurate information about the identity oftheir customers, including beneficial ownership information, the abilityto trace assets is greatly enhanced.Administrative authorities, such as tax authorities, can hold usefulinformation about the ownership and control of assets, and on declaredincome and assets.As well, FATF Recommendation 3 requires tax crimes to be predicateoffences for money laundering (see the definition of “designatedcategories of offences”, as that term is defined in the Glossary to theFATF Recommendations).9. Financial institutions and DNFBP play a key role in this process.For example, it is important for financial institutions and DNFBP toimplement robust programmes to combat money laundering. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 119This includes policies and procedures for sharing information withinfinancial groups for AML/CFT purposes, in line with FATFRecommendation 18.Financial institutions should also be required, at a minimum, to ensurethat their foreign branches and majority owned subsidiaries applyAML/CFT measures consistent with the home country requirements.Supervisors and regulators also have an important role which includesensuring that the financial sector meets the applicable AMLrequirements, and understands where the corruption and bribery risksare.10. It is important for countries to have mechanisms in place to facilitatedomestic co-ordination and co-operation among relevant lawenforcement agencies, administrative authorities, and financialintelligence units (FIUs) in the investigation and prosecution ofcorruption offences and related money laundering, in line with FATFRecommendation 2.International cooperation is also needed to ensure that the authorities cansuccessfully trace assets which have been moved abroad.Networks of practitioners can be a useful tool, enabling practitioners whoare working on the same case in their respective countries to cometogether and better coordinate their efforts.Provisional measures (freezing and seizing)11. AML/CFT measures such as the FATF Recommendations provide forvaluable tools that enable the freezing and seizing of assets related tocorruption.There are also many useful tools available in international Conventions,including the United Nations Convention against Corruption (UNCAC).The participants recognised the need for strong domestic andinternational cooperation to ensure that the financial intelligence _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 120gathered through AML/CFT measures can be effectively used by theauthorities in corruption and related money laundering cases, and tofacilitate the enforcement of foreign freezing/seizing orders.12. Transforming the information which is gathered by FIUs intoevidence that can be used in court to support a freezing/seizing action issometimes challenging.Where the enforcement of a domestic freezing/seizing order is beingsought, further obstacles may arise if the processes and standard of proofrequired by the requested country are not well understood by therequesting country.The challenges associated with international corruption cases were alsodiscussed including: the length, complexity and cost of investigations;the difficulties associated with obtaining evidence to the requiredstandard; and the complexity of restraining assets internationally.13. It is important to ensure that stolen assets do not remain frozen abroadindefinitely.Countries need to implement effective measures which facilitateinternational cooperation, and also respect the important principles ofdue process, rule of law and fundamental human rights.Experience in recent years has shown the difficultly of transforming anational freezing action into a successful confiscation and asset recoveryaction which results in the frozen assets being returned to the countriesand people from whom they were stolen.The participants recognised that this is an area which would benefit fromfurther capacity building and resources.Confiscation14. AML/CFT measures are useful in facilitating the confiscation ofassets in corruption and related money laundering cases. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 121The participants discussed a number of successful cases of internationalcooperation involving confiscation.Many countries already have in place sufficient legal frameworks toenable confiscation, including non-conviction based confiscation.However, in practice, action is sometimes not taken swiftly enough, andbefore the assets are hidden or moved abroad.The ease of moving money electronically or through the use of cashcouriers or bulk cash smuggling, combined with the use of legal personsand arrangements (including shell companies and trusts), and the lack ofaccurate information on beneficial ownership create serious obstacles toconfiscation.The effective implementation of AML/CFT measures as required by theFATF Recommendations and other international instruments, such asthe OECD Anti-Bribery Convention, are valuable tools for addressingthese issues.15. Taking confiscation action in international corruption cases can beparticularly challenging because much of the evidence in a foreignbribery cases is often not locally available.Political upheaval and social unrest can sometimes create practicalimpediments to secure Information exchange with foreign counterparts.It is also important to focus on both the demand side and the supply sideof bribery transactions.It was also noted that multiple legal proceedings create complexity inconfiscation cases.For example, assets might be dissipated in the course of a criminal case,leaving little for victims who are seeking compensation or restitutionthrough a civil action.Overall, the participants recognised that there is a great need for further _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 122capacity building in this area.Asset recovery and international cooperation16. Effective and timely international cooperation is essential for therecovery of assets related to corruption.The necessary legal frameworks for international cooperation should bein place, based on international instruments such as the UNCAC, and theFATF Recommendations.The FATF Recommendations require countries to implement a strongframework for information sharing.Under FATF Recommendation 37, countries should provide the widestpossible range of mutual legal assistance (MLA) in relation to moneylaundering and associated predicate offences such as corruption andbribery.Under FATF Recommendation 38, countries should have the authority totake expeditious action in response to requests by foreign countries toidentify, freeze, seize and confiscate the proceeds of crime.Where dual criminality is required for MLA, it is important for countriesto have criminalised an adequate range of corruption and briberyoffences, and related money laundering, in line with FATFRecommendation 3.Participants agreed that these requirements are particularly important inasset recovery cases, given their international dimension.17. There are many potential obstacles to effective mutual legal assistancewhich can seriously delay and thwart the investigation and prosecution ofcorruption, bribery and related money laundering.For example, not all countries have established an FIU with sufficientcapacity to trace assets and cooperate with foreign counterparts. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 123The cross-jurisdictional aspect of cases involving stolen assets createslegal and practical complexities, including those of language.Corruption can negatively impact how the rule of law is applied in somecountries, which can impede their ability to provide internationalcooperation effectively.Conflicts can arise where mirror proceedings are not underway in thecountry where the predicate offence was committed as well as in thecountry where the assets are held, and the UNCAC provides formechanisms to help address this issue, such as spontaneous informationexchange.18. Proactive approaches are particularly useful including: spontaneousinformation exchanges among competent authorities and makingeffective use of FIU information transmission channels and exchangemechanisms, in line with FATF Recommendation 40; utilising opensource information; taking a multi-agency approach and strategicplanning, in line with FATF Recommendation 2; and developing a casemanagement strategy with the country from where the assets were stolenand other countries which may be holding stolen assets (e.g., to considerissues such as which country should start the criminal, civil oradministrative proceedings).The participants also noted that a number of supporting initiatives areavailable to help countries manage these issues, including the StolenAsset Recovery Initiative (StAR) which is a partnership between theWorld Bank and the UN Office on Drugs and Crime (UNODC).Conclusions19. Both anti-corrruption and AML experts confirmed that there is agrowing recognition that, even though anti-corruption and AML effortsare mutually reinforcing, they have not always been brought togethereffectively. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 124It would be extremely useful to have a greater understanding, at thepolicy, legislative, operational and enforcement levels of how AML/CFTmeasures may be effectively leveraged in the fight against corruption.Developing tools which take into account the needs of anti-corruptionexperts, such as best practices, to further this understanding couldusefully advance cooperation and the effectiveness of bothanti-corruption and AML/CFT efforts.The participants noted that anti-corruption and AML/CFT expertsshould continue working together on these important issues. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 125Lim Hng Kiang: What’s next for hedgefunds?Keynote address by Mr Lim Hng Kiang,Minister for Trade and Industry and DeputyChairman of the Monetary Authority ofSingapore, at the SkyBridge Alternative (SALT)Conference, Marina Bay Sands***Mr Anthony Scaramucci, Managing Partner,SkyBridge Capital Distinguished guests, ladies and gentlemen.A very good morning to all of you.I am very pleased to join you at the inaugural Asian leg of the SALTconference.Global outlookAs we move into the last quarter of 2012, the world economic outlookremains uncertain.Advanced economies continue to encounter headwinds as deleveraging,fiscal consolidation and a still-weak financial system act as a drag ongrowth.With US and Europe facing economic difficulties, Asia will not beimmune to a global slowdown given its heavy reliance on trade.This can be seen by Asia’s slowing growth in the last two quarters as weakdemand in the G3, especially the Eurozone, exerted a sharp dragon exports from the region.The IMF has recently revised its growth estimates downwards. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 126Global growth is now expected to be 3.3% in 2012 and 3.6% in 2013.However, this is dependent on the assumption that there will be sufficientpolicy action to ease financial conditions globally and that recent policyeasing moves in emerging market economies will gain traction.Overall, global growth is expected to remain muted for an extendedperiod.Impact of macro conditions on the global hedge fund industryThe macro economic environment has left global institutions, includinghedge funds, grappling with historically low interest rates, volatilefinancial markets, and an environment that has grown averse to risktaking.As hedge funds cope with a more demanding operating and economicenvironment, the industry will have to deal with two key challenges.Firstly, soft returns amidst the volatile environment.The average hedge fund returns across strategies was negative 4.6% in2011, with most of the losses occurring in 3Q 2011 when global equitiesdeclined by around 17%.Whilst hedge fund performance this year-to-date as at end-August 2012was up 3.8%, the outlook remains uncertain and I think hedge fundsmay struggle to provide consistent returns over time.Secondly, a more challenging fund-raising environment.Business and compliance costs have increased due to more stringentmanager selection criteria by investors and enhanced global regulatorystandards.As a result, funding gestation periods have lengthened and failure rateshave increased. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 127Hedge funds now require larger assets under management to breakevenand remain economically viable.Managers without a strong track record will be in for a hard time.Against this backdrop, some consolidation of the global hedge fundindustry is to be expected.Long term prospects for the hedge fund industry remainspositiveNonetheless, if we look beyond the immediate economic challenges, thelong term prospects for the alternative investment industry remainpositive.A number of studies have identified a growing interest from institutionalinvestors for yields in the alternative space.In the 2012 Towers Watson Global Pension Asset Study, asset allocationto alternatives in the seven largest pension fund markets has increasedfrom 5% in 1995 to 20% in 2011.In another recent study, McKinsey estimates that global alternativeinvestments across the retail and institutional segments doubled in assetsunder management between 2005 and 2011, to reach US$6.5 trillion.This represents a compound annual growth rate of 14% over this period,exceeding the growth of the traditional asset classes.Specifically in the hedge fund space, institutional investors haveincreased allocations to hedge funds significantly over the last decade,from only US$125 billion in 2002 to approximately US$1.5 trillion as of end2011.Looking forward, institutional investors in the major markets haveindicated their intent to increase allocations to almost all alternativeclasses, including hedge funds. Increased institutional participation will _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 128drive growth as hedge funds become an important part of the investmentlandscape.To meet the demands of institutional investors and global regulatorystandards, hedge funds have taken steps to beef up their riskmanagement and compliance functions.In a recent study by the Managed Funds Association, BNY Mellon andHedgemark, it was found that 79% of global hedge funds now separatethe roles of the risk manager and fund manager, with 60% of the largerhedge funds having a dedicated risk management function.This augurs well for the hedge fund industry, as it allows the industry togrow in a more sustainable manner with strong internal control systemsand risk management oversight.Asia is well placed to provide capital and investmentopportunitiesAs global institutions and investors seek to address challenges resultingfrom structural shifts in the global economy, many are turning to Asia toharness opportunities and to generate higher returns.This is due to a few reasons.Firstly, Asia has been leading the global recovery with growthexpectations in developing Asia projected to exceed global growth at6.7% in 2012 and 7.2% in 2013.Secondly, both demand and supply side factors in Asia are relativelypositive.Corporate and government balance sheets are generally healthy.Households are not overly levered, savings rates are high andunemployment is comparatively low. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 129The rising middle class, highly educated workforce and favourabledemographics are also plus points for Asia.These factors, coupled with Asia’s strong commitment to economicopenness and free trade, are important in creating a business friendly andconducive environment for its financial sector to continue to thrive andgrow.Thirdly, with Asia’s relatively strong economic growth and favourabledemographics, investible assets from the institutional and private wealthsegments are set to grow.In a 2011 report published by Cerulli Associates, institutional investableassets from Asia ex-Japan are expected to triple from US$4.3 trillion in2006 to US$13.6 trillion by 2015.Total wealth from the private wealth segment is also expected to increase.In its recent Wealth Report, Julius Baer expects the number of high networth individuals in Asia to more than double over the next three years toalmost 3 million.As Asia grows in wealth, there will be more capital requiring active andcustomised fund management expertise to take advantage of theinvestment opportunities in Asia.Asia’s strong fundamentals will support the valuations of Asian assets,which will draw a growing interest from institutional investors around theworld looking to diversify and generate returns.According to Preqin, 46% of Asia-Pacific hedge fund investors intend toinvest opportunistically in Asia-Pacific hedge funds, whilst 31% ofAsia-Pacific hedge fund investors are looking to increase theirlonger-term allocations to Asia-Pacific.Deutsche Bank also noted in its 2012 Alternative Investment Survey thatNorth America and Asia are currently the most sought after investment _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 130regions, with investors planning to allocate approximately 26% of assetsto Asia.ConclusionAs a source as well as a destination for investments, Asia presentscompelling prospects for the hedge fund industry.Singapore’s strategic location makes us well-placed to serve as a hub withstrong physical connectivity, trade and financial linkages to the rest ofAsia.Together with our strong commitment to growing a well-regulated fundmanagement industry, this makes Singapore an ideal vantage point forasset managers to understand Asia and to manage pan-Asianinvestments.So it leaves me now to congratulate SALT on its inaugural Asian leg of theSALT Conference.I wish all of you a fruitful conference ahead. Thank you. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 131Gill Marcus: Why education is importantto the South African ReserveBankAddress by Ms Gill Marcus, Governor of theSouth African Reserve Bank, at the Partners inPerformance 2012 Celebration Lunch at theMaths Centre, Braamfontein***Good morning to the Board of Trustees, thepartners, donors, members and friends of the Maths Centre forProfessional Teachers.It gives me great pleasure to be here today.This is an institution whose work I have long admired, ever since I cameto know its Executive Director, Ms. Sharanjeet Shan during my tenure atthe Gordon Institute of Business Science.In my opinion, both Sharanjeet and her team are wonderful examples ofwhat can be achieved when a small group of committed people sets out tomake a difference in the world.From its humble beginnings in 1985, when it was only a very smalloutreach project run from Auckland Park school under the directorship ofMrs. Patchitt, the Centre has done extraordinary work to grow to theimpressive organisation that it is today; one that is making a clear andimportant difference to the teaching, learning and understanding ofMaths, Science, Technology and even entrepreneurship in the country.Without question, all of us are stakeholders in the outcomes of the SouthAfrican education system. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 132While the Maths Centre and other NGOs may work more directly in it andon it on a daily basis, as South Africans we see the reports and headlines.We know the statistics and we know the reality.We all know how critical it is to make every effort to steadily fix theeducation system, and to ensure that NGOs such as the Maths Centre,whose work is outstanding, act in a manner that renders such support.Why is education important to the South African Reserve Bank?This is not only for all the reasons we are familiar with, but because, asMichael Spence, the recipient of the 2001 Nobel Memorial Prize inEconomic Sciences, has noted, “in a world in which knowledge andconnectivity are increasingly the basis for value creation, failures in theeducation system are the surest form of exclusion there is.”It is also because the Bank, in fulfilling its mandate of price stability,touches the lives of every South African, directly or indirectly, and thegreater the financial literacy in a society is, the better the understandingof the economy and the more effective is the inclusion in how societyfunctions.So bear with me as I revisit some of South Africa’s educational facts andfigures with statistics drawn from the National Planning Commission’swork. As the NPC points out, education is one of the MillenniumDevelopment Goals.It is also a prominent feature of South Africa’s Constitution.As such, our education system, one which encompasses just over 14million learners, has received significant attention from government:• Grade R has been made mandatory for children turning five, resulting ina significant increase in the participation rate of these children. 80.9%were enrolled in 2007 compared to 22.5% in 1996.• Compulsory education for children aged 7 – 15 has been introduced. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 133• Almost 6 million learners are fed nationally through the National SchoolNutrition programme.• The poorest 40% of our schools are exempt from school fees and have ano fee policy.• An equalisation of per capita government expenditure between raceshas been achieved.But despite this attention, as we all know, and as the NPCCommissioners put it clearly, “the system is grossly underperforming.”They go on to say that “several comparative studies show that SouthAfrica’s educational outcomes are poorer than many poorer countries.Apart from a small minority of black children who attend former whiteschools and a small minority of schools performing well in largely blackareas, the quality of education received by African learners remains poor.Literacy and numeracy tests are low by African and global standards,despite the fact that government spends about 6% of GDP on educationand South Africa’s teachers are among the highest paid in the world (inpurchasing-power parity terms)”.At the risk of stating the obvious, the causes and symptoms of thissystemic underperformance are complex.Sometimes they seem intractable.But it is almost impossible to overstate the consequences since there is aclear relationship between the education that an individual receives andtheir prospects in life.Of course, there will always be exceptional individuals who transcend thisgenerally true cause-and-effect relationship; those who, despite their lackof education, make notable successes of their life. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 134Equally, the converse is true; there are many people who, despite all theeducational opportunities in the world, never realise their potential.But for most of us, the relationship between education and success is areinforcing one, one which starts with our socio-economic prospects atbirth.It is these prospects which set the first potential parameters of our lives.They have a significant impact on our cognitive ability in early childhoodand on the degree to which the foundations of learning, including ourcapacity to be numerate and literate, will be successfully laid.In turn, these early childhood foundations have a direct bearing on oureducational performance in our early school years.These early school years then go on to influence our Matric educationalachievement.And despite all the limitations of a Matric qualification, it was for most ofus the key determinant of our ultimate educational achievement.It still is.Finally, more than any other factor, it is the quality of our educationalachievement that ultimately affects our labour market performance, notleast because it is a large determinant of whether we will be able to enterthe job market at all.And from there, the cycle continues because our ability to enter the labourmarket – or not – then goes on determine the socio-economic situation ofour own children.This inter-dependency between many causal factors is something that weignore at our peril. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 135This critical early phase is also one that we too often overlook in ourrelentless focus on pass rates and one pass rate at that, namely Matricexam results.This focus, while important, occurs far too late in the learning cycle of achild.Without question, Matric results are the obvious and critical ones tomeasure and assess ourselves against.It is simply unacceptable that we have such poor matric results in such anunacceptably high number of South African public schools.It is wholly without justification that our statistics show that of ouruniversity graduates, only 22% of 60 000 students graduated within thespecified number of years.With the result that, to use Heather Dugmore’s words, our universities“become playgrounds for those who completed a substandard matric(instead of) places of higher education established to nurture topacademic skills”But, as Professor Ruksana Osman, Head of the Wits School of Educationpointed out so correctly:“To look at the end result, Matric, and declare the public educationsystem is failing without attending to the issues in early learning gives usa distorted picture of the schooling system as a whole.”She makes it clear that she is arguing “for looking at the teaching andlearning input from the earliest stage of schooling and not just the finaloutput of schooling – the matric examination results.”This same point has been made by many others and I could not agreemore.We need to be looking at the whole cycle and many indicators of successor signs of failure. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 136We need to be broadening our definition of success to extend beyond justuniversity degrees as an indicator and enabler of skills.Of the experts who have made this point are Mary Metcalfe, Mark Orkinand Jennie Glennie.In a newspaper article earlier this year, succinctly titled “Our pass ratefocus is too narrow”, they outlined three critical additional indicators ofsuccess for education.The first is retention.In other words, are learners staying in school for a reasonable amountof time?This is not to say that all learners must, or will, finish 12 years ofschooling.While this is unquestionably the ideal, the reality will always fall short.But how far does the reality fall short and for how many learners?Any situation where significant numbers of learners are leaving theschools system at a point before which they have a fundamental andcritical mass of skill, cannot consider itself successful.The second is quality.Again, this is a self-evident and common sense indicator; one that speaksof meaningful teaching and learning and reasonable proportions of goodand excellent marks within a framework of high standards.Access to education is of minimal benefit if the quality of that education isat best only marginally better than no education at all.The third additional indicator of success, over and above Matric passrates, is equity. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 137When education provides social mobility across issues such as gender,race, income and / or geography, it can be judged to be successful.When a lack of equity entrenches, rather than transcends, social patterns,the opposite is clearly true.Within this cycle of interdependence, and the debates around whatsuccessful education really looks like, quality Maths skills are critical –both as ends in and of themselves as well as means to various ends.In the same article I referred to earlier, Mary Metcalfe and her coauthorscalled Maths results “the litmus test of system quality for the needs of amodern economy.”And once again, the results of our litmus test are deeply troubling.While it is true that South Africa’s Maths pass rates have remainedunchanged over the past few years, given that the number of candidateswriting Matric Maths has declined, i.e. the denominator has decreased,basic Maths tells us that the numerator must have decreased too for thisratio to have remained constant.And this is precisely the case.The number of maths passes at the 40%-plus level were down from 85 000to 67 000 for the period 2009 to 2011.Consequently, we have 18 000 fewer matriculants able to enter universityprogrammes requiring this level.This decrease is compounded by marked differences between theprovinces.While the pass rates of 27% in Limpopo and 20% in the Eastern Cape aredeeply concerning, there is scant consolation to be had from looking atthe best performing areas; only 54% of learners in the Western Capeachieved Maths passes at the 40% plus level compared to 45% in Gauteng. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 138In defence of Limpopo and the Eastern Cape, however, it should be notedthat 47% and 58% of matric candidates, respectively, at least attemptedmaths.In the Western Cape and Gauteng, however, it was only 35% and 38%.So, as with many things in life, the first and seemingly obvious problemwe are presented with is not always the right problem and / or the onlyproblem.Maths results are a litmus test not only because of the usefulness of mathsskills in and of themselves but because such skills help develop a numberof integrated thinking skills that are needed, today more than ever, tonavigate a complex and changing world.Of course, maths is not the only thing that develops such integrated andintegrative skills but it certainly helps lay a foundation.The first of these is creative thinking skills.While it may not seem so to many learners attempting to tackle animpenetrable calculus or algebra exam question, Maths really does helpdevelop creative thinking skills, i.e. the ability to make connectionsbetween concepts and ideas that seem unconnected and unrelated.It was Steve Jobs, the founder of Apple, who said it best: “Creativity is justconnecting things.When you ask creative people how they did something, they feel a littleguilty because they didn’t really do it, they just saw something.It seemed obvious to them after a while.That’s because they were able to connect experiences they’ve had andsynthesize new things.”Secondly, maths develops those problem-solving skills that allow peopleto recognise not only that a problem exists but also to be clear on what the _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 139right problem is, and, from there, to devise appropriate means ofresolving it.This is a skill that is much more difficult than it sounds.Not least because there is a marked difference between the complexproblems of real life and the exercises we get presented with in textbooks.Thirdly, maths helps develop decision-making skills, i.e. the capacity andcompetence to weigh up options and trade-offs between alternatives and,in the face of them, to make the best decision you can, at the time that youhave to, with the information that you have.Finally, it helps develop the visualisation skills that allow us to imaginehow things work – or could work – by looking at drawings, sketches orschematics.These integrative and holistic thinking skills are the ones that, atprecisely the time we need them the most, are in chronically short supply.Not least because, in a world irrevocably changed by technology, we alltoo often fall into the trap of confusing instant access to almost infiniteinformation with knowledge itself.Clearly, information and knowledge are very different.Just as real education is very different from much of the education thatgets offered up.Real education is not the rote learning of facts that many of us weresubjected to.Instead, it is the development of all our latent abilities.Similarly, real education concerns itself less with teaching us what tothink and more with teaching us how to think. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 140With these kinds of pressures facing all of us, the Reserve Bank is assubject as any other institution to the pressure to find positive ways tocontribute and meaningfully enhance the capacity of our country.As part of our assessing our impact on stakeholders, the Bank recentlyconcluded an extensive corporate reputation study.It was the first of its kind that we had undertaken and helped us tounderstand how we are perceived by our stakeholders, what the keydrivers of our overall reputation are and what critical improvement areasand areas of strength we should address or leverage to further build ourreputation.With the baseline now in place, we will be able to measure our progress aswe proceed.The results of the survey were overwhelmingly positive, with the Bankconsidered highly respected and credible.It was clear that our stakeholders trust and respect us.However, their feedback also made the important point that theexcellence that they see in us also imposes additional obligations on us.Specifically, stakeholders want and need us to engage even further withthose parts of our society that are facing the most challenges, specificallyeducation and the development of our youth.This feedback was very much in line with what the leadership of the Bankwanted to achieve.We had recognised the need to be more engaging with society and ourstakeholders, and as part of a number of initiatives had taken a long, hardlook at our Corporate Social Investment (CSI) policy.Of course CSI is only a small component of a company’s overallCorporate Social Responsibility. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 141In the description offered by the World Economic Forum, CorporateSocial Responsibility is “the entire contribution that a company makes tosociety through its core business activities, its social investment andphilanthropy programmes and its engagement in public policy.”In the context of the current financial crisis, fundamental questions arebeing asked of central banks around the world.These questions go to the heart of our Corporate Social Responsibility.What is the role that central banks should have played in averting thecrisis?What is the role we should play going forward? What is our contributionto society and to public policy?What should it be?As with education, these are complex, and in some quarters, contestedissues.But as these debates continue, one of our responses at the SARB has beento institute a new Corporate Social Investment strategy based on fourprinciples.First of these principles was that the Bank’s CSI policy and activitiesshould be informed.In other words, our funding and partnership decisions should begrounded in research, benchmarking and an understanding of thelegislative and other imperatives that underpin the South African CSIenvironment, one in which billions are spent every year.Education and skills development are universally accepted to be one ofthe key challenges facing South Africa. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 142It is therefore a critical area for support and investment, not only when itcomes to filling the Bank’s needs for skilled and trained employees butalso for meeting the many challenges South Africa faces.Secondly, they should be meaningful.We want to ensure that whatever activities the Bank engages in areundertaken in such way that there is a real investment of effort andcommitment from our side.This will not only maximise benefit for the Bank but also for partnerorganisations and, by extension, for society as a whole.Given the Bank’s unique role in the country, as well as its strong base asan institution of knowledge and research, it has a unique opportunity toadd considerable value to many organisations, especially those workingin education.Critically too, our activities should be partner orientated.We were adamant that the Bank should not seek to “reinvent the wheel”.Instead, it should focus on finding examples of best practiceorganisations and initiatives and partner with them.As and where the Bank does initiate something on its own, this would bethe exception rather than the rule and only where a unique opportunity,one which by definition only we can fill, presents itself.Finally, we agreed that our CSI efforts should be aligned.In other words, we needed to be clear that the Bank’s CSI policy shouldbe congruent with the Bank’s role as the central bank of the country, itsstrategy and its values.Our consequent focus on education is not only aligned with the Bank’sculture but also with its strategy, one which sees the Bank increasingly _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 143positioning itself as a knowledge institution with domestic andinternational stakeholders.Within our educational focus, there are a number of initiatives that we arevery proud of as the Bank.These include our partnerships with three of the country’s universities –Rhodes, WITS and Pretoria.The partnerships with the Centre for Economic Journalism at Rhodes andWITS Journalism were motivated by the recognition that the Bank shouldseek to actively play a role in improving the level of economics journalismin the country.Monetary policy is a complex subject and it became of increasing concerna few years ago that the reasoning behind our decisions was not alwayssufficiently understood by the journalists who communicated them to thebroader public.Our work with the Chair of Monetary Policy Economics at the Universityof Pretoria also aims to deepen the understanding of, and research into,the subject and to develop capacity in the field in South Africa and thecontinent.Our relationship with the South African Institute of CharteredAccountants is also one that we think is an important one given that weare working together to find, and nurture, talented upand-cominglearners.At the same time, the generous bursaries that we give to talented studentsliterally provide the potential to change the course of such student’s lives.But the project that we are particularly excited by this year is the pilotMPC Challenge which was initiated at the end of 2010.The Challenge was run in conjunction with the Gauteng Department ofEducation and modelled on initiatives run by other central banks around _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 144the world, including the Bank of England and the Reserve Bank of NewZealand.The aim of the challenge was threefold.Firstly, to increase understanding in South African schools of the roleplayed by monetary policy and of economics.Secondly, to build relationships between the Reserve Bank, schools andlearners and, thirdly, to get learners and schools excited about the subjectof economics.Eighty three schools from across the province were chosen to participatein the inaugural challenge.The initial selection of schools was done having reviewed all Gautengschools’ 2011 Matric Economics results.Only schools that received at least a 90% pass rate were invited into theinaugural challenge and invited schools represented all income quintilesand districts.The 56 schools that finally entered needed to select a team of betweenfour and five Matric Economics learners.These teams were given data from the Bank’s Research Department tointerrogate over the course of a few weeks in May and June.At the conclusion of the analysis period, each team then submitted a 1000word essay to the Bank.Team essays followed the same format as the Bank’s Monetary PolicyStatement, i.e. analysed local and global conditions and concluded with adecision as to what the country’s repo rate should be.Reserve Bank economists went through the initial essays and choose 5finalist teams, who were then invited back to present to members of theBank’s Monetary Policy Committee (MPC). _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 145The months of hard work by both Bank staff and learners and schoolsculminated on the 7th of August at a function at the Bank whereKrugersdorp High School’s team were announced as the winners of theinaugural challenge.Both the team and the schools received cash prizes, the winning teacher alaptop and the team also became eligible for Reserve Bank bursaries.If you don’t remember the 7th of August, let me jog your memory bysaying that it was the day that it snowed in Gauteng.Members of the Bank’s MPC Challenge team are still convinced that thisis less to do with meteorological conditions and more to do with the factthat the walls of the Bank’s Conference Centre auditorium wereresounding to the sound of The Black-Eyed Peas’ “I gotta feeling” as partof the winners announcement and celebrations.For those of you who know central banks, this is about as common assnow on the Highveld.The team’s final prize was to come to the Bank on the 20th of Septemberwith their teacher and school principal, as my guests, to be present at thelive MPC decision announcement to the media.They then joined members of the MPC at a small function hosted in theirhonour afterwards.The challenge really offered a wonderful opportunity to MatricEconomics learners and their teachers to make a very abstract subjectcome alive; to step into the shoes of the Bank’s Monetary PolicyCommittee and become central bankers for a few weeks and to beexposed to opportunities that might never have occurred to themotherwise.In this regard, Matthew Lester, a member of the winning team fromKrugersdorp High School, made an indelible impression on me and allthe judges of the MPC Challenge at the function after the MPC statement. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 146In response to the question “What are you going to do after school?” hequite calmly and confidently informed us that he was going to studyeconomics.While we were all nodding our approval, Matthew followed this up bypointing at Brian Kahn, my special advisor, and announcing that, once hefinished his studies he was “going to join the Bank and then take his job.”The feedback from the Gauteng Department of Education, learners,teachers and the Bank’s members of staff who were involved wasoverwhelmingly positive; so much so that it was clear that we needed tocontinue with the Challenge and to take it further.How to do this most successfully is being considered at the moment andwe look forward to announcing further details as soon as all necessaryrequirements are finalised.In conclusion, the words of one of the Gauteng Department of Educationsubject advisers we worked with on the MPC Challenge bear repeatingand remembering by all of us.As she said it, “it’s not about how much we pour into learners but howmuch we plant”.A more feminine version perhaps of the Greek historian Plutarch’s wiseadmonition that “the mind is not a vessel to be filled but a fire to be lit.”Whichever way you say it though, the need to inspire and act was as true2000 years ago in ancient Rome as it is in the world of the 21st century.It is as true for the Maths Centre as it is for the Reserve Bank.And it is as true when we work outside our respective organisations withour stakeholders as it is when we work within the boundaries of ourorganisation with each other.So, as we all navigate extremely challenging times – ones that show nosign of ending soon – may we all work together to contribute to fixing the _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 147education system, to plant seeds of hope and opportunity and to lightfires of commitment and ability.Only then will we truly be able to deliver on the potential that South Africaholds.Thank you. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 148Andrew G Haldane: The Bank and thebanksSpeech by Mr Andrew G Haldane, ExecutiveDirector, Financial Stability, Bank of England,at Queen’s University, Belfast***The views expressed within are not necessarily those of the Bank ofEngland or the Financial Policy Committee.I would like to thank Bethany Blowers, Forrest Capie, John Keyworth,Victoria Kinahan, Emma Murphy, Varun Paul, Richard Roberts, and thestaff of the Bank’s archives for their comments and contributions.In the light of the financial crisis, there is much to explain.Doing so is not just important for reasons of accountability to the public.Explaining and understanding errors of the past is absolutely essential ifpolicymakers are to learn lessons for the future.To misquote someone none of you have ever heard of, those who forgetthe errors of the past are doomed to repeat them.During the course of its 318-year history, the Bank of England has hadplenty of crisis experience.And encouragingly, on my reading of history, there is evidence of ithaving learnt from this experience.In response, radical reform of the Bank’s policymaking framework hasbeen commonplace.There are few better examples than the radical reform of the Bank’stransparency and accountability practices over the past twenty-five years. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 149Those reforms are continuing to the present day.A wholly new framework for financial stability policy is being put in placein the UK, perhaps the most radical in the Bank’s history.I will discuss that framework later on.This framework can be seen as an evolutionary response to crisisexperience, not just this crisis but a great many previous ones.It is impossible to know if this framework will proof us against futurecrises.But in remembering those errors of the past, it gives us a fighting chanceof not repeating them.So I want to take you on an historical journey charting the Bank ofEngland’s role in financial crises and its response to them.Now, I know what you are thinking.The evolution of financial stability in the UK viewed through the lens ofthe Bank of England sounds deadly dull.So I am going at least to try to add a touch of colour to the events andpersonalities of the time.The very beginningLet’s start at the very beginning.The Bank of England was put on earth, way back in 1694, to do none ofthe things it does today – namely, preserving monetary and financialstability.Instead, it was a confection of the then monarchs, William III and MaryII, to pay for their war debts. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 150At the time the Bank was little more than a branch, with a mere twentystaff.Pretty early in its life, however, the Bank began to involve itself in thebusiness of banking.It began to grow its balance sheet by taking deposits from and extendingloans to other banks, typically by the practice of “discounting” bills ofexchange.The Bank also issued its own notes which, due to the implicit backing ofthe government, circulated as currency with the public.At this stage, the Bank was far from being the nationalised, policymakingbody we know today.Rather, the Bank was a quasi-private bank conducting its business forquasi commercial ends.Other banks at the time were engaged in similar commercial pursuits,including often issuing their own notes.Except, of course, they lacked the government as guarantor.This made for a competitive, and at times rather antagonistic,relationship between the Bank and the commercial banks.This strained relationship lasted for the whole of the 18th and a goodchunk of the 19th centuries.Was the Bank friend or foe, collaborator or competitor?The commercial banks did not know. And the Bank – private in name butpublic in finances – was itself in a state of mild schizophrenia.These psychological flaws were exposed in the middle of the 19th century.By then, the Bank had been granted monopoly rights to issue currency. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 151Quite literally, this cut the commercial banks out of a lucrativemoney-making scheme.This did little to ease competitive tensions between the Bank and thebanks.This tension bubbled over in the famous case of Overend and GurneyBank. In the early part of the 19th century, Overend had grown rapidly tobecome the largest discount house in London.If not too big to fail, it was certainly large enough to look after itself – asthe Bank found out in 1860.Two years earlier, the Bank had abolished the right of other banks tocome to it for cash by discounting bills.The banks took umbrage.With Overend and Gurney playing the role of shop steward, theycollectively withdrew £1.6 million from the Bank over three days in anattempt to bring the Bank, if not to its knees, then at least to its senses.Dark, anonymous messages were sent to the Bank, presumably not byTwitter, warning: “Overends can pull out every note you have”.In the event Overend eventually caved, returning to the Bank the notesthey had withdrawn apologetically – or at least semi-apologetically, as thenotes actually came back cut in half.Six years later in 1866, when Overend and Gurney asked the Bank for anemergency loan of £400,000, the answer was “No”.The Bank won this battle, but was to lose decisively the war. Overend andGurney failed.The City shook. Panic took hold. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 152The Bank was forced to lend £4 million – ten times the initial sum – tosupport other banks.There was a chorus of disapproval.The Bank’s role in crisis management would never be the same again.Supporting the financial systemCriticism of the Bank’s role in the Overend crisis came prominently fromWalter Bagehot, then-editor of The Economist and Bank-of-Englandbasher of his day.He lambasted the Bank’s acting “hesitatingly, reluctantly and withmisgiving”.Henry Gibbs, Governor of the Bank from 1875 to 1877, highlighted theOverend experience as “the Bank’s only real blunder”.Yet the Bank had also learned from this experience.It had discovered that its role could be neither commercial norcompetitive.Instead its role was as guardian of the financial system as a whole,protecting banks from what is today called systemic risk.In Bagehot’s words, the Bank should act as last resort lender to solventinstitutions against good collateral at a penalty rate.It has done so ever since.The Bank did not have to wait long to put its new-found role into practice.On Saturday 8 November 1890 the Bank Governor of the day, WilliamLidderdale, summoned his Directors. This itself aroused suspicion.Bank directors were never seen at work at the weekend. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 153They typically departed for the country around Friday lunchtime.(Let me tell you, things have changed for Bank of England Directorssince then.)What Lidderdale told his Directors was electric.There were serious liquidity problems at another big and famous bank,Baring Brothers and Company.But the Bank had not the faintest clue as to Barings’ true financialposition.To rectify that, Lidderdale ordered an accountant’s report on Barings tobe brought to him with immediate effect.And with that, he departed to London Zoo with his son.The accountant’s report showed a solvent but illiquid Barings.Back from the Zoo, Lidderdale began to construct a financial “lifeboat”for Barings, with a contribution from the Bank but also from thecommercial banks.This was the system acting in support of the system.The lifeboat was launched and Barings was saved, in what has becomeknown as the “crisis that never became a drama”.The Bank’s lifeboat has since been re-launched on more than oneoccasion.A second financial lifeboat – different in detail, but identical in principle –was launched by the Bank of England in the early 1970s.Then, it was intended to save the small banks rather than the large.It, too, steadied some sinking ships. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 154Third time, however, was not so lucky.On 24 February 1995, it was Barings Bank who were again knocking onthe Bank of England’s door for help.Bank Directors were again summoned on a Saturday.I myself was caught by a TV crew entering the Bank on that Saturdaymorning, arousing suspicion something was amiss.In fact, I had not been recalled to save the day.(I believe I was filmed wearing a tracksuit.)And I was as blissfully unaware of Barings’ problems as most of the rest ofthe world.(I was at the Bank completing a research paper on “A Structural VectorAutoregressive Model of the Monetary Transmission Mechanism”.)Life was easier then.Nick Leeson, at the time a despised and corrupt rogue-trader, today amuch-admired reality- TV star and after-dinner speaker, had put a hugehole in the Barings boat.Over the weekend, then-Governor Eddie George tried hard to assemble alifeboat.All visits to London Zoo were cancelled.But the lifeboat failed and with it Barings.That Barings was allowed to fail, and did so without rupturing the system,is a key lesson for today, to which I will return later.So what does this tell us about how the Bank of England’s role hadevolved on entering the 20th century? _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 155The Bank now spoke and acted as steward of the financial system,marshalling its own and others’ financial resources to keep the financialsystem panic-free.The Bank was at the frontline of crisis management.But these episodes also contained lessons.When the first Barings crisis came, the Bank had been reactive andbackfoot.It had been blindsided by the risk to its own and the financial system’sbalance sheet.The Bank was finding its feet as a crisis-container.But in attitude and expertise, it was a world away from being an effectivecrisis-preventer.Supporting the economyFast forward to the start of the First World War.William Lidderdale had been replaced as Bank Governor by WalterCunliffe.Cunliffe was not what would these days be called an equal opportunitiesemployer.The Bank’s staff rules were stifling and sexist – although were ahead oftheir time compared to other City firms.The Bank went 150 years without employing any women at all.When they did, it was to do the work of 15–18 year old boys, sorting andlisting returned notes. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 156On getting married, women at the Bank were required to resign theirposition.The Bank was “Old Lady” by name but “Young Lady” by nature.Cunliffe’s greatest achievement was his contribution to solving thefinancial panic of 1914.On Friday 24 July, the City woke to the threat of war as Austria made anultimatum to Serbia.There was a worldwide scramble for the safety of cash.Mass-selling led to stock markets closing in Europe, then New York, thenAustralia.London was not exempt. By 31 July, the London Stock Exchange hadclosed for the first time in its near 150-year history.Panic soon spread to the money markets, sucking liquidity and life out ofthe financial system.Unable to finance themselves, lending by the banks began to drain away,starving the economy of credit and causing it too to crater.This was truly a credit crunch.Cunliffe’s plan, hatched with the Treasury, was to lift the liquidity burdenon the banks by purchasing the IOUs they were holding from overseasborrowers which had become understandably illiquid on the outbreak ofwar.These bills were bought by the Bank and stored in its vaults, in whatbecame known as the “cold storage” scheme.By freeing the banks’ balance sheets in this way, the cold storage schemewas intended to stimulate credit. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 157It was only a limited success, with the banks still fearful about makingnew loans because of the rising risk of default by overseas borrowers.In response, the government announced an extension to the scheme, withthe government effectively insuring the banks against the credit risk onthese assets too.It worked.Within a couple of months, money market conditions had stabilised andcredit was once more flowing.Cunliffe’s cold storage plan had averted a credit crisis.The cold storage scheme was a piece of clever financial engineering bythe Bank, designed to support credit and the wider economy.In the past few years, with credit growth and the economy weak, the Bankhas been in the vanguard of creating new pieces of machinery to serve asimilar end.In 2008, the Bank introduced a Special Liquidity Scheme, or SLS, to helpfinance UK banks’ legacy asset portfolio.Over £180 billion of support was provided to the banks and has sincebeen repaid.The SLS bears more than a passing resemblance to the first phase of thecold storage scheme.In June this year, the Bank announced a second scheme, the Funding forLending Scheme, or FLS. It provides liquidity support to UK banks onterms which depend on their lending to the UK economy, thereby actingas a direct incentive to stimulate new lending.The FLS bears some resemblance to the second phase of cold storage. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 158The SLS and FLS may be less famous than JLS, the London R&Bboy-band.But they are an important recognition of the Bank’s role in supportingcredit intermediation.That role began in the early part of the 20th century with schemes likecold storage.The Bank’s role had expanded beyond its own doorstep, on which thebanks stood, to the doorsteps of households and companies up and downthe country seeking credit.Supporting financial infrastructureYet one thing at least had stayed the same: in 1914, the Bank had onlyacted when jolted into doing so by war.Its role was still as crisis-container rather than preventer.During the 1920s and 1930s, the Bank of England became MontaguNorman’s Bank.And Norman set about changing that.Norman was not Cunliffe’s greatest fan and the feeling was clearlymutual.“There goes that queer-looking fish with the ginger beard again”,Cunliffe is said to have observed about Norman.“Do you know who he is? I keep seeing him creep about this place like alost soul with nothing better to do.”Nor would Norman necessarily have ingratiated himself to today’s armyof Bank economists. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 159“You are not here to tell us what to do, but to explain why we havedone it” is the way Norman rebuked the Bank’s Chief Economist of theday.Norman saw the Bank’s role in expansive terms, as provider not just ofemergency help but as builder of infrastructure and supporter of industry.The Bank became part of the post-war reconstruction effort.Having spent 200 years tending to its back garden, the Bank began toexplore pastures new.To take one example, in 1928 the Lancashire cotton industry was on itsknees.These problems risked ricocheting back to the financial system, with atleast two of the big five UK banks up to their neck in cotton.A plan was conceived involving consolidating the industry into aLancashire Textile Corporation.This was to be financed with debt and shares issued and supported by –you’ve guessed it – the Bank of England.It was a bold and cunning plan. Unfortunately, it flopped.The share issue by the Corporation in 1931 was a resounding failure,leaving the underwriter with a large chunk of the shares.The Bank ended up having to support the market.It, too, found itself up to its neck in cotton.Undaunted, the stage had nonetheless been set for the Bank’s on-goinginvolvement in financial infrastructure.This came not a moment too soon. In the immediate post-war period, _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 160the UK faced pressing financial infrastructure problems – the so-called“Macmillan gaps”.These gaps referred the inability of small firms to finance themselves withlong-term loans.If these gaps sound strangely familiar, then they should.The post-war Bank set about closing these Macmillan gaps with gusto.In 1945 it set up two new financing entities – the Finance Corporation forIndustry (FCI) and the Industrial and Commercial Finance Corporation(ICFC).These were financially supported by banks and institutional investors,providing a platform for the supply of longer term funding and venturecapital finance to small firms.In 1973, the two corporations combined to form Finance for Industry(FFI).During the early 1980s, the company was rebranded as Investors inIndustry, commonly known as 3i.In 1987, the entity went public as 3i Group.This was not a flop.Arguably, 3i and its predecessors were one of the largest feathers in theBank’s post-war cap, helping support generations of new businesses andstart-ups.And those MacMillan gaps?Regrettably, the crisis has re-opened them.Today, small firms are once more starved of finance, including many herein Northern Ireland. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 161Once again, the quest is on for a new financial infrastructure to help closethese gaps.Through the 1980s and 1990s, there were further examples of the Bankstepping in to close structural financial gaps.When the UK’s high-value payment system started creaking in the early1980s, the Bank designed and built a new, bullet-proof system.Given the Bank’s somewhat chequered record on gender diversity up tothat point, it was rather unfortunately named CHAPS.And indeed still is.In 1993, the Bank stepped-in to rescue a flagging project to upgrade thesecurities settlement process in the UK.The Bank designed and built a new, safety-first, system which againexists to this day.Fortunately, we did not call this one BLOKES, but rather thegender-neutral CREST.Most recently, in the light of the crisis, the Bank has been at the forefrontof the debate about re-organising the structure of banking, with aring-fence or firewall between the basic retail and investment bankingsides of the business.This structural approach is increasingly finding favour both in the UK(through the proposals of the Vickers Commission) and internationally(for example, through the Volcker proposals in the US and the recentLiikanen proposals in Europe).For the past half-century, the Bank’s structural agenda has become acentral feature.But at the time it marked a radical departure from the Bank’s past. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 162Designing what are in effect financial public goods is a front-foot activity.The Bank had grown a new limb, augmenting its crisis-managementright arm with a crisis-prevention left arm.Stitching it all togetherSo far, I have made no real mention of monetary policy.That is because, for much of its life up to the early 1970s, monetary controlat the Bank of England was pretty simple.It came care of fixing the exchange rate – first to gold under the GoldStandard and latterly in the post war period to the dollar.With the demise of the dollar standard in the early 1970s, however, theexchange rate anchor had been tossed overboard.At the Bank of England, as elsewhere, the search was on for a newnominal anchor.Into this vacuum stepped Andrew Duncan Crockett. Crockett joined theBank in 1966 as a graduate entrant, just before the break-up of the BrettonWoods dollar standard.He set to work on the biggest problem of the day, locating a new nominalanchor.In so doing, he began working alongside another young(ish) new Bankentrant, Charles Goodhart.The result was a joint paper published in the Bank’s Quarterly Bulletin inJune 1970.It was titled “The Importance of Money”.Re-reading it now, it was a prophetic piece of work. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 163In the UK, it laid some of the analytical foundations for what, during thelate 1970s and 1980s, became monetarism.More than that, the paper placed commercial bank money and credit atthe centre of the macro-economy.It could as well have been titled “The Importance of Credit” or indeed“The Importance of Banks”.After a successful spell at the IMF, Crockett returned to the Bank ofEngland in 1989.In 1994, he then became General Manager of the Bank for InternationalSettlements, the central banks’ central bank.In central bank circles, change was in the air. Monetary policy wasembarking on a path which targeted inflation and which, unlikemonetarism before it, downplayed money and credit.And the regulation of banks, long the preserve of central banks, was inmany countries being hived off to separate regulatory agencies.What happened next was truly extra-ordinary.Whether by coincidence or causality, the world experienced the largestbanking bubble in history.Between 1990 and 2007, global bank balance sheets rose by a factor four.On the eve of the crisis they had reached around $75 trillion, or almost 1.5times the annual output of the entire planet.At the Bank for International Settlements, Andrew Crockett saw troublebrewing.In 2000, he gave a speech calling for a “macro-prudential” approach toregulation. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 164Crockett argued that central banks needed to look at, and act on,developments across the whole financial system if systemic risk was to beheaded-off.Credit booms, the like of which was occurring for real at the time, sowedthe seeds of that systemic risk.The rest is of course history, as pre-crisis credit boom turned toshuddering bust.Or rather it would be history were it not for the fact that this crisis, whoseseeds were sown in the credit boom, is still with us.Output in the UK is still well below its 2007 level.The so-called Great Recession in the UK is already as severe as the GreatDepression of the 1930s.In response, the policy framework has, once more, been radicallyaugmented.Macroprudential policy is the next big thing.It is now widely acknowledged as the missing policy link during thepre-crisis period, the essential bridge between monetary policy andregulation.As I discuss below, this bridge is now being constructed through newframeworks in the UK and internationally.The Bank tomorrowSo where does all of this leave the Bank today and, indeed, tomorrow?In the light of the crisis, we are moving to a wholly new structure forfinancial policymaking in the UK. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 165In many important respects, this can be seen as building on the lessons ofhistory.To illustrate that, let me set out some of its main features.First, there is to be a radical shift in the organisation and approach tosupervising individual financial institutions.The UK will move to a so-called “twin-peaks” regime.That means in practice separating the safety and soundness aspects of theregulation (so-called prudential) from the consumer protection aspects(so-called conduct).The prudential part will from next year sit in the Bank of England in anew Prudential Regulatory Authority, or PRA.This is much more than deck-chair rearrangement.Accompanying this change will be a rootand-branch change in ourapproach to supervision.There will be a focus on the big risks – the Barings of yesteryear, the RBSof yesterday.Supervision will be front-foot, testing for stress before it strikes and visitsto the zoo need to be cancelled.It will be also tolerant of bank failure – Barings Mark 2 rather than Mark 1– so that market discipline can work its magic.Second, during the course of the crisis, there has been a radical, ifunderplayed, rethink of the Bank’s approach to supplying liquidity to thebanking system.While not quite a change on the scale of the Overend and Gurney crisis,this allows banks to access the Bank’s facilities against a much widerrange of collateral. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 166The Bank’s liquidity menu is now crystal clear, from which banks cannow themselves choose.Third, an entirely-new piece of policy machinery has been introduced –new not just for the UK, but internationally too.In the UK, this is called the Financial Policy Committee or FPC.It was put on earth to do macro-prudential policy, to act as the bridge, toprovide the missing link, to monitor the punchbowl before it is emptiedand before aspirin needs administering.A year on, the FPC is doing just that.Most recently the FPC has been navigating a particularly hazardouscourse.The financial system and economy are suffering the hangover from hell.The FPC’s task is to keep the system safe in the face of heightened risksof a relapse, while at the same time keeping the banks’ credit arteriesopen to support the economy.Both objectives are steeped in the Bank’s history – and both objectives areembodied in the FPC’s remit.The FPC has a remit, too, to strengthen the structural fabric of thefinancial system, including through improved financial infrastructure.That objective has a place deep in the Bank of England’s heart – fromLancashire cotton mills of the 1930s, to 3i of the post-war years, toCHAPs of the 1980s, to Vickers of the past few years.Supporting and executing these new responsibilities will be a massivetask.First and foremost, it will require the Bank to have a rich and diverse setof skills. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 167Historically at least, the Bank has been skills-rich but diversity-poor.But I am pleased to say that, too, has been changing for the better.This year’s graduate intake has close to a 50/50 gender split.One in seven of the intake is drawn from ethnic minorities.Only a fifth come from Oxford or Cambridge.The PRA’s arrival next year will broaden further the diversity of theBank’s skills and experience – legal, accountancy, banking, insurance.The Bank’s policy committees, meanwhile, bring diversity of experienceand expertise to the decision-making table, from academe and the privatesector.There has been a transformation, too, in the Bank’s approach to externalcommunications and transparency.Think back twenty years.Then, there were no quarterly Inflation Reports, no six-monthly FinancialStability Reports and certainly no press conferences to accompany both.Twenty years ago, there were no minutes of the deliberations of theBank’s policy committees (today, the MPC and FPC).Back then, press interviews were rare and scripted to within an inch oftheir life.In the past year, Bank officials gave around 65 speeches and over 200press interviews.In Montagu Norman’s day, the combined total was one.The days of “keeping the Bank out of the press and the press out of theBank” are well and truly gone. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 168Earlier this year, the Governor gave the Bank’s first live peacetime radioaddress to the nation for 73 years.The Bank Tweets, fortunately with rather less vigour than your averagePremiership footballer.Soon we will have, for the first time in history, published minutes of theBank’s Court of Directors.The Governor has appeared before the Treasury Committee on no lessthan 47 occasions since he took office.In 2011, a word search of “Mervyn King” in the press revealed more hitsthan “Kylie Minogue”.To my knowledge, this is the first time a sitting Bank of EnglandGovernor has toppled the Aussie pop princess in the media opinion polls.Given its new responsibilities, the Bank cannot fail to remain in thepublic’s eye in the period ahead.Transparency and accountability will remain the watchwords – andrightly so.ConclusionWhen pressed by the Macmillan Committee in 1930 to explain the Bank’sactions, Montagu Norman replied: “Reasons, Mr Chairman? I don’t havereasons, I have instincts”.I suspect such an answer would work less well with today’s TreasuryCommittee, to say nothing of today’s media.All public policymakers have an obligation to explain.And all policymakers have an obligation to learn from past crises and pastmistakes. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 169That is the only way credibility can be built: not the avoidance of crisesand mistakes, which is impossible, but the recognition by the public that,when they do happen, the crises are contained and the mistakes arehonest ones.The Bank of England is embarking on the latest chapter in its 318-yearhistory.We cannot avoid a crisis but, as with Barings in 1890, we can endeavour toprevent it becoming a drama.We will certainly be doing our best to prevent it becoming a tragedy likethat of the past few years.If nothing else, this new chapter will have learnt from, and will build on,the lessons of history.Thank you. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 170Proposal for a Directive of theEuropean Parliament and of theCouncil on criminal sanctions forinsider dealing and marketmanipulation (MAD)State of play and orientation debateINTRODUCTION1. On 21 October 2011 the Commission presented a proposal for aDirective of the European Parliament and of the Council on criminalsanctions for insider dealing and market manipulation (hereinafter"MAD") as part of a broader "package" of measures, includingproposals currently under discussion in other preparatory bodies of theCouncil (Directive on markets in financial instruments - "MiFID";Regulation on markets in financial instruments and OTC - "MiFIR";Regulation on insider dealing and market manipulation - "MAR").2. The proposal for MAD has been examined in the Working Party forsubstantive criminal law (DROIPEN).On 25-26 April 2012 the Justice and Home Affairs Council reached partialgeneral approach on Articles 5 to 12.Delegations kept open the possibility to revert to those provisions in thelight of further developments in the negotiations concerning theremaining parts of the Directive.3. The Cyprus Presidency resumed discussions on MAD at the meeting ofDROIPEN on 9 July 2012.Subsequently, the Council Legal Service issued an opinion on theappropriateness of the legal basis of the proposal and on the compatibilityof the proposal with the ne bis in idem principle. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 171[Note: Ne bis in idem, translates literally from Latin as "not twice in thesame". It means that no legal action can be instituted twice for the samecause of action. It is a legal concept originating in Roman Civil Law, butit is essentially the double jeopardy clause found in common lawjurisdictions]4. Furthermore, on 27 July 2012 the Commission submitted an amendedproposal, integrating in the scope of MAD questions concerning themanipulation of benchmarks for interbanking lending rates; a similarproposal was submitted concerning MAR.5. On the basis of these documents, and building on the commentsreceived from delegations, the Presidency has presented an amendeddraft text of the Directive.This draft was discussed at the meeting of the Friends of the Presidencyon 12 October 2012.Further meetings are planned for 22 October and 9 November 2012.6. Given the outcome of discussions of the meeting of 12 October 2012 thePresidency would like to ask the Council for orientation in view of futurework on the proposal, in particular for what concerns the questionrelating to the application of the principle of ne bis in idem.APPLICATION OF THE PRINCIPLE7. The legal basis of MAD is Article 83 (2) TFEU, according to whichprovisions of substantial criminal law may be the object of approximationthrough Directives when this "proves essential to ensure the effectiveimplementation of a Union policy in an area which has been subject toharmonization measures".In this respect, MAD compliments MAR by ensuring properimplementation of the rules set out therein.For this purpose, it imposes on Member States the obligation to providein their national law that certain forms of insider dealing and market _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 172manipulation are punishable as criminal offences, through sanctionswhich are dissuasive, proportionate and effective.8. This implies that the description of the offences (administrativeoffences in MAR, criminal offences in MAD) is partially overlapping, withthe concrete possibility that certain conduct may fall both within thescope of application of the administrative penalties provided for by MARand within that of the criminal sanctions which the laws of the MemberStates will provide once MAD has been implemented.It should be recalled that this situation, i.e. that the same conduct may bepunished both by criminal and by administrative sanctions, is commonpractice in several Member States while it is not known in some MemberStates.9. It must be further recalled that, under certain conditions, penaltieswhich are labelled as administrative could be considered to be insubstance of a criminal, or punitive, nature.Among others, the case law of the European Court of Human Rights hassince many years elaborated on the principles applicable (the so-called"Engel criteria", after the leading case on the subject of 1976) in itscase-law.The CJEU has integrated these criteria in its own jurisprudence.10. Considering the above, it could be argued that the current structure ofthe MAR and MAD proposals may give rise to tensions with the principleof ne bis in idem, enshrined in Article 50 of the Charter of FundamentalRights of the European Union.In accordance with this principle, if a person has already been subject tocriminal proceedings for a particular offence, and if he has been acquittedor convicted by a final decision of a competent authority of a MemberState, that person cannot be subject to new criminal proceedings forthe same act within the Union. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 17311. During discussions in the Working Party, it has been indicated that therisk of breaching the ne bis in idem principle could present itself if thecompetent authorities of one (or more) Member States applied to thesame conduct of a person both the criminal sanctions provided for undertheir national law for that criminal offence and administrative sanctionsprovided by MAR, when these are of such severity to be substantiallyconsidered punitive under the "Engel criteria".It should be noted, in this context, that the ne bis in idem principleapplies across the borders of the EU.12. Some delegations have indicated that this risk should already be takeninto consideration at the level of the EU legislation and, consequently, beaddressed by specific provisions of MAD (and MAR) regulating therelationship between the different instruments and sanctioning regimes.In the opinion of these Member States, since EU law imposes both anobligation to provide for administrative sanctions (in MAR) and anobligation to provide in national law for criminal sanctions for certaintypes of conduct (in MAD), it should be the same acts of EU law toprovide Member States with the rules to avoid conflicts between thesesanctions.13. A number of other delegations disagree with this point of view.In their opinion the question of respecting the principle of ne bis in idemdoes not arise at the level of the EU legislation, but rather must beaddressed by the competent authorities of each Member State in theapplication of the legislative instruments to a concrete case.Accordingly, the mere fact that MAR and MAD provide for (potentially)interfering sanctions - as is the case in the national law of several MemberStates - does not have any significance in relation to the principle of ne bisin idem.Instead, it is for the authorities of each Member State, acting inaccordance with the rules of their legal system, to avoid in a concrete casethat the simultaneous application of different types of sanctions would _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 174violate the right of the person not to be tried twice for the same offence.Each Member State would therefore be called to regulate the relationshipbetween criminal and administrative sanctions for insider dealing andmarket manipulation in accordance with the specific rules that their legalsystem already employs to protect the ne bis in idem principle.CONCLUSIONS14. In the light of this discussion, and in order to advance in theexamination of the proposal, the Presidency asks the Council forguidance.The Ministers are invited to express their views on this matter and, inparticular, on the following questions:· Do Ministers consider that the protection of the principle of ne bis inidem is relevant in relation to the MAR and MAD proposals?· In case of a positive answer to the previous question, do Ministersconsider that the task of protecting the principle of ne bis in idem shouldbe left to each Member State, when implementing this legislation and inits application? _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 175Certified Risk and Compliance Management Professional(CRCMP) distance learning and online certification program.Companies like IBM, Accenture etc.consider the CRCMP a preferredcertificate. You may find more if yousearch (CRCMP preferred certificate)using any search engine.The all-inclusive cost is $297.What is included in the price:A. The official presentations we usein our instructor-led classes (3285 slides)The 2309 slides are needed for the exam, as all the questions arebased on these slides. The remaining 976 slides are for reference.You can find the course synopsis at:www.risk-compliance-association.com/Certified_Risk_Compliance_Training.htmB. Up to 3 Online ExamsYou have to pass one exam.If you fail, you must study the officialpresentations and try again, but you do not need to spend money. Upto 3 exams are included in the price.To learn more you may visit:www.risk-compliance-association.com/Questions_About_The_Certification_And_The_Exams_1.pdfwww.risk-compliance-association.com/CRCMP_Certification_Steps_1.pdfC. Personalized Certificate printed in full colorProcessing, printing, packing and posting to your office or home. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
    • P a g e | 176D. The Dodd Frank Act and the newRisk Management Standards (976slides, included in the 3285 slides)The US Dodd-Frank Wall Street Reformand Consumer Protection Act is themost significant piece of legislationconcerning the financial servicesindustry in about 80 years.What does it mean for risk andcompliance management professionals?It means new challenges, new jobs, newcareers, and new opportunities.The bill establishes new riskmanagement and corporate governanceprinciples, sets up an early warningsystem to protect the economy from future threats, and brings moretransparency and accountability.It also amends important sections of the Sarbanes Oxley Act. Forexample, it significantly expands whistleblower protections under theSarbanes Oxley Act and creates additional anti-retaliationrequirements.You will find more information at:www.risk-compliance-association.com/Distance_Learning_and_Certification.htm _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com