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Solvency ii News July 2012


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Solvency ii Association …

Solvency ii Association

We are pleased to announce our updated Distance Learning and Online Certification programs:
1. Certified Solvency ii Professional (CSiiP) Distance Learning and Online Certification Program

2. Certified Solvency ii Equivalence Professional (CSiiEP) Distance Learning and Online Certification Program

Register to receive Solvency II / Omnibus II related alerts, opportunities, updates, our monthly newsletter and limited time offers for our Solvency II / Omnibus II Training and Certification programs:

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  • 1. Solvency ii Association1200 G Street NW Suite 800 Washington, DC 20005-6705 USATel: 202-449-9750 www.solvency-ii-association.comDear member,Todaywewill start from the SolvencyII EquivalencedevelopmentsSolvency II – Equivalence TransitionalsmeasureShort introduction of the concept and to the technical workcurrentlyundertaken by EIOPA1.Introduction1.This note aimstoprovidesome additional informationasto theconcept of SolvencyII EquivalenceTransitional measures (proposedunder the current draft OmnibusII Directive) aswell astotheworkcurrentlybeingundertaken by EIOPAin respect to the Commissionrequest for technical input of February 20121.2.TheCommission hasdeveloped a transitional regime for Solvency IIequivalencefor third countrieswhicheither have a risk based regimesimilar toSolvencyII or are willingand committedtomovetowardssucha risk based regime over a predefinedperiod (5years in initialCommissionproposal).3.Thetransitional measuresrecogniseboth that it will not be possibletoundertake full equivalenceassessmentsin respect of all pertinent thirdcountriesprior totheimplementationof SolvencyII, and that there are anumber of third countrieswheretheir solvencyand/ or prudentialregimesare not currentlyableto satisfythe equivalencecriteria in full,Solvency ii
  • 2. but will be in a position todo soonce planned changesto theregimehavebeen made.Thetransitional measureswouldallowundertakingsin or connectedtothesethird countriesto obtain the benefitsof a positive equivalencefindingon a temporary basisduring thetransitional period.4.Inclusion in thetransitional regime wouldbe subject toaCommission Decision.This will most likely be taken in mid2013under the workingassumptionthat the SolvencyII regime will be appliedby EU undertakingsfrom 1January2014.Thecriteria envisagedfor eligibilityfor thetransitional regime are stillsubjecttoongoingpolitical discussion (negotiationson the OmnibusIIDirectivein the Council of Ministersand theEuropean Parliament).Commission‟srequest for EIOPA‟sinput5.In respect of thethird countriesthat haveindicated to theCommissionthat theyare interestedin beingcoveredby thetransitionalprovisions,theCommission hasrequestedthat EIOPAcarryout an analysisof thefollowingduring 2012:- Whether personsworkingfor, or on behalf of, the supervisoryauthoritiesare bound by obligationsof professional secrecy.Professional secrecyequivalenceisa prerequisitetoinclusion in atransitional regime.- Themain areaswheretheequivalencecriteria wouldcurrentlynot bemet.6.In its letter toEIOPA, theCommission hasnoted that the same level ofdetail aswouldbe required for a full equivalenceassessment isnotSolvency ii
  • 3. requiredfor thepurposeof identifying the main areaswheretheequivalencecriteria may not currentlybemet.With the exception of the professional secrecyprovisions,what theCommissionhasrequested is a gap analysis.However, thisanalysis clearlyneedstobe basedon informationcoveringthesame ground aswouldbe covered in a full equivalenceassessment.Participatingthird countrieshave thereforebeen invited to provideinformation by wayof completing the questionnaire annexed to thisnote, which closely reflectsthat used in the earlier equivalenceassessmentsundertaken by CEIOPS/EIOPA.Participating third countriesand next steps:7.To date, the following third countriesthat have expressed an interest inbeing covered by the transitional provisions have received the EIOPArequestsfor information for theSolvencyII gap analysis:_Australia_ Chile_ China_ Hong Kong_ Israel_ Mexico_ Singapore_ SouthAfrica8.EIOPA will baseits adviceto the Commissionlargely on theresponsestothe questionnaire provided by theseparticipatingthirdcountries.9.However, followingadoption of the OmnibusII Directive(politicalagreement among colegislators)EIOPAexpectstolauncha “Call forevidence”procedure invitingany interestedpartiesto providetheir inputSolvency ii
  • 4. regardingpractical experience/ directknowledgeof thesethird countriessupervisorysystems.2.Basic principlesunderlying EIOPAtechnical contribution tothe Commission decisions on equivalence transitionalsPositive Equivalence of third country professional secrecy is adeterminative element for a third country to be included in theequivalence transitional regime.1.Professional secrecyis the basisfor all supervisory cooperationamongEU and third country supervisors.EIOPA will aim to ensure that appropriateprofessional secrecyandconfidentialityrequirementsare in place.2.Afull equivalenceassessment of the third country professional secrecyregimewill be undertakenusingtheprinciple,objectiveaswell astheindicatorsCEIOPS (EIOPApredecessor) proposed in itsfinal 2010Level 2Advice tothe Commission.3.When pursuingthe assessment of theoverarching principleofprofessional secrecy, theprincipleof proportionalitywill not applyinrelationtoprofessional secrecy.Technical input to the Commission regarding identification ofregulatory & supervisory gapsby reference to Solvency IIframework isNOT an equivalence assessment.4.EIOPAwill NOT seekto establishwhetherthe country supervisorysystem providesfor a similar level of policyholder/beneficiaryprotectionasunder SolvencyII to be consideredequivalent.EIOPA will conduct a gap analysisthrough whichit will seekto identifytheareaswherethethird country doesnot meet the current criteria forSolvency ii
  • 5. equivalencewhichwill be embeddedin the criteriatobe set out in theLevel 2 implementingmeasures.2.5. The gap analysiswill be conducted using the indicatorsofequivalencepreviouslyidentified by CEIOPSand taken over by EIOPAi.e. thosefactorswhichEIOPAconsidersprovideguidanceindeterminingwhether the relevant principlesand objectivesare achieved.Proportionality principle.6.Proper consideration shouldbe given to the adequacyof third countrypractice in applying the proportionalityprinciple,wherethis isrelevant.As such, a proportionalityprinciplein theapplicationof regulatoryprovisionsin third country jurisdictions(contingent upon thenature,scaleand complexityof therisksinherent in the business) should not initselfbe seen asan indicatorof regulatory/supervisory gaps.Thegap analysiswill be made in respect of the regime in existenceandappliedby a third country supervisoryauthority at the timeof theassessment. Nevertheless,relevant plannedregulatory developmentswillalsobe taken intoaccount in EIOPAAdvice tothe Commission.7.Plansand ongoing initiativesfor changingthenational insurancesupervisoryregime in the third country should be taken intoaccount atthetime of the gap analysisalthough theywill not automaticallylead toassessorsconcluding asto the absenceof a gap in the third countrysupervisory/ regulatoryframework.Such initiatives should be taken into account to the extent they arerelevant and clearly identified as ongoing work when providing thetechnicalgapanalysisto the Commission.8.As EIOPAexpectsthat a full equivalence assessment will beperformedduring thetransitional period.Solvency ii
  • 6. Thecurrentlyplannedor ongoing developmentstaken intoaccount forthepurpose of performing thegap analysis will be revisitedat the time ofthefull equivalenceassessment.3.Main operational aspects of gap analysis process1.EIOPAworkis of technical nature only.TheEuropean Commission retainsfull decision making powersastothethird countriesto be included in the list of beneficiariesof an equivalencetransitional regime.The Commission also retains full responsibility as to the contents of anyfuture convergence plans that may be agreed with a third country as partof the processtobe accepted in the transitionalregime.2.EIOPAconsidersthat the activecooperation of the third countrysupervisoris essential for a proper analysis tobe undertaken.EIOPA will not engage in any SII gap analysisin the absence ofconfirmation of willingness to participate from the third countrysupervisoryauthority.Theconfirmation of thethird country willingnessto engageisprovidedbytheCommission.3.EIOPA will post a call for evidence on its website following OMD IIapproval (i.e. agreement of the criteria for a third country to be includedin thelist of beneficiariesfrom an equivalencetransitional regime).4.Thecall for evidencewill allowany interestedparties anopportunity, earlyin the process, to bring to EIOPA‟s attentionany factorsthat theythink may be relevant tothe gap analysisor the professionalsecrecyequivalenceassessment.Solvency ii
  • 7. 5.Informationprovidedunder a call for evidencewill be considered byEIOPA but will not be published.Neither will EIOPArespond to thepointsmade.6.EIOPAassessment teamswill expertise, knowledgeand supervisoryexperiencein the followingareas:_ Legal expertise_ Financial requirementsexpertise (pillar I issues) includingactuarialexpertise_ Expertisein supervisoryreview, governanceand reporting(pillar II &III issues)_ Group supervision expertisefor assessmentsin relationtoArticles227and 260.7.The minimum number of assessors per team should be no less than 3,including a EIOPA Staff representative who can also cover one of theaboveareas.8.EIOPAhasinvitedthird country supervisoryauthoritiestocompletethe annexedquestionnairerelevant totheArticlesof the SolvencyIIDirectiveunder whichan assessment isto be undertaken.Thesequestionnairesare be based on thecriteriaset out in the Level 2implementingmeasuresand encapsulatethe indicatorsthat EIOPAconsidersprovide guidancein determiningwhetherthecriteria are met.9.Where necessary, EIOPAwill request additional evidencefrom therespectivethird country supervisoryauthority.10.While the responsesof the third country supervisory authorityto thequestionnairesissued by EIOPAwill form the basisof the analysis,EIOPA will not be restrictedtoconsideringonly thismaterial.Solvency ii
  • 8. 3.11.EIOPAmay alsoconsider other relevant information available, whereappropriate, such asany assessment carriedout by theIMF or WorldBank, or whetherthe third country is partyto the IAIS MultilateralMemorandum of Understanding.Such informationwill only be used assupportinginformationfor thegapanalysis.QUESTIONNAIRE FOR EQUIVALENCE GAP ANALYSISIN RELATION TO ART. 172, 227 AND 260 OF SOLVENCYII DIRECTIVE (2009/ 138/ EC)Principle 1. Powersand responsibilities of third countrysupervisory authoritiesObjectiveThesupervisoryauthoritiesof thethird country have thenecessarymeans,and therelevant expertise, capacity, and mandatetoachievethemain objectiveof supervision, namelytheprotectionof policyholdersandbeneficiariesregardless of their nationalityor placeof residence.In particular, thesupervisoryauthoritiesin that third country shall havethenecessarycapacities, includingfinancial and human resources.Thesupervisoryauthoritiesof thethird country duly consider thepotential impact of their decisionson thestabilityof financial systemsglobally, particularlyduring emergencysituationsand take intoaccountthepotential procyclical effectsof their actionswhereexceptionalmovementsin the financial marketsoccur.Reinsurance specificities:Thesupervisoryauthoritiesof thethird country are empoweredby law orregulation to effectivelysupervise domestic insuranceor reinsuranceundertakingscarrying out reinsuranceactivitiesand toundertake aSolvency ii
  • 9. rangeof actions,includingthe abilitytoimposesanctionsor takeenforcement action in relation to the domestic insuranceor reinsuranceundertakingscarrying out reinsurance activitiesthat it supervises.Group supervision specificities:The supervisory authorities of the third country shall be empowered bylaw or regulation to supervise insurance and reinsurance undertakingswhicharepart of a group.Thesupervision of insurance and reinsuranceundertakingswhicharepart of a group shall be carriedout effectivelyand thesupervisoryauthoritiesof thethird country shall be empoweredby law or regulationtoundertake a rangeof actions,includingthe ability toimposesanctionsor totake enforcement action in relationtothegroup that it supervises.Thesupervisoryauthoritiesof insuranceand reinsuranceundertakingswhicharepart of a group shall be ableto assesstherisk profileandsolvencyand financial position of that group aswell asitsbusinessstrategy.Third country provisionsand arrangementsshould allowefficient andeffectivesupervisionthrough cooperation and exchangeof informationamongsupervisorsof the group.1.Pleaseprovidea comprehensivepresentation of your supervisoryauthority, includingdetails asto:- Alegal basisspecifying supervisoryresponsibilitiesand enforcementpowers;- Freedomfrom undue political, governmental and industryinterferencein the performanceof supervisoryresponsibilities;- Transparencyof supervisoryprocesses/ procedures;- Adequate financial and nonfinancial (e.g. sufficient numbersofSolvency ii
  • 10. appropriatelyskilledstaff) resources;- Appropriateprotectionfrom beingliablefor actionstaken in goodfaith.2.Pleaseprovide detailsasto supervisorypowersavailableto theauthorityin respect of undertakingsin difficulties(solo) / ultimateparent undertakingsin difficulties(groups), whichmay include:- Prohibition of disposal of assets;- Arecovery plan, financescheme;- Reestablishment of the level of own funds, reduction of risk profile;- Downwardrevaluations;- Preventingthe conclusion of new contracts;- Withdrawalof authorisation;- Measuresrelatingtodirectors, managers, controllersand otherrelevant persons.3.Pleaseoffer a detailed overview of theenforcement actionsavailabletothe authorityincludingasto the supervisoryauthority‟s abilitytocooperatewith other authorities/ bodiesin respect of enforcement action.4.Pleaseprovide information on your authority‟s powerstotakepreventativeand correctivemeasurestoensure that insuranceandreinsuranceundertakingscomplywith the applicablelaws,regulationsand administrativeprovisionsincludingdetails astothe authority‟s:- Ability to ensure complianceon a continuousbasiswithlaws,regulationsand administrativeprovisions(includingthrough onsiteSolvency ii
  • 11. inspections)includingmeasuresto prevent/ penalisefurtherinfringements;-Ability to communicate concerns, includingthoserelatingtotheundertaking‟s/ group‟sfinancial position;-Ability to oblige the(re)insurerto respond to concernsraised by thesupervisor;- Ability to obtain all information necessaryto conduct the supervisionof the undertaking/ group.5.Pleaseindicate whetherin the exerciseof your general duties, you aredulyconsideringthepotential impact of your decisionson the stabilityoffinancial systems globally, particularlyduring emergencysituations,onthebasis of the informationavailableat the time.- Pleaseprovideany examplesof actionsrecentlyundertakenin thisrespect;-Pleaseprovidedetails asto regulatoryrequirementsastoinformationsharingin crisis/ normal situation with foreign supervisors.- In the context of group supervision, pleaseprovidedetails astoregulatory requirementsasto informationsharing in crisis/normalsituationswhichmay include:Ability/ Willingnessto submit information on intragrouptransactions;Exchangeof prior information on decisionsthat couldaffect thesolvencyof the entitiesbelongingtoan EEA MemberState;Ability/ Willingnessto allowthe transferof cash;Ability/ Willingnessto support restrictionson free assetsforsupervised entities.Solvency ii
  • 12. 6.Please indicate whether the you are taking into account the potentialprocyclical effects of your actions where exceptional movements in thefinancial marketsoccur- Pleaseprovideany examplesof actionsrecentlyundertakenin thisrespect.7.In thecontext of group supervision, pleaseexplain your supervisorypowers/arrangements/ requirementsfor cooperationwithothercountries.Pleaseindicatewhether:- Under your national provisions,you may act asgroup supervisorfortheentiretyof groupsdomiciledin your jurisdiction.- Whereyou are thegroup supervisor,do you act asthe point ofcontact for keyquestionsat group level and take responsibilityfor:Thecoordinationand dissemination of information;Review of the groups‟financial position;Planningand coordination of supervisory actionsin respect ofthegroup asa whole;Establishment of a framework for crisismanagement;Theassessment of theapplicationfor a group internal model ifrelevant and takeitsdecision in consultation withother supervisoryauthoritiesconcerned.- As group supervisor doyou have theprerogative to consult andinvolvein advancethe relevant supervisoryauthoritiesconcerned incaseyou intend to carry out an inspectionin an (re)insuranceundertakingsituated in theEEA.Solvency ii
  • 13. - Doyou haveprovisionsin placefor the establishment of cooperationarrangements,whichallowthat:Acollege of supervisorsor similar cooperationarrangementscanbe establishedcomposingaminimum of all relevant authoritiesfor thegroup supervision under the followingcircumstances:Relevanceofthegroup tooverall financial stability; Relevanceof the group inspecific insurancemarket; Similarity of supervisorypractices;Thenature and complexityof the businessundertakenby thegroup;In casea Collegeof supervisorsor similarcooperationarrangementsare established, the functioningand organisationof thesemechanismsis based on writtenarrangements,includingprovisionson obligationto cooperate/exchangeof information and decisionmakingprocesses(aimed at consensus);Pleaseindicatewhetherand, should it be the case,providedetailsastothe existenceof a mechanismfor disputesolving mechanism in caseof disagreement withother relevant supervisoryauthoritiesPrinciple 2 Professional secrecy, exchange of information andpromotion of supervisory convergenceObjectiveThesupervisoryauthoritiesof thethird country and supervisoryauthoritiesof Member Statesinvolved in thesupervision of domesticinsuranceand reinsuranceundertakingsshall cooperate and, whererelevant, ensurethe effectiveexchangeof information.Thesupervisoryauthoritiesof thethird country shall providethat allpersonswhoareworkingor whohave workedfor thesupervisoryauthorities,aswellasauditorsand expertsactingon behalf of thoseauthorities,are bound by obligationsof professional secrecy.Theabovementioned obligationsof professional secrecyshall extend toSolvency ii
  • 14. information received from thesupervisoryauthoritiesof MemberStates.8.Pleasedescribethe applicableregime with regard tothe professionalsecrecyobligationstheauthoritymust observe(incl. theexistenceandextent of these obligations) including:- Confidential information – identification;- Legal dutytoprotect confidential information;- Applicable toall relevant individuals(i.e. all thosewhowork, haveworked or act(ed) on behalf of the supervisoryauthority);- Ongoingobligation(applicablewhilst working/actingon behalf ofsupervisoryauthorityand on continuousbasisthereafter);- Disclosureof confidential information in restricted and clearlydefinedcircumstancesaswell assubject toconditionsof professional secrecyUseof confidential information only in thecourseof supervisoryduties:compliancemonitoring (includingmonitoring of technicalprovisions, solvencymargins, administrative/accountingprocedures andinternalcontrols),impositionof penalties,court proceedings/ appeals;-Consent of Competent Authority wherethe confidential informationoriginatesfrom another competent authorityprior agreement tothedisclosure,disclosureis made in accordancewith any specifiedconditions,includingthoserelatingto the purpose of thedisclosureand useof theinformation.Solvency ii
  • 15. - Ability to enter intocooperationagreements(subject to guaranteesofprofessional secrecy.9.Pleasedescribenational applicablelegal provisionsin caseof breachof the obligationof professional secrecylike for exampletheprovisionsin national law in respect of thebreach of professional secrecy(forexampleoffences,penalties,enforcement).10.Please describe the exceptions allowed by the applicable regime withregard to the professional secrecy obligations the authority must observeincluding:- Expressagreement todisclose/ use;- Summary/ aggregate disclosure (individual undertakingnotidentifiable);- Civil/ criminal proceedings(wherethe undertaking hasbeendeclaredbankrupt or is being compulsorily wound up information must notconcern third partiesinvolved in rescueattempts).11.Pleasedescribetheapplicableprovisionsregardingthe existenceandextent of provisionswithregard toyour abilityto exchangeinformationwith:- Supervisoryauthorities includingin relation toauthorisation andsuitability assessmentscoveringindividualsaswell ascommunicationof concernsregarding financial soundnessofsupervised undertakings/ groups;- Other authorities/ bodies/persons/institutionsresponsiblefor, orhaving oversight of:supervision of financial organisations/markets,liquidation/ bankruptcyproceedings,Solvency ii
  • 16. carrying out statutoryauditsof accounts,detection/ investigation of breachesof company law,- Central banks;- Government administrationsresponsiblefor financial legislation (forreasonsof prudential control);- Other authorities/ bodies/persons/institutions(pleaseindicate).Principle 3 Taking up of businessObjectiveThetakingup of thebusinessof reinsurancein the third country shall besubjecttoprior authorisation.Authorisation for thetakingup of businessshall be conditional on theundertakingmeetinga clear, objectiveand publicly availableset ofwrittenstandardson a continuousbasis.12.Pleaseprovidedetails asto existenceand content of standardsinrespect of the Legal Entity:- Legal form;- Head office of theundertaking to be situatedin thesame country asitsregisteredoffice;- ArticlesofAssociation.13.Pleaseprovidedetails asto existenceand content of standardsinrespect totheundertaking‟soperations:-Limitation toreinsurance and relatedoperationsfor pure reinsuranceundertakingswhichmay include, for example, a holdingcompanyfunction;Solvency ii
  • 17. - Limitationtothe businessof insuranceand operationsarisingdirectlytherefrom for insuranceundertakings;- Schemeof operations(including, for thefirst three years, a forecastbalancesheet, estimatesregarding but not limited to: future SolvencyCapital Requirements,Minimum Capital Requirements,thefinancialresourcesintended tocover technical provisionsand capitalrequirements);- Financial resourcescoveringset up costs;- Basicown fund itemsthat constitutetheabsolutefloor of theminimum capital requirements;- Compliance withthe system of governancereferred tounder Principle4.14.Pleaseprovidedetails asto existenceand content of standardsinrespect totheundertaking‟sobligationto provideinformation onShareholders/Members:- Identityof shareholders/ memberswithqualifying holdings;- Amount of holdings;and- Assessment of reputation and financial soundnessof theownerandacquirer.15.Pleaseprovidedetails asto existenceand content of standardsinrespect tocloselinks:- Identification of closelinks(i.e. a situation in whichtwoor morenatural or legal personsare linked by control or participation, or arepermanentlylinkedtoone and thesame person by a controlrelationship);Solvency ii
  • 18. - Monitoring of closelinkstoensure theydonot prevent the effectiveexerciseof supervisory powersover theauthorisedundertaking.16.Pleaseprovidedetails asto existenceand content of standardsinrespect of refusal/withdrawal of authorisation:- legallypossible;- possibledue to qualificationsof shareholders/ members;and- wherecloselinksprevent effectivesupervision.Principle 4 System of Governance; Supervisory Review andPublic DisclosureObjectiveThesolvency/prudential regime of thethird country shall requiredomestic insuranceand reinsuranceundertakingscarrying outreinsuranceactivitiestohave in placean effectivesystem of governancewhichprovidesfor sound and prudent management of thebusiness, andrequiregroupstohave in placesuch asystem at thelevel of the group.That system shall at least includean adequatetransparent organisationalstructure witha clear allocation and appropriatesegregation ofresponsibilities,requirementsfor ensuringthat personsmanagingtheundertakingare fit and proper and effectiveprocessesto ensure thetimelytransmission of information both within the undertaking or groupand totherelevant supervisory authorities.Thesolvency/prudential regime of the third country shall requiredomestic insuranceand reinsuranceundertakingscarrying outreinsuranceactivitiesto have in placean effectiverisk managementsystem comprisingthe strategies, policies,processesand internal andsupervisoryreportingproceduresnecessarytoidentify, measure,monitor, manage and report, on a continuousbasisand at an individualand an aggregated level, the riskstowhichtheundertakingisor couldSolvency ii
  • 19. beexposed, and their interdependencies,aswell asan effectiveinternalcontrol system.It shall require groupstohave in placesuch asystem at the level of thegroup.Thesolvency/prudential regime of thethird country shall requiredomestic insuranceand reinsuranceundertakingscarrying outreinsuranceactivitiesto establish and maintain riskmanagement,compliance, internal audit and actuarial functions.Groupsshall be required toestablishand maintain thesefunctionsatgroup level.Thesolvency/prudential regime of thethird country shall require groupsanddomestic insuranceand reinsuranceundertakingscarrying outreinsuranceactivitiesto disclosepublicly, on at least an annual basis, areport on their solvencyand financial condition.Group supervision specificities:Theprudential regime of thethird country shall require thegroup tohavesound reportingand accountingproceduresto monitor and manage itsintragroup transactionsand risk concentrationsand toreport at leastannuallysignificant riskconcentration at the level of the group andsignificant intragroup transactions.17.Pleaseprovidean overview of the governance includingriskmanagement general requirementsand supervisory powersapplicableinyour regime, includinginformationon theexistenceof:- Effectivesystem of governance(includingbut not limited totransparent organisational structure witha clear allocation andappropriatesegregation of responsibilities,effectivesystem for timelytransmissionof information);Solvency ii
  • 20. - Requirementsrelevant tothe fitness(for exampleappropriateprofessional qualification, knowledgeand experience) and propriety(for examplegood repute and integrity) of management and keyfunction holders;- Effectiveand well integratedrisk management system aimedatidentifying, measuring, monitoring, managingand reporting(on acontinuousbasis) the risks towhichtheundertaking isor could beexposed (on an individual and aggregatedlevel, interdependencies),and the amount of ownfundsnecessarytocover thoserisks(comparabletoan own risk and solvencyassessment;- Objectiveand independent internal audit function witha directreporting linetotheadministrative, management or supervisorybody;- Effectiveinternal control mechanisms(for art. 172 includingthoseappliedtoensurethat data received from cedantsarereliable andtimely);- Sound writtenadministrative/ accountingprocedures;- Contingencyplans.18.Pleaseindicatewhetherand under which conditionsis an actuarialfunctionrequired by your system includingwhetherthere isa clearcondition of knowledgeof actuarial and financial mathematicsappropriatetothe nature, scaleandcomplexityof theriskinherent in the(re)insurancebusiness.19.Please indicate whether your supervisory system requires continuoussupervision of outsourced functions or activities (in order to ensure thatmeetingof obligationsshall not be affected).In your replypleasealsoprovide information on theexistence/ extent ofprovisionsin relationto outsourcingincludingastothe requirement fora notification tothesupervisoryauthorityprior to outsourcingof criticalor important functionsor activitiesaswell asany other materialsubsequent developments.Solvency ii
  • 21. 20.Pleaseindicatewhetheryour supervisorysystem requiresthatundertakingshave a ComplianceFunction in placeto providetheadministrative,management or supervisorybody adviceon compliancewith law,regulationsand administrativeprovisionsincludinganassessment of thepossibleimpact of any changesin the legalenvironment and theidentificationand assessment of compliancerisks.21.Pleaseprovide details asto governancerequirementsapplicableinorder to ensure identificationof deteriorating financial conditionsandremediation of deteriorating with appropriate monitoring toolsin place.22.Pleaseprovidedetails asto the existenceand extent of theauditorsdutytoreport:- Breach of laws,regulations,administrativeprovisions;- Issueswhichmay affect the continuousfunctioningof theundertaking;- Refusal (or reservations) in respect of certification of accounts;- NoncompliancewithSolvencyand Minimum Capital Requirements.23.Please provide a comprehensive overview of requirements for thepublic disclosure of report(s) on solvency and financial conditions atleast on an annual basiswithadescription of:- Thebusinessand performance;- System of governance;- Riskexposure, concentration, mitigation and sensitivity;- Assets;- Technicalprovisions,other liabilities;Solvency ii
  • 22. - Capital management;- Significant intragroup transactionsand significant riskconcentrations,in thecaseof groups.24.Pleasedescribethe type and frequencyof accounting, prudential,statisticalinformationobtainableby thesupervisoryauthority:- Annual Report on thesolvencyand financial condition of theundertaking;- Annual accounts(coveringall operations, financial situationandsolvency);- Returns/statisticaldocuments;- Information regarding contractsheld withintermediaries,in thecaseof reinsuranceundertakings(art. 172)Principle no. 5 Changesin business, management or qualifyingholdingsObjectiveThesolvency/prudential regime of thethird country shall require thatproposed changesto thebusinessor management of domesticinsuranceor reinsuranceundertakingscarrying out reinsuranceactivitiesor ofgroups,or toqualifying holdingsin suchundertakingsand groupsareconsistent withmaintainingthesound and prudent management of thedomestic insuranceor reinsuranceundertakingor group.25.Pleaseprovide information on the existence/ extent of provisionsandsupervisorypowersin respect of acquisitions,includingasto:- Notification of intentionto hold or increasedirectlyor indirectlyaqualifying holding;Solvency ii
  • 23. - Right of supervisoryauthorityto opposeproposed acquisitionaswellasabilitytosuspendvoting rightsand/ orability toannul castedvotes;- Existenceof thresholdsprompting notification;- Possibilityfor assessment of acquisitionby financial undertakingstobesubject toprior consultation.26.Pleaseprovide information on the existence/ extent of provisionsandsupervisorypowersin relationto disposals,includingasto:- Notification of intentionto disposedirectly/indirectlyof a qualifyingholding;- Thresholdsprompting notification.27.Pleaseprovide information on the existence/ extent of provisionsandsupervisorypowersregardingthe information obtainablefrom anundertaking, includingasto:-Thresholdspromptingnotification of acquisitions/ disposals;-Regular notification (e.g. annual) of qualifying holdings,includingsize.28.Pleaseprovide information on the existence/ extent of provisionsandsupervisorypowersin relationto the requirementsfor ongoingassessment, approval and disclosureof relevant information, includinginformation in respect of:- Portfolio transfersor transfer of individual contracts(e.g. in thecontext of reinsurancecontracts);- Changesto management;and- Schemeof operation.Solvency ii
  • 24. 29. Pleaseprovidedetails asto existenceand content of standardsandsupervisorypowersin respect to theundertaking‟sobligationto provideinformation on assessment of reputation and financial soundnessof thenew owner / acquirer.Principle no. 6 –SolvencyAssessmentObjectiveThesolvency/prudential regime of thethird country shall requiredomestic insuranceand reinsuranceundertakingsand groupsto holdadequatefinancial resources.Theassessment of thefinancialpositionof domesticinsuranceandreinsuranceundertakingsand groupsin the third country shall rely onsoundeconomic principlesand solvencyrequirementsshall be based onan economicvaluation of all assetsand liabilities.Thesolvency/prudential regime of thethird country shall requiredomesticinsuranceand reinsuranceundertakingsand groupstoestablishtechnical provisionswith respect to all of their insurance andreinsuranceobligationstowardspolicyholders and beneficiariesofinsuranceand reinsurancecontracts.Thesolvency/prudential regime of the third country shall require thatassetsheld tocover technicalprovisionsare invested in thebest interestsof all policyholdersand beneficiariestakingintoaccount anydisclosedpolicy objectiveand that domesticinsuranceand reinsuranceundertakingsand groupsonlyinvest in assetsand instrumentswhoseriskstheundertaking concerned can properlyidentify, measure, monitor,manage, control and report.Thesolvency/prudential regime of thethird country shall requiredomestic insuranceand reinsuranceundertakingsand groupsto meetcapital requirementsthat are set at a level whichensuresthat in theeventof significant lossespolicyholders and beneficiariesareadequatelySolvency ii
  • 25. protectedand continueto receivepaymentsastheyfall due toa level ofconfidenceat least equivalent tothat achieved byArticle 101of Directive2009/ 138/ EC.Thosecapital requirementsshall be risk based withtheobjectiveofcapturingquantifiablerisks.Wherea significant risk is not quantifiableand cannot be captured in thecapital requirements, thenthat risk shall be addressed through anothersupervisorymechanism.Thesolvency regimeof thethird country calculationof capitalrequirementsshall ensure accurateand timely interventionbysupervisoryauthoritiesof the third country in the event that thosecapitalrequirementsare not complied with.Thesolvency regimeof thethird country shall require domesticinsuranceand reinsuranceundertakingsand thosewhich arepart of agroup tomaintain a minimum level of capital, noncompliancewithwhichshall triggerimmediate and ultimate supervisoryintervention.Thesolvency regimeof thethird country shall require domesticinsuranceand reinsuranceundertakingscarrying out reinsuranceactivitiesto meet thecapital requirementsreferredtoin paragraphs5and6above withownfundsthat areof a sufficient qualityand whichareableto absorb significant losses.Ownfund itemsconsideredby thesupervisoryauthoritiesto be of thehighestqualityshall absorb lossesboth in a goingconcern and in caseofa windingup.For group supervision assessments:Thecalculationof group solvencyin thethird countrysprudentialregimeshall produce a result that is at least equivalent totheresultSolvency ii
  • 26. achieved by either one of the calculationmethodsset out inArticles230and 233 of Directive2009/ 138/ EC.Thecalculation shall ensure that thereis no doubleuseof own fundstomeet thegroup capital requirement and that theintragroup creation ofcapital through reciprocal financingis eliminated.30.Pleaseprovide information on the existence,content and extent ofprovisionsin respect of financial supervision, including asto:- Verification of stateof solvencyand financial condition ofundertaking/ of thegroup;- Verification of establishment and abilitytorequest increaseoftechnical provisionsand coveringassets;- Obligation of undertakingto submit financial reportingtosupervisor.31.Pleasedescribe provisionsasto rulesfor valuationof assetsandliabilities,and indicate whetherthe followingare applicable:- Thevaluation of assetsand liabilitiesisbased on an economicvaluation of thewholebalancesheet;- Assetsand liabilitiesare valued at the amount for whichtheycouldbe exchanged betweenknowledgeablewillingpartiesin an arm‟slengthtransaction;- Valuationstandardsfor supervisorypurposesisconsistent withinternational accountingstandards, tothe extent possible.32.Pleaseprovidedetails asto the legaland supervisory regimeapplicablein relationtotechnical provisions(TP) and indicatewhetherand/ orhow:Solvency ii
  • 27. - TP are establishedin respect of all (re)insuranceobligationsand aimtocapture all expectedrisksrelated to (re)insuranceobligationsof theundertaking;- TP are calculatedin a prudent, reliable and objectivemanner;- Thelevel of TP is theamount a third country (re)insuranceundertakingwouldhavetopay if it transferred or settleditscontractual rightsand obligationsimmediately toanotherundertaking/ knowledgeablewillingpartyin an arm‟s lengthtransaction;- Thevaluation of TP is market consistent and makes use, totheextent possible,of and isconsistent withinformation provided byfinancial marketsand generallyavailableinformationonunderwritingrisks;- Asegmentation of the (re)insuranceobligationsintoappropriateriskgroupsand asa minimum by linesof businessisout in order toachievean accuratevaluation of reinsuranceobligations;- Processesand proceduresexist to ensure theappropriateness,completenessand accuracyof the data used in thecalculationof TP.- Thesupervisor is ableto require theundertakingto raisetheamountof technical provisionsif it doesnot complywiththe requirements.33. Pleaseprovidedetails asto the regimeapplicablein relationto ownfundsincluding, whereapplicable, asto:- Ownfundsare classified in accordancewiththeir abilitytoabsorblossesin the caseof windingupand on a goingconcern basis;- Thehighest qualitycapital is available toabsorb lossesin a goingconcern and in caseof a windingup, withadditional requirementsofsufficient duration of the own fund item, absenceof incentivestoSolvency ii
  • 28. redeem, absenceof mandatory servicingcostsand absenceofencumbrances;- Adistinction is made betweenown fundson thebalancesheet andoff balancesheet items(for exampleguarantees);- Accordingtotheir classification, own fundsare eligibleto coverpartiallyor fully(for thebest qualityownfunds) the capitalrequirements;- Quantitativelimitsapplytotheown fundsto ensure thequalityofownfundscoveringthecapital requirements.In theabsenceofquantitativelimitsother supervisory requirementsshould ensure thehigh qualityof own funds.34.Pleasedescribethe applicableregulatory and supervisoryregime inrelationtoinvestmentsproviding detailssupportingthat:- Undertakingsare onlyallowedto invest in assetsand instrumentswherethe riskscan be properlyidentified, measured, monitored,managed, controlledand reported and appropriatelytaken intoaccount in their solvencyneeds;- Assetsheld tocover TP are investedprudentlyin the best interestofall policyholdersand beneficiaries;- All assetsare invested in such a manner as to ensure the security,quality, liquidity, availability and profitability of the portfolio as awhole;- Prudent levelsof investmentsin assetsnot admitted totradingarerequired;- Investment in derivativeinstrumentsare possibleinsofarastheycontributeto a reduction of risks or facilitatean efficient portfoliomanagement;Solvency ii
  • 29. - There is avoidanceof excessiverelianceon any one particular asset,issuer or accumulationsof risk; noexcessiveriskconcentration.35. Pleaseprovidedetails asto the legaland supervisoryregimeapplicablein relationtocapital requirementsand indicatewhetherand/ orhow:- Capital requirementsare be riskbasedand aim at measuringallquantifiable unexpected risks of theundertaking. Pleasecover thefollowingpoints:Where a significant risk is not captured in thecapitalrequirements,pleaseprovidedetails astothemechanism applied toguaranteethat capital requirementsadequately reflect suchrisk;How thecapital requirementsreflect a level of ownfundsthatwouldenabletheundertakingtoabsorbsignificant lossesand that givesreasonableassuranceto policyholdersand beneficiaries that paymentswill be made astheyfall due;What is thecalibration target for the capital requirements?Dothe requirementsenablethe undertakingat a minimum towithstanda 1in 200ruin scenario over a one year period or ensurethat policyholdersandbeneficiariesreceiveat least the samelevel of protection;Thecalculationof capital requirementsshall ensure anaccurateand timely intervention by supervisoryauthoritiesof thethirdcountry;Obligationon undertakingstocommunicateconcernsrelatingtotheir financial position;Obligationon undertakingtorespond to concernsraised;Thesupervisoryauthorityhaspowerstotakethe necessary andappropriateactionsagainst the undertakingto restorecompliancewiththat requirement;Solvency ii
  • 30. Appropriate standardsare in place wherecapital requirementstake intoaccount theeffect of riskmitigation techniques.- There is a minimum level under whichcapital requirementsshouldnot fall whichequatestoaminimum level of policyholder protectionwhichtriggersimmediateand ultimatesupervisory interventionaction.- Soloand group capital requirementsare calculatedat least annuallyandmonitored on an ongoing basis.36.If your regime providesfor the useof internal models, pleasedescribethe applicableprovisionsregarding specificitiesof assessment of internalmodelsin the context of assessingcapital requirements, includinginformation relatingto the followingareas:- Wherethe (re)insuranceundertakingusesa full or a partial internalmodel tocalculate itscapital requirements, the resultingcapitalrequirementsprovidea level of policyholder protection that isat leastcomparable tothelevel that wouldbe required under local rules if nointernalmodel is used (i.e. it adequatelymodelsthe riskstheundertakingisor could be exposedtoand providecapitalrequirementswiththe same confidencelevel asthestandardapproach);- Theregimehas a processfor the approval of internal modelswhichincludesa requirement for prior approval of the internal model beforetheundertaking is permitted to use themodel to determineitsregulatorycapital requirements;- Theapplicableregime includesthe followingrequirementsfor aninternalmodel tobeused to calculateregulatorycapital:Aprerequisitefor an adequate risk management system;Theinternal model is widelyused in and plays an important rolein the undertakingssystem of governance(usetest);Solvency ii
  • 31. Statistical qualitystandards;Validationstandards;Documentation standards;Calibration standards;Profit and lossattribution.- Wherea (re)insuranceundertaking usesa partial internal model tocalculateitscapital requirements,thescope of the partial internalmodel is clearlydefinedand justified toavoid the "cherrypicking" ofrisks. Pleaseprovideany supportinginformation todemonstrate thatthereis noambiguityasto whichrisks, assetsand/ or liabilitiesareincludedor excluded from the scope of thepartial internal model.37.Pleaseprovidedetails asto the legal& supervisoryregimeapplicablein relationtogroup capital requirementsand indicatewhetherand/ orhow:- Appropriatestandardsare in place wherecapital requirementstakeintoaccount theeffect of risk mitigationtechniquesanddiversificationeffectsat group level;- In order to reflect the total risks that the group may face, the groupsolvency capital requirement also reflects the risks that arise at thelevel of the group and that arespecific tothe group;- Thecalculation methodsusedfor determiningthegroup capitalrequirement.38.Pleaseprovidedetails asto the regimeapplicablein relationto groupownfundsincluding, whereapplicable, asto provisionsrequiring that:- Doublegearing and the intragroup creationof capital throughreciprocalfinancingis eliminated;Solvency ii
  • 32. - Theresult of theassessment of fungibility/ transferabilityissues(e.g. restricted assets) is communicatedby the group supervisor;- Solodeficitsare fully taken intoaccount at group level unlessthegroup can provethat its responsibilityis limitedtoitsproportionalshareof the capital;- Thecalculationof thegroup solvency shall take account of theproportional share held by theparticipatingundertaking in itsrelatedundertakings.However, wherethe relatedundertaking is a subsidiaryundertakinganddoesnot have sufficient eligibleown fundstocover itsSolvencyCapitalRequirement, thetotal solvencydeficit of the subsidiary shall be takenintoaccount.Principle 8 Parent undertakingsoutside the Community: groupsupervisionObjectiveThesupervisoryauthoritiesof thethird country shall have a legal orregulatory framework for determiningwhichundertakingsfall under thescopeofsupervision at group level.Thescope of supervisionat group level shall at least includeallundertakingsover whicha participatingundertaking, asdefinedbyArticle 212of Directive2009/138/EC, exercisesdominant or significantinfluence.Thescope may excludeundertakingswherethiswouldbe inappropriatetothe objectivesof group supervision.39. Pleaseprovide information on whetherthe scope of groupsupervision coversall parts of thegroup particularlyfor entitiesfor whichSolvency ii
  • 33. thereis a dominant or significant influenceare included in thescope ofgroup supervision.Thescope may excludeundertakingswheretheir inclusionwouldbeinappropriateto the objectivesof group supervision (i.e. the undertakingwhichshould be included is of negligible interest withrespect to theobjectivesof group supervision or the inclusion of the undertaking wouldbeinappropriate or misleadingwithrespect to the objectivesof the groupsupervision).40.Pleaseindicateyour approach, asgroup supervisor, to informingother supervisoryauthoritiesconcerned whereyou have decidedthat anentitywithinthe group should be excludedfrom group supervision.In communicatingwith theother supervisoryauthoritiesin such casesdoyou includethe reasonsfor this decision?41.Pleaseprovideany other relevant information on how your regulatoryframeworkprovidesfor a singleidentifiedgroup supervisor responsiblefor coordinationand exercisinggroup supervision.Solvency ii
  • 34. Financial Stability Report 2012First half year reportIntroductionEIOPA‟sFinancial StabilityCommittee(FSC) hasupdateditsreport onfinancial stabilityin relationtotheinsuranceand occupational pensionfund sectorsin theEU/EEA.Thecurrent report coversdevelopmentsin financial markets,themacroeconomicenvironment, and the insurance,reinsuranceandoccupational pension fund sectorsasof 4 May2012unlessotherwiseindicated.Summary of main issuesand conclusionsINSURANCE SECTORLately, the relativelypositivedevelopment of insurersexperienced inrecent years, hasstartedtoreverse.This hasshown in solvencyratiosaswell asprofitability and to an extentalsopremium growth.Though the solvency situation of insurersis onlyreflectedon a SolvencyI basis1in this report right now, thedevelopment of keyvaluedrivers(e.g. lowyield environment in anumber of currencyzonesin Europe)indicatesthat the situationalsoputssignificant pressure on marketvalues.Solvency ii
  • 35. Nevertheless, SolvencyI ratios for insurersarestill at a comfortablelevelwith ~200% at theend of 2011.Followingup on last report‟s risk perception, EIOPAhasanalysed thesector‟sresiliencetoa possiblelonger lastinglowinterestrateenvironment aswell.Although the sector overall seems to be capable of coping with thesechallenges for some time, EIOPA continues to monitor the situationclosely.However, if accompaniedby other potential threatsmaterialising, thesituation might lookdifferent, e.g. in caseof renewedturmoil duetothefailure of governmentstostabilisefiscal situations, a strong weighingofthesedevelopmentson economicgrowth, or a disruptiveunwindingofcurrencyrisk (e.g. asa consequenceof developmentsin Greece).While first order effectsof such an event on the European insurancesector asa wholeseem limited(accordingto EIOPAanalysisconducted), localinsurersare likely tosuffer and second order effectsmight alsohit other European insurers,though mainlythrough thepotentiallytriggered disruption of financial markets(e.g. sovereigns,banksand equities).REINSURANCE SECTORIn 2011, a largenumber of very severenatural catastrophesoccurred,making2011the costliest year ever for thereinsurancesector.Thenatural catastrophelossesexceededby far theheavy lossesof thepreviousrecord year 2005(withhurricanesKatrina, Rita, Wilma).At the same time, the financial crisisworsened,withinterest rate levelsgenerallyremaininglow.Solvency ii
  • 36. As a consequencethereinsuranceundertakingswereconfronted withhugechallengesregardingboth the liabilityside and the asset sideof thebalancesheet.However, at the beginningof 2011theoverall reinsuranceindustry wasvery well capitalised.As a consequencethereinsurersdealt well withthe challengingenvironment; the capital reduction wasonly verymodest.Several years of relatively benign payoutsaswell asthe recovery of thefinancial marketshad ledto reinsurancecapacitiessubstantiallyinexcessof demand.Altogether, theinternational reinsurancemarket remained relativelystablein 2011and saw onlymodest price increasesat thebeginning of2012.Raisingpriceslargelycould not yet be seen in spiteof themany naturalcatastrophesin 2011.Therenewalsat thebeginningof 2012aswell asat April 1ledto somemarked increasesin reinsurancepricesin the regionsand segmentsaffected by losses.But overall therateshave gone up onlymodestly, last but not least due totheextensiveabsenceof major losseventsin Europe and North America.Furthermore, there isan increasedcapital flowintothereinsurancemarket.In the background of the financial crisisinvestors are searchingforrelativelysafe investments,exertinga moderatingeffect on the rates.Solvency ii
  • 37. OCCUPATIONAL PENSION FUNDS SECTORThemembersand beneficiaries of Institutionsfor OccupationalRetirement Provisions(IORPs) are currentlyconcentrated mainlyin afew Member States,but continueto grow in importanceacrossEurope;in some Member Statesreforms are in place to foster thisgrowthin thefuture.A trend is observed towards defined contribution schemes, which leavesponsors less vulnerable to market downturns as risks are borne mainlybymembers and beneficiaries.Data for 2011(providedby supervisorson a best effort basis) document agrave evolution in thefundingpositionsof IORPs, especiallyfor thelarger defined benefit (DB) systems suchasUK and NL, wherelevelsin2011seem tohave declined below 100%.Thelow yield environment in both countries is a key driver behind thisdevelopment, asit forcesthemarket valueof liabilitiesup.At the same time both systemsalsoresult in low expected future assetreturnsgiven thedominance of debt investmentsfor most occupationalpensionsin most countries.Supervisorshave takenactionstoaddressthese lowfundinglevels.In NL fundsare obligedto participatein a recovery programme astheircoverageratio (assetsdividedby technical provisions)dropsbelow therequiredlevel (on average120%).TheUK pensionsregulator is alsorunning recovery programmesand haspublisheda statement inApril settingout expectationsof trusteesof DBIORPsstartingvaluationsunder thecurrent conditions.Other recent trendsincludean increasein sovereigndebt exposuresofIORPsin 2011withrespect to2010.Solvency ii
  • 38. At least in high yield countriesthis isfocussingon shorter maturities.Given current turbulent market conditions,a number of regulatorshaveemphasisedthe increasingimportanceof proper governanceprocessesand increasingreporting requirements,alsoincludingregular scenarioanalysesand stresstests.Recent developmentsFINANCIAL MARKET DEVELOPMENTSThemacroeconomicenvironment is still challengingin manyEuropeancountriesand thusa main source of concern for financial stability.Uneaseover government debt levelsremains and political uncertaintycontinuesto influencemarketsalsoafter the relativelystrongpolicyresponsesat the European level.Overall, the political and economic climate continuesto weighongrowthprospectsin Europe, although there are regional differences.Figure 1showstheevolution of twoleadingEuropean businesscycleindicatorsfor theeconomiccycles six monthsahead.TheOECD indexshowsa somewhat decliningtrend in macroeconomicoutput, althoughpossiblyat a slowerpacethan in previousmonths.TheZEW Eurozone indicatorhad improved at thebeginningof 2012after having reached levelscomparablewiththoseobserved during thefinancial crisisin 2008.Thelatest figure, however, indicatesthat the sentiment is againdeterioratingslightly.Solvency ii
  • 39. Note: Thefigure showsleadingindicatorsfor the economiccycle sixmonthsahead.Twoindicatorsaredepicted. Onederivesfrom theZEW (Zentrum fürEuropäischeWirtschaftsforschung) Eurozoneexpectation of economicgrowth and theother from OECD.Theformer isplotted in blue on theleft hand axis and the latter isplottedin green on the right hand axis.TheOECD updatedits methodology for thecalculation of the indicatorin April 2012touse GDP asa referenceseries.Several European countries are facingcontinuedeconomic downturn.Figure 2 showsthedevelopment in GDP in several largeEuropeancountries.Solvency ii
  • 40. Onlyin a few countries is theGDP back topre crisislevels.In several countries,GDP seemsto be sloping downwards.Combinedwith deleveragingby the banking sectorin Europe and the fiscalconsolidationpath followedby major governments, growthprospectsforseveral countriesseem dim, at least in the short term.Thefact that fiscal consolidation and bank deleveragingis occurringinmanycountries at thesame time increasesthedisruptivepotential of thesituation.At the same time, there is littleevidenceof inflationarytendencieswhichmight have been expected given the debatesat the politicallevel ongrowth oriented instrumentsand global fiscal expansionarypolicies.Figure 3 showsthat overall inflationexpectationsare well anchored ataround 2% at a fiveyear horizon.Solvency ii
  • 41. Note: Thefigure showsthe evolution of therateof the 5 year EURinflationswap.It is noted that the swaprate is not adjusted for any inflation or other riskpremia.Combined withhigh levelsof Government debt followingthebankingcrisiswhichstartedin 2008, thissituationhas led European governmentbond yields todiverge further.Government bond yields are high compared to the last few years formany European countries and several currently show an increasingtrend.Solvency ii
  • 42. LEGISLATIVE AND REGULATORY DEVELOPMENTSAnumber of legislativeand regulatory developmentshavebeen reportedby 29 Membersand Observerson the basisof an EIOPAsurveyonnational regulatoryreformswhichhavebeen adopted in the secondhalfof 2011and thefirst part of 2012.Thevolatility in thecapital market and theturbulenceexperiencedin theEurozonesovereign debt market areperceived asthemajor thrust of theregulatoryand legislative changesreportedby most of the respondingcountries.As a reaction to the impact of sovereign risk on thesolvencyposition oftheinsuranceundertakings,in several countrieschangesweremadeinthevaluation approach tosovereign bonds(DE, DK, GR, IT).Supervisoryengagement alsoincluded increasingthe requiredfrequencyof reporting of sovereign, banking and other assetclassexposuresbyinsuranceundertakingsand groups(IE, LU, SI).To deeply explore potential risk concentration areas and marketvulnerabilities ad hoc risk analyses, legislative amendments andreporting requestshavebeen made (BE, FR, IT, PL).Thecomposition of the asset portfolios held by insuranceundertakingsandthe asset allocation policiesare closely monitored in many territories(BE, DE, EE, FR, GR, IE, IT, PL, RO) aswell asthe liquidityposition(BE, CY, PT, PL, RO) asa consequenceof higher lapserates.Likewisein houseStressTest exerciseswerewidelyperformed, or areplannedtobeconducted in 2012,to assessthe insurers‟abilityto absorbadditional shocksaswell astheimpactsof relatively largemovementsinrisk factorsusing new stresstest calculations,methodologiesoradditional adverse financial contexts(EE, FR, FI, LU, NO, PL, CZ).Solvency ii
  • 43. Low yield valuation exercisesare alsoconsidered to be a key instrumenttobe further usedtoinvestigate financial weaknessesof the domesticmarket players.In thiscontext, and in preparation of 2012European stresstesting,several countrieshave alreadylaunchedor are planning toconduct aQIS5bisexerciseover thecurrent year.Followingup on theregular and ad hocmonitoring of the solvencyandcapital positionsof undertakings,more than half of therespondingcountriesreported the need toadopt additional supervisorymeasurestoprevent or solve solvencystrains.In few countries a need wasseen toput in placetargeted actionsor torequest ad hocdata (EE, MT, SE) on the basisof concern over the highrisk profile of individual companies.This hasbroadlyledto a review of theannual, quarterlyor monthlyreporting packages(LU, LI, SE) which in some caseshave alsobeenamended or newlyimplemented to allow an impact assessment of thenew prudential requirementsto be adoptedunder the SolvencyIIframework.Action planstograduallyimplement the new prudential requirementshavealreadybeen initiatedin the observed period (second half 2011firsthalf 2012) and will be carried out over theyear 2012(DE, LI, MT, FR).Thesemainlyconsist in exercisesfor evaluatingthe preparednessandaffectednessof the industry bySII requirements,supported in somecountriesby dedicatedmeetingsand byon sitevisitscarriedout aspartof the Internal Model pre applicationprocessand of the SolvencyIIimplementationprocess.Similar programs, startedbeforethe observed period, are ongoingandbroadlyperformed in many other European jurisdictions.Solvency ii
  • 44. Developments in the European insurance sectorINSURANCE SECTOR DEVELOPMENTSOverall, the reported data from a sampleof largeEuropean insurersindicatesa slight worseningin profitabilityand solvencylevelswhilenewbusinessisquitesluggish for a significant number of reportinggroups.Lifeinsurancepremiumshave increased by only3% on averagethoughmore than half of the participatinggroupsreported decliningpremiums.While in traditional life insurance, with a guaranteecomponent,premiumsdeclinedby around 10% on average, unit linked life insurancerecorded higher premiums(+3%).In non life business,premiumsdecreased on averageby 2% whilemorethan half of the sampleexperiencedhigher premiums.Thehighest increasesin premiumshavebeen seen in marine/ aviation/ transport (+24%), whilein credit / suretyship premiumsshrank by17%.Solvency ii
  • 45. Source: EIOPA, based on worldwide consolidated financial informationreceived from a sample of 24 large European insurance groups from AT,CH, DE, ES, FR, IT, NL, SE and UK (22 groupsfor 2011data).Source: EIOPA, based on worldwide consolidated financial informationreceived from a sample of 24 large European insurance groups from AT,CH, DE, ES, FR, IT, NL, SE and UK (22 groupsfor 2011data).Overall profitsof surveyed groupsdecreasedfrom 2010to2011– whenconsideringthemedian group, profitsweresome 17% lower.Return on equityalsodecreased (from 9.6% to7.8% for themediangroup) though the dispersion especiallyon the lowerend of thedistribution wassignificantlylowerin 2011than in 2010.Solvency ii
  • 46. Source: EIOPA, based on worldwide consolidated financial informationreceived from a sample of 28 large European insurance groups from AT,CH, DE, ES, FR, IT, NL, SE and UK (25 groupsfor 2011data).Though 2011wascharacterised by a largenumber of unusuallycostlynatural catastrophes, profitabilityof thelarge non life insurancegroupsdid not deteriorate:Net claims incurred grew lessthan net premiumssocombinedratioswerequitestable.Overall, it declinedfrom 99% to 97%. Also thistrend wasobserved for amajorityof surveyed groups.Solvency ii
  • 47. Source: EIOPA, based on worldwide consolidated financial informationreceived from a sample of 22 large European insurance groups from AT,CH, DE, ES, FR, IT, NL, SE and UK (18groupsfor 2011data).LOCAL MARKET DEVELOPMENTSIn addition tothe quantitativeanswersbasedon thefast track reportingsummarised above, membershave providedqualitativeassessmentsofmarket conditions, key aspectsof the life and non life insurancesectors,andthemain risks and challengesastheyareobserved in local markets.In EIOPA‟s view theinsurancesectoracrossMember Statesappearstobe generallyresilient.In spiteof adversemarket conditionsand sluggish economy, life and nonlife companiesare sufficientlycapitalisedin termsof solvencyratiosfollowingthe current regime.Alargegroup of Membersreported that solvencyratios in their nationalmarketssufferedend 2011from decreasesin market valuation andSolvency ii
  • 48. sovereigndebt crisis, however,some insurershavealreadyrecapitalisedand othersannounceto doit during theyear 2012.Overall, in themajorityof the Member States(DE, DK, ES, FR, IT,UK) a stabilisation in the upcoming 6 to12monthsis expected.In a significant number of Member Statesa declinein grosspremiumsin thelife sector hasbeen observed recently, primarilydue to thesluggisheconomic activityin some countries.Continuedhigh unemployment alsomakes it difficult financiallyformanyindividualsto purchasenew products.In addition, in some MemberStatesthedemand for classicallifeinsuranceproductsdecreased slightlycomparedtolast year whichmaybesomehow relatedtothetrend in manyMemberStatesto marketingtowardsunit linkedor zero guaranteeproducts.While a few Member Statesreport slight improvementsin financialresultsof life and non life companies, in most MemberStates, insurerswereaffectedby adverse market conditions,low interestratesand by thesovereigndebt crisis.Hence, lowerreturnson assetsduetovolatilefinancial markets, lowinterest rates, the sovereigndebt crisisand the macroeconomicdownturn, are highlighted asthemain causesfor themixed financialresultsof the European life and non life sectors.In particular, thecurrentlyavailableinformationpointed out thatfinancial market developmentsduring thesecond half of 2011contributedtoa deteriorationof the solvencysituationof theinsurersinEurope, however, the sectorsare reported to remain well capitalised.Anumber of key aspectsand developmentsin theEuropean life and nonlife insurancesectorshave been reported by Members.Solvency ii
  • 49. As life insurersexaminehow to reducethecapital strainscaused byguaranteed products, theprolonged low interest rate environment willdepresstheyieldsfor new cashflow and maturing bonds.Thereforethere isan increasedtrend in many Member States(DE, FI,NO, SE, UK) towardsmarketing unit linkedor zero guaranteeproducts.Aparticular issuepertainsto thelapserateswhichdeterioratein some oftheMember States(AT, BE, FR, IT) whichmay be somehow related toweakmacroeconomic environment.In particular in some Member Stateswereobserved higher lapseratesduring thelast quarter of 2011but latest information availablepoint outtoa decrease(FR) or a stabilisation in 2012(AT, BE, IT, SE).In termsof assetsheld by insurancecompanies,in a few Member States,insurersdetermined concentration limitsfor asset management, reducingexposurestoor even banning euro peripheral sovereign.Furthermore, in themajorityof MemberStatesmost insurerswrotedownthe value of Greek government bondsin thesecond quarter.In a largegroup of MemberStatesthere hasalsobeen an allocationfromperipherallowgraded government bondsto higher graded governmentbonds, equity and high graded non financial corporatebonds(DE, FR,UK, FI, NO). Moreover, in a few Member Statesit is expected thatinsurersshorten maturities,hold cash and favour liquid assets(FR, IT).Risk and ChallengesTheoverarchingand somewhat interconnectedrisk themes,whichhavebeen onthe economic agenda for some timenow,remain mainlyunchanged:(i) sovereignrisk;Solvency ii
  • 50. (ii)thelow yield environment, and the riskof not meetingissuedinterestrate guarantees; and(iii) thesearch for yield and the additional risk assumed in this process.Emergingthemesmay well followon the back of these three well knownrisk factors.Thelist could contain eventssuch asfurther developmentsin thesovereignbond marketsin Europe, renewedstrainson the bankingsector, further deteriorationof the US economy and fiscalbudget, imbalancesand further uneven growth rateswithintheeuroareaeconomiesand followingpolitical and macroeconomic risks.SUPERVISORY RISKASSESSMENT FOR THEINSURANCE SECTORAs regardstherisk themeshighlightedby Members,some of theriskfactorswhichare affectedmore for adversefinancial marketsconditionsand a weakereconomicenvironment are seennow tobe more relevant.Therisksexpected toincrease:sovereign, property and credit tocorporatesand householdsemerge simultaneouslyin a sluggisheconomicenvironment suchasEurope experienced in the past months.Moreover, in an environment wheregovernment yieldsare located at lowlevels,interest rateguaranteesbecome hard to fulfil.Furthermore, asa result of a weakeconomicrecovery, the remainingeconomy and industrial enterprisesfacedifficulties, and theaveragecredit rating of governmentsand industrial corporationswouldthereforedeteriorate.Hence, investment opportunitiesin lower rated investmentvehicles,such as, for example, sub investment gradebonds, increasein supply, makingit relativelyeasierfor insurancecompanies toengagein such investments.Solvency ii
  • 51. As highlightedby several Members,it is important tobe vigilant and tocontain and monitor theserisksdescribed above.Otherwise,it can be envisaged that weakercapitalisedinsurancecompanies could suffer unsustainablelossesfrom their investmentactivities.Indeed, macroeconomic conditionsindicate that 2012will likelybeanotheryear in Europe of lowGDP growth, lowinterestratesandmoderate equitymarket performance.Even if the economicrecovery continues, insurersmay find that theassetsunderpinningtheir balancesheetshave decreased in value.EIOPA Membersand Observershave been askedtoassessrisksandchallengesaccordingto the probability of a materialisationand theimpact on thenational insurancemarkets.While for theAutumn 2011EIOPAFinancial StabilityReport a morecomprehensivelist of 45risksand challengesisused asthe basisfor therisk assessment, many of them being of a structural nature, thelist usedin thethisSpring Report isprimarily focussedon market and creditrisks.Based on the responses from 29 Member States4, the following risks andchallenges are classified as the most imminent, ranked by the product ofthe scoresfor probability and potential impact.Sovereign risk, equityrisk, lowinterest ratesaswell ascredit risk ofbanksare the riskswith highest overall rankings.Especiallythefirst of these itemsis consideredto have an increasedprobabilityof materialisationand alsothe impact of such a scenarioisexpectedto be significant.Solvency ii
  • 52. Over thelast six monthseight of the10 risks mentioned above haveincreasedaccordingto the feedback of national supervisors.Thehighest increasesare reported withregard to equityrisk, propertyrisk and liquidityrisk.On thecontrary, natural catastrophesand currency risk are consideredtobe stabilisedcomparedwith data from six monthsago.For thenext six monthsthreerisksare expected to increasefurther, dueto turbulencesin thefinancial marketsand asa consequenceof asluggisheconomy, e.g. credit risk on sovereigns, propertyrisk and creditrisk to corporatesand households.Conversely, interestrate risk relatedtoa prolonged period of low interestratesisexpectedtodecreaseslightly.Solvency ii
  • 53. Developments in the European reinsurance sectorMAJOR LOSS EVENTSIN 2011AND AT THEBEGINNING OF 2012Theyear 2011has set new records.At about USD 380bn, global economic lossesfar surpassed2005, thepreviousrecord year withlossesof USD 220bn and make 2011a year ofunprecedentedlosses.Original insured lossestotalled USD 105bn, slightlymore than 2005 sUSD 101bn(in original values).Themost destructive lossevent of the year 2011wasthe devastatingearthquakeof 11Marchin Tohoku, Japan, whichalone (includingthetsunami and without consideringtheconsequencesof thenuclearaccident) accounted for overall lossesof USD 210bn and insuredlossesof about USD 35bn - 40bn.It wasthecostliest natural catastropheof all timesand the strongestearthquake (magnitude of 9.0) ever recorded in Japan.Theearthquake wasalsothemost severe natural catastrophe in 2011relatingtofatalities:15,840people werekilled, roughly more thanthehalf of all peoplewhohave been victimsof natural catastrophesin 2011.However, thefigure doesnot includethecountlesspeoplewhodied asaresult of the faminefollowingthe worstdrought in decadeson the HornofAfrica, whichwasthe greatest humanitariancatastropheof theyear2011.Thesecond most expensivenatural catastrophein 2011for the insuranceindustrywasagain a very severe earthquake.On 22 February, New Zealand s second largest town, Christchurch, waspartly destroyed by an earthquakewith a magnitudeof 6.3, whichcausedSolvency ii
  • 54. insuredlossesof about USD 13bn and overall lossesof roughlyUSD16bn.Thesetwolargeearthquakeswereresponsiblefor making geophysicaleventsthe dominant lossdrivers in 2011.Nearlytwothirdsof economiclossesand about half the insured lossesstemmedfrom geophysical events.Thelong term averagecontribution of geophysical eventshasbeen just22% of theeconomiclossesand only 10% of the insuredlosses.So2011wasexceptional not onlyduetoitsextraordinarilyhigh losses,butalsobecauseof significant deviationsof thedistributionof the lossestothedifferent perils.Sincethe hurricaneseasonwasrelativelyharmlessthestorm relatedinsuredlossesreachedonly 37% of all insured lossesin 2011comparedwith 76% in thelongterm average.Again, untypically, more than 50% of all insured storm lossesstemmedfrom devastatingthunderstormsand tornadooutbreaksin theUSAwhichaccountedfor an absoluterecordof insured lossesof about USD26bn.Afurther record in 2011representsthe floodingin Thailand.Solvency ii
  • 55. With overall lossesof about USD 40bn and insured lossesof about USD10bnthe floodingin Thailand wasnot onlyby far the country smostexpensive catastrophe to date, but alsotheworld smost expensive flooddisaster.Aprominent role played the increasedimportanceof Thailandregardingthe global manufacturing supplychains.Alargenumber of keycomponent manufacturerswereaffectedby theflooding, leadingto production delaysand disruptionsat clientbusinesses.As a consequenceinsured lossescaused by production disruptionssoared up.So, despite thedominant geophysical eventsin 2011, the weatherrelatedeventsin total werealsovery severe, leadingtothesecond highest valuesrecorded since1980in termsof overall and insured losses(in 2011currencyunits).Even without the earthquakes,2011wouldhave been an extremenatural catastropheyear.Moreover, thedistribution of insured lossesbetweenthe continentsin2011wasalsoexceptional.Asia accountedfor 44% of all insured losses, whereasNorthAmerica andEurope together accounted for fewerthan 40% in 2011contrary tothelongterm averageof more than85% of all insured losses.Theabsenceof major losseventsin theWestern developed countrieswith a high insurancedensity left the insured lossesin relation to theoverall lossesat a low level and is one major reason whyoverall theratesonlyincreasedrelativelymodest in spiteof theheavy lossesin 2011.By contrast, lossactivityduringthe first three monthsof 2012hasbeenrelativelylight.Solvency ii
  • 56. Insuredlossesduring the quarter are expectedtobe lessthan USD 5bn,significantlylowerthan lossesof over USD 50bn in thefirst three monthsof 2011.Thesinking of the cruiseship Costa Concordia, regional tornadooutbreaksin the US and earthquakesin Mexicoand Chile werethe mostsignificant lossesthat occurred in the first quarter of 2012.Despitetheheavy lossesof 2011, thereinsurancemarket continuestofunctionnormallyand hassufficient capital.At the end of 2011, the reinsurancecapacitywasonlythree percent underthelevel of 2010.Therenewalsin January andApril reveal that sufficient capacitywasavailablein the market in spiteof theheavylossesand thechallengingmacroeconomicenvironment (particular low investment yieldsandincreasedinvestment volatility).Several years of relatively benign payoutsaswell asthe recovery offinancial marketshad ledto reinsurancecapacitiessubstantiallyover thedemand, whichdepressed theprices.Consequentlythe ratesdid not riselargely, whichisvery different from other post lossmarkets.There are, of course,somemarked increasesin reinsurancepricesin theregionsand segmentsaffectedby losses, especiallyregardingtheAsiaPacific region.But overall therateshave gone up onlymodestly, last but not least due totheextensiveabsenceof major losseventsin Europe and North America.Particularlythe demand for reinsurancein theUS, wherereinsurancedemand far exceedsthat of any other region, continuestobe verysensitiveto price.Solvency ii
  • 57. The2011hurricaneseason wasrelatively harmless.Themodel version changes(RMS v.11) wereoften alreadyreflectedinunderwritingprocessestovarying degreesbased on previouslossexperiencewith theresult of a lessincreaseddemand for reinsurancethan expectedearlier.Annex 1:Country abbreviationsAT AustriaBE BelgiumBG BulgariaCY CyprusCZ Czech RepublicDE GermanyDK DenmarkEE EstoniaES SpainFI FinlandFR FranceGR GreeceHU HungaryIE IrelandIS IcelandIT ItalyLI LiechtensteinLT Lithuania LULuxembourgLV LatviaMT MaltaNL NetherlandsNO NorwayPL PolandPT PortugalRO RomaniaSE SwedenSolvency ii
  • 58. SI SloveniaSKSlovakiaUK United KingdomCH SwitzerlandSolvency ii
  • 59. The translation (Japaneseto English) is ready!Insurance Inspection Manual(Inspection Manual for Insurance Companies)Points ofAttention for Inspections with Use of ThisManual(1)This inspectionmanual shall applytoall insurancecompanies,includingthe overseasofficesof Japanese insurancecompanies(overseasbranches,locallyincorporatedentities,representativeoffices,etc. provided however, that the determination of whether toincludetheseofficesin the inspectionsubject to thismanual shall be judged inview of applicablelawsand regulations,includingthe local regulatoryframework), aswell asJapanesebranchesof foreign insurancecompanies, etc. and specified corporations.(2)Whenthe insurancecompany is a company witha committeesystem,inspectionsshall be conducted from theviewpoint of whether the Boardof Directors, committees(such asthe nomination, compensation, andaudit committees), executiveofficers,and other corporatestructuresexercisetheir empoweredauthority, etc., paying attention tothefollowingpoints:- 1) Theauthorityto executebusinessis bestowedon executiveofficers,and in principle, directorsdo not have theauthoritytoexecutebusiness.- 2) The Board of Directorsmay delegate, by resolution, the authoritytomake businessdecisionsto executiveofficers.Solvency ii
  • 60. - 3) The purposeof theBoard of Directorsis to supervisetheexecutionof therespectivedutiesperformed by directorsandexecutiveofficers.- 4) Auditing authorityis bestowedon theaudit committee,and not onindividual audit committeemembers. (Audit committeemembersappointedby theaudit committeemay exercisethe authorityof theaudit committee.)(3)In thecasewherean executivedirector (non-director) assumestherolesand responsibilitiesthat wouldnormallybe assumed by a directorin chargeof a specificbusinessoperation, it is necessarytoconduct acomprehensivereview asto whethertheBoard of Directorshasassignedtheofficer authoritysimilar in effect tothat whichwould be granted toadirector in charge, whetherthe focusof the responsibilityis made clear,and whether the Board of Directorssufficientlymonitorsthe execution oftherelevant businessoperation.Basedon thefindingsthereof, theinspectorshould determine whethertheexecutive officer is performing the rolesand responsibilitiesrequiredfor a director in charge, asspecified in thechecklistsof this manual.(4)Furthermore, whendue tocertain special reasons,it isnecessarytoconduct an inspectionof subsidiaries, etc., of insurancecompaniesorpartiesconductingbusinesson their behalf, examinationsasmay berequiredshall be conductedin accordancewiththeapplicablesectionsof this manual.(5)Unlessspecified otherwise,itemsexpressed in the question formsuch as“doesthe company…” or “isthe company…” refer torequirementsthat must bemet by insurancecompanies.Meanwhile, itemsprecededby “It isdesirable…” refer tobest practicesrecommended for insurancecompanies,unlessspecifiedotherwise.Solvency ii
  • 61. With regard toitemsaccompanied by “for example,” insurancecompanies arenot required tofully complyletter-by-letterwiththecriteria and requirementsspecified therein.Theyare merelyexamplesof itemsthat may be useful for checkingwhetherinsurancecompaniesare meeting certain criteria andrequirements,in a manner befittingthe scaleand nature of theirbusiness.(6)Thefollowingare definitionsand usesof someof thekey termsinthismanual- 1) Itemsthat are defined asroles of “the Board of Directors” areitems for which the Board of Directors itself needs to determinesubstantial mattersrelated thereto.However, thisshall not precludeanother deliberativebody, divisionor department from discussing draft proposalsfor decision.- 2) The “Board of Directorsor organizationequivalent to theBoard ofDirectors”includes, in addition to the Board of Directors,otherentitiesthat decide mattersconcerningcorporatemanagement, withtheparticipationof senior managerssuch asa council of managingdirectorsand a corporate management council (hereinafterreferredtoasthe “Council of Managing Directors,etc.”).It is desirablethat decisionsconcerningitemsspecified astheprerogativesof the Board of Directorsor organizationequivalent totheBoard of Directorsbe madeby the Board of Directorsitself.In the casewherethedecision- making authorityis delegated to theCouncilof ManagingDirectors, etc., it isnecessaryto make sure thatthedelegation hasbeen madein a clearmanner, that a follow-upreview is provided for through the compilation of theminutesofmeetingsof the Council of ManagingDirectors,etc., and that asufficient check-and-balancesystem is ensured, througharrangementssuch asrequiringreportstobe madetothe Board ofSolvency ii
  • 62. Directors,and allowingcorporate auditorsto attend meetingsof theCouncilof ManagingDirectors, etc.- 3) The “businesslocations”referstoorganizations,other than thehead office, whichincludesbranches,regional offices, businesslineheadquarters,businessoffices,overseasbranches, and overseascorporations.Theterm “businesslocations,etc.” refers tobusinesslocations,andalsoincludesservice centers(includinglossinvestigationoperations), overseasrepresentativeofficesand other locationsthatare not engaged in salesactivities,and businesslocationsother thanthehead office.- 4) The “manager” refers topersonsin senior managerial positionsinmanagement divisions(includingdirectors).Furthermore, the term alsoreferstothehead of a businesslocation,or seniormanagers thereof(includingdirectors) with levelsofresponsibilityequivalent toor higher than thehead of a businesslocation.- 5) The “employees, etc.” refers toemployees, salesrepresentatives,and insuranceagentsof insurancecompanies.- 6) The “insurancesalesrepresentatives”refers tosalesrepresentativesand insuranceagents,but doesnot includeinsurancebrokers.- 7) The “policyholders” referstopersonswhoarepartiestoinsurancecontractswithinsurancecompanies.- 8) The “policyholders,etc.” refers topolicyholders, insuredpersons,andbeneficiaries.Solvency ii
  • 63. - 9) “Internal rules”are rules that specifyarrangementson aninsurancecompany‟sbusinessin accordancewithitscorporatemanagement policy, etc. that are applicablewithinthe company.It should be noted that internal rules donot necessarilyhavetospecify detailed procedures.- 10)The “marketingand salesdivision” referstoa division,department, or businesslocation engaged in salesbusiness.Forexample, a division involveddirectlyor indirectlyin salesor engagedin salespromotionplanningis a marketing and salesdivision.- 11) The “legal checks, etc.,” which includesa compliancecheck,means, for example, a validation of the consistencyand compatibilityof internal rulesand the legalityof transactionsand businessoperationsbypersonnel in chargeof legal affairs, a division in chargethereof, personnel in chargeof compliance,thecompliance controldivision, and in-houseor outside lawyersand other experts.- 12)“Monitoring” refers tonot onlysurveillancebut alsoimplementationof specificpre-emptivemeasuressuch asissuingwarnings.- 13)The “risk profile” of a financial institutionrefers tothesum offeaturesof variousriskstowhichthe institutionis exposed.Checklist for BusinessManagement (Governance) (for BasicElements)Checkpoints- In order toprotect customersby ensuring the sound and appropriatemanagement of businessand fairnessof insurancesolicitationof aninsurancecompany, under appropriate governance, thoroughimplementationof legal compliance,proper insurancesolicitationandcustomer protection, and accuratemanagement of variousrisksacrossall businessesof theinsurancecompanyare needed.Solvency ii
  • 64. -In order toenablean insurancecompany to conduct businessmanagement (governance) effectively, officers and employees, aswellasorganizationswithin thecompany must perform their respectiverolesand responsibilities.Tobe more specific, directorsand other executivesare responsiblefornurturing workethicsand cultivatinga company-wide culturethatattachesimportanceto internal control.Therepresentative directors,non-representativedirectorsand corporateauditorsmust understand their own rolesin thevariousprocessesofinternalcontrol and fully involvethemselvesin theprocesses.Also, it is important that theBoard of Directorsand the Board ofAuditorsfunction effectivelyand that thefunctionsof a check-and- balancesystemamongdivisionsand departments, and thefunctionsof internalauditsbytheInternalAudit Division are executed appropriately.-Theinspectorshould determine whether the insurancecompany‟sbusinessmanagement (governance) system is functioningeffectivelythroughout the institutionand whetherthe management isperformingitsrolesand responsibilitiesappropriatelyby wayof reviewing, withtheuseof the check itemslistedin thischecklist, theeffectivenessof thefunctionsof five basicelements,namely a system of(1)Businessmanagement (governance) by therepresentativedirectors,non-representativedirectorsand the Board of Directors,(2) Internal audits,(3) Auditsby corporate auditors,(4) External audits,and(5) Checkingby actuaries.- If the insurancecompany‟s management fails torecognize weaknessesor problemsrecognized by the inspector,it is alsonecessarytoexplore,Solvency ii
  • 65. in particular, thepossibilitythat the Internal Control System isnotfunctioningeffectively, and review the findingsthereof through dialogue.-Theinspectorshould review the statusof improvementswith regard tothemajor issuespointed out on the occasion of the last inspectionanddeterminewhetheror not effectiveimprovement measureshave beendeveloped and implemented.Checklist for Legal ComplianceCheckpoints-The development and establishment of a legal compliance system isone of the most important tasks for an insurance company in order tosecure the sound and appropriate management of itsbusiness.Therefore, the company‟s management ischargedwith and responsiblefor taking theinitiativein developing and establishingthe legalcompliancesystem that coversthe company‟s entire businessbydecidinga basic policyon legal complianceand developing anorganizational framework,etc..-Theinspectorshould determine whether the legalcompliance system isfunctioningeffectively and whethertherolesand responsibilitiesof theinsurancecompany‟sBoard of Directorsare being appropriatelyperformed by wayof reviewing, withtheuseof check itemslistedinChapter I., whetherthemanagement isappropriately implementing(1) Policy development,(2)Development of internal rulesand organizational frameworksand(3) Assessment and improvement activities.- If any problem is recognizedasa result of reviewsconductedwiththeuseof the check itemslistedin Chapter II and later in this checklist, it isnecessaryto exhaustively examinewhichof the elementslistedinChapter I are absent or insufficient, thuscausingthesaid problem, andSolvency ii
  • 66. review findingsthereof through dialoguebetweenthe inspector and theinsurancecompany.-If the company‟s management fails torecognize weaknessesorproblemsrecognized by theinspector,it is alsonecessarytoexploreinparticular the possibility that the InternalControlSystem is not functioningeffectivelyand review findingsthereofthroughdialogue.-Theinspector should review the statusof improvementswith regard totheissuespointed out on the occasionof the last inspectionthat arenotminor and determinewhetheror not effectiveimprovement measureshavebeen developed and implemented.Toread morehttp:/ / en/ refer/manual/ hoken_e/ h-all.pdfSolvency ii
  • 67. Interview with Gabriel Bernardino, Chairman of EIOPA,conducted by Silke Wettach, WirtschaftsWoche (Germany)Mr Bernardino, howmuch doesEIOPAcurrentlyknowaboutoccupational pensionsin theEU?Bernardino:We currentlyhave very littledata from pension fundsat theEuropean level.We d on ‟t h ave a comm on lan guage and national regimesconsiderablyvary from eachother, whichmakesit even more difficultto havecomparable data for different countries.We cannot easily assessthesustainabilityof thefundsand thesoundnessof their promises.Acommon and transparent frameworkthat ensurescomparable datawouldbe extremely useful in this case.Sohowareyou goingto proceedwith it?Bernardino:If wehad comparable data wecould conduct stressteststhewaywealreadydofor insurers.We have no scheduleddate, but thisis in our plansin thenear future.What doyou expect from theIORPsstresstest?After thestresstestsinthe bankingsector thepicture wasinsufficient.Bernardino:European pension fundsmanagein total 3 trillion EUR inassets.Solvency ii
  • 68. Theyare represented in assetseverywhere whichmakesthem relevantfor the economy and for the stability of our financial system.That is whyEIOPAproposesto conduct annual stresstestsfor the bigpension fundsat theEuropean level.At the same time supervisoryauthoritiesshould perform stresstestsatthenational level.SmallerIORPscan be testedon a lessfrequent basis.What wewant to know while conductingstresstestsis wherethe futurevulnerabilitiesare?But here weare talkingabout a very longtermperspective.With thebankingstressteststherewerealot of national reflections.Nobodywanted to seenational championsfailing. Will thesituation inoccupational pensionsbedifferent?Bernardino:We have now a very sensitivediscussionon thepensionssideand it wasexpected.Thetruth must finallybe put on the table.And howexactlydoesthetruth looklike?Bernardino:Occupational pensionsarenow under a great pressure.Everywhere be it Germany, theNetherlandsor theUK population andlabour forceare contracting.At the same time stock marketsbecome very volatileand have atendencyto go down.Thelong term interestratesare alsodecreasing.All this threatensthosepension promisesthat weremade in the past.Solvency ii
  • 69. But if wedeny the reality, wewill not takeany action.And I am afraid that on theoccupational pensionsif wedon‟t act, wemight be heading towardsan inter-generational conflict, whenthepensionsof future generationsmight be significantlyreduced.What arepolicyholdersgoingtoface?Bernardino:It isquitesimple:if I make a promisetopay basedon acertainassumptionand thisassumptionchanges,theneither I can paylessor I request higher contribution.In the Netherlandswealready witnessthe consequences:occupationalpension fundscut their paymentsbecausemarket interestratesare lowerthan it wasoriginallyanticipated.Are theNetherlandssmarter than theothers?Bernardino:Some countriesare more transparent. And thisisexactlywhat werequire from others when wesuggest a “holistic balancesheet”or an extendedsolvencybalancesheet.Each employee will exactlyknow the riskshebearsand whichpaymentshewill get. Sosuch a reality+driven check+up wouldbe beneficial foreverybody.Perhapssome fundsareabsolutely not interested that their truecondition comestolight?Bernardino:Some fundsdiscount long term liabilitieswithtoohighinterest rates.If you use more prudent and real discount ratesthey will report hugeunderfunding. And of coursecompaniesdo not want that it comesout,but it isnot a secret.How goodarethefunds‟managers?Solvency ii
  • 70. Bernardino:Thequalityvariesand in any caseit must be improved. Thecurrent low interest ratesmake IORPssearch for interestinginvestments.And thismakesit very important for fund managersnot just tooutsourceasset management.Thosewho, however, instruct a third party to invest in derivativesorstructuredfinancial instruments, should at leasthavea thoroughunderstandingof the possibleconsequences.Theindustryexpectsthat theEU is goingto set upthesamecapitalrequirement fortheIORPsasfortheinsurers. Is that correct?Bernardino:We do not want just tocopythe requirementsfor insurers.However, let‟stakea situation when a companyhasa pension plan andtransfersthe risk tothe IORP like it usedto do withan insurancecompany.In thissituation whycan‟t thesame regulation be appliedtothe IORP?.But thisshouldnot be the caseif pension fundsact asinvestmentvehiclesand their risk is taken by the company or a protection fund.SomeGerman criticsfear that theCommission s planscould destroytheGermansystem. Doyou understand their fears?Bernardino:It isnot our intention todestroy anykind of systemsand ourgoal is not todesigna perfect regulation, whichmakesoccupationalpensionssoexpensive that nobody can afford them.But the worst scenario wouldbe if thosepension promiseson whicheverybody counted, fail. This is whywemust act. Ultimately, it is like thedebt crisis:it emerged not becausepeople know littleabout economics,but becausetheyweredenying the reality. And this isalwaysexpensive.Solvency ii
  • 71. Overview of Progress in the Implementation of the G20Recommendations for Strengthening Financial StabilityReport of the Financial Stability Board to G20 Leaders, 19June2012IntroductionSincethe onset of theglobal financial crisis, theG20hasestablished coreelementsof a new global financial regulatoryframework that will makethefinancial system more resilient and better abletoserve theneedsofthereal economy.National authoritiesand international bodies,withthe Financial StabilityBoard (FSB) asa central locusof coordination, havefurther advanced thisfinancial reform programme, basedon clearprinciplesand timetablesforimplementation.TheFSB coordinatesand closelymonitorsthe national implementationof agreed G20and FSBfinancial reformsand is responsiblefor reportingon it tothe G20.TheFSB set up in October 2011a Coordination Framework forImplementation Monitoring (CFIM), in collaborationwithinternationalstandard-settingbodies (SSBs), to intensifyitsmonitoring and publicreporting on implementation, focusing in particular on priorityreformareas.This report details theprogressmade in global policy development andin implementation of global policyreformssincethe G20 CannesSummit in November 2011.Acentral pieceof theinternational policyreformsisstronger minimumstandardsfor bank capital and liquiditythrough implementation of BaselII, II.5and III requirements.Solvency ii
  • 72. As of end-May 2012:- 20of 27member jurisdictionsof the Basel Committeeon BankingSupervision (BCBS) had implementedthe BaselII.5rulestostrengthen capital chargesfor banks‟tradingbooksand complexsecuritisations,whichweredue to come intoforce from end-2011.Six member countrieshave not issuedfinal regulationsin thisarea.- 20of 27BCBS member jurisdictionshave issued draft or final BaselIII regulations,implementation deadlinefor which is1January 2013.Sevenmember jurisdictionshave yet todo so, but themajorityofthesebelieve theycan issuefinal regulationsby theimplementationdeadline.Another central reform objective is ending “too big to fail” throughstrengthened resolution regimes and resolution planning for globalsystemically important banks(G-SIBs):- Encouraging progresshasbeenmade by major jurisdictions,includingthe US, UK and EU, toput in placeor proposelegislationtoestablish effectiveresolution regimes;- However, although cross-border crisis management groups(CMGs)havebeen establishedfor 24 of the 29G-SIBs, much further workisneeded to develop resolution strategiesand plans,and thecross-border co-operationagreementsneededtoensure the resolvability oftheseG-SIBs.With regard toreformstoover-the-counter(OTC) derivativesmarkets,all jurisdictionsand marketsneed toaggressively push ahead to achievefull implementationof market changesby end-2012tomeet the G20commitmentsin asmany reform areasaspossible:- Good progresshasbeen made by thosejurisdictionswiththelargestOTC derivativesmarkets, includingtheUnitedStates(US),European Union (EU) and Japan, in advancingnational legislationSolvency ii
  • 73. and regulation and practical implementationof reformstomarketinfrastructures;- SSBshave alsomade significant progressin developing theinternational policiesthat are keyto advancingOTC derivativesreform implementationacrossjurisdictions.All jurisdictionsnow have sufficient informationabout internationalstandardsand policiestoput in placethe needed domesticlegislationand regulation.With regard toreform of compensation structuresat financialinstitutions:- Almost all FSB member jurisdictionshave now implementedthe FSBPrinciplesand Standards for sound compensation practicesinregulation or supervisoryguidance.SinceCannes, jurisdictionsthat showedsignificant gapshaveprogressed.However, sustainedsupervisoryand regulatoryattention will beneeded to achievelastingimprovementsin financial firms‟compensation structuresand practices.Sincethe CannesSummit, the FSB and itsmembershave made goodprogressin policy development in areaswhere G20objectiveshave beenagreed, includingdeveloping proposalsfor public consultation onextendingthe frameworkfor systemically important financial institutions(SIFIs) to cover global insurersand domesticbanks, measuresto addresstheregulation and oversight of shadowbanking, and thedevelopment ofa governanceframework for a global Legal EntityIdentifier (LEI) system.An important goal of the monitoring processisto highlight, forcorrectiveaction, areaswheretherearerisks that policyobjectiveswillnot be met, or whereimplementationis not meeting theagreedtimelines.Solvency ii
  • 74. Among theseareas:- Although CMGs have been established, much further work onresolution plans and on cross-border co-operation is needed toimproveresolvability.Progressisbeingmadein national legislativereformstoestablishmore effectiveresolutionregimes.The standards set out in the FSB‟s November 2011 Key Attributes ofEffective Resolution Regimes provide international standards in thisarea, and the detailed assessment methodology being developed willprovidefurther guidance.- Many jurisdictionsstill need to addressweaknessesin theirsupervisors‟mandates,to ensure sufficient independencetoact,appropriateresources,and a full suiteof powersto proactivelyidentify and addressrisks.The Basel Core Principles are being strengthened in this area, with aconsultativepaper havingbeen issued lastDecember.The following sections describe in greater detail the progress made bythe FSB and its members to promote financial stability and strengthenthe resilience of the global financial system, including through surveysconducted by theFSB‟sImplementation Monitoring Network (IM N).2. Building resilient financial institutions2.1Implementation of Basel II/ II.5/IIITheG20 Leaders,at the CannesSummit, reaffirmed their commitmenttoimprove banks resiliencetofinancial and economic shocks,andcalledon jurisdictionstomeet their commitment toimplement fullyandconsistentlytheBasel II/ II.5/III requirements.TheBaselIII frameworkseeksto strengthen theresilienceof thebankingsystem through prudential measuresthat will enhancetheSolvency ii
  • 75. qualityof capital;increasethe level of capital;promote thebuild-up ofcapital bufferstomitigatepro-cyclicality; supplement the risk-basedcapital requirementswitha leverageratio; and introducea set of globalliquiditystandards.Together with theBasel II and Basel II.5frameworks,Basel III willimprovethebankingsector‟sabilityto absorb shocksarisingfromfinancial and economicstress,whateverthesource, thusreducingtherisk of spillover from thefinancial sector tothe real economy.TheBCBS withtheendorsement from GHOS, meanwhile launched inJanuary2012a comprehensiveprocesstomonitor itsmembers‟implementationof Basel II/ II.5/III. The processconsistsof three levelsof review:(i)Level 1: ensuring thetimelyadoption of BaselII/ II.5/III;(ii)Level 2: ensuring consistencyof domesticregulationswithBaselII/ II.5/III; and(iii)Level 3: ensuringconsistencyof outcomes(initially, thisassessmentof implementationat the bank level will focuson risk-weightedassets).Thethree-level monitoring framework will promote timelyandconsistent implementation of BaselII/ II.5/III and alsoprovide inputstothe FSB‟sreportingto the G20 Leaderson implementationof priorityreforms.On thetimelyadoption of Basel II/ II.5/III (Level 1), theBCBSpublished in October 2011, April 2012and June 2012reportsthat detailedtheprogressBCBSmembershave made in implementingBaselII/ II.5/III.As of end-May 2012,21of 27BCBSmember jurisdictionshaveimplementedBasel II, whichwasdue tocome intoforce from end-2006.In addition, Indonesia and Russiahave implemented Basel II‟sPillar 1(minimum capital requirements).Argentina, China, Turkey and the US are in theprocessof implementingBasel II.Solvency ii
  • 76. With regard toBaselII.5, asof end-May 2012,20BCBSmemberjurisdictionshad implementedthoserules,whichweredue tocome intoforcefrom end-2011.Argentina, Indonesia, Mexico, Russia, TurkeyandtheUS had not issued final regulations.TheUS authoritiesapproved final rulescoveringthe market riskelementsof Basel II.5in earlyJune2012.SaudiArabia hasissued final regulationsbut thesehave not yet comeintoforce.Among the 29G-SIBs identified in November 20114, nineareheadquarteredin jurisdictionsthat havenot yet fullyimplementedBaselII or Basel II.5.Draft Basel III regulationshad not been issuedby seven BCBS memberjurisdictionsasof end-May 2012:Argentina, Hong Kong, Indonesia,Korea, Russia, Turkeyand theUS.TheUS authoritieshoweverhavesincethenpublished the draft Basel IIIrules.Themajorityof these countriesbelieve theycan issuefinal regulationsbythe implementation deadlineof 1January 2013.However, for the others,dependingon their domestic rule-makingprocess, meeting thedeadlinecould posea significant challenge.In addition tomonitoring the timelyadoption of Basel III rules, theBCBShasestablisheda processtoreview the content of thenew national rulesfor the implementationof BaselIII.This second level of review is meant to ensure that thenationaladaptationsof Basel III are consistent withtheminimum Basel IIIstandards.TheBCBS hasinitiatedpeer reviewsof the domesticregulationsof theEU, Japan and theUS to assesstheir consistencywiththe globallyagreedstandards.Thefindingsof these reviewsarepreliminarysincetheanalysis is not yetcompleted and theformulation of national standardsis still ongoing.Solvency ii
  • 77. Nevertheless, there isa possibility that national and regionalimplementationwill be weakerthanthe globallyagreed standardsinsome keyareas.Athird level of review by the BCBSexamineswhetherthere areunjustifiableinconsistenciesin risk measurement approachesacrossbanksand jurisdictions,and the implicationsthesemight have for thecalculationof regulatory capital.This review will initiallyfocuson banks‟risk-weightingpracticesin thebankingand tradingbooks, and includestheuseof test portfolioexercises,horizontal reviewsof practicesacrossbanksand jurisdictions,and joint on-sitevisitstolarge, internationallyactivebanks.TheBCBS intendstodevelop an updated progressreport bythetime oftheG20 FinanceMinistersand Central Bank Governorsmeeting inNovember 2012that includes:(i)An updateon its members‟domestic rule-making;(ii)Thefinal outcome of the regulatory consistencyassessment of theEU, Japan and theUS; and(iii)Preliminaryfindingsfrom itsdeeper analysisof banks‟riskmeasurement approachesand regulatorycapital calculations.Areview of theconsistencyof Singapore‟sregulationswiththeinternational standards(i.e. a Level 2review) will commencelater in2012,withreviewsof China and Switzerlandtofollowin 2013.This scheduleensuresthat all countries that are home to G-SIBswillhavebeen reviewedbeforethemiddleof 2013.ReviewsofAustralia,Brazil and Canadawill take place during thesecond half of 2013.TheBCBS is collaboratingwiththe International MonetaryFund (IM F)andWorld Bank toensure that itsscheduleis complementaryand non-duplicativetothe Financial SectorAssessment Program (FSAP) reviewprocess.2.2 Liquidity standardsunder Basel IIIAkey component of theBasel III frameworkis theintroductionof globalliquiditystandards.Solvency ii
  • 78. During the financial crisis, thebankingsystem experienced severe stressbecausemany banksdid not manage their liquidityin a prudent manner.Basel III‟sLiquidityCoverageRatio(LCR), is designed to promoteshort-term resilienceby ensuringa bank holdsadequatehighlyliquidassetstosurvive significant stresslastingfor one month.Theother standard, theNet StableFundingRatio (NSFR), is intendedtopromote a sustainablematurity structure of assetsand liabilitiesandtherebyavoid significant maturity mismatchesover longer-termhorizons.Tobetter understand thepotential effect of thesestandards, theBaselCommitteeon BankingSupervision (BCBS) agreed toput in placerigorousreportingprocessestomonitor the LCR and NSFR during anobservation period that beganin 2011.TheBCBS‟oversight body, theGroup of Central Bank Governors andHeads of Supervision (GHOS), requested in January 2012that theLCRrules text be clarifiedsothat the 100% threshold wouldbe a minimumrequirement in normal timesand bankswouldbe expectedtousetheirpool of liquid assetsduring the stressperiod, therebytemporarilyfallingbelow theminimum requirement.TheGHOSalsoaskedthe BCBStofinalise and publishrecommendationsbythe end of 2012toaddressspecific concernsregardingthepool of high-qualityliquid assetsaswell assomeadjustmentstothe calibrationof net cash outflowssoasto reflect theactual experienceduring the crisis.TheBCBS is workingtowardsfinalisingthe LCR bythe end of 2012,with a view to implementingit in January 2015.TheNSFR will be implementedin January 2018.2.3 Quantitative impact assessment of Basel IIIApart from monitoring the timelyand consistent implementationof BaselII/ II.5/III acrossmember jurisdictions,the BCBS isconductingasemi-annual monitoring exerciseto assesstheimpact of Basel III on arepresentativesample of institutionsin each member jurisdiction.Solvency ii
  • 79. Accordingtothemost recent results(asof 30June 2011), if changestothedefinition of capital and risk-weightedassetswereapplied withoutconsideringthetransitional arrangements,the averagecommon equityTier 1capital ratio (CET1) of Group 1banks wouldhavebeen 7.1%,higher than the Basel III minimum requirement of 4.5%.For theother banks(Group 2 banks), theaverage CET1ratio stood at8.3%.TheBCBS hasalsoestimatedthat thesum of profitsafter taxesand priortodistributionsduring the second half of 2010and the first half of 2011wouldcover about 70% of thecapital that the Group 1banksneed to raiseover thecoming six-year implementationhorizon tosatisfythe 7% targetfor CET1and the surchargefor G-SIBs.Meanwhile, for thesmaller Group 2banks, the capital shortfall to be metover the same horizon is much lessthan these banks‟profits.There is considerablevariation acrossindividual banks, soit is difficulttodraw firm conclusionsfrom the BCBSestimates.However, theaveragesmay suggestthat a proportionof the industry hasthecapacityto meet thenew capital targetsthrough earningsretentionand reduced distributionsover thetransition period.On theother hand, theestimated impact of theBasel III liquiditystandardsby the BCBS seemstosuggest theneed for banks tofurtheradjust their liquiditypositionsduring theobservation period, forexample, through lengtheningtheterm of their fundingor restructuringbusinessmodels whicharemost vulnerableto liquidityrisk in periodsofstress.Assuming banksweretomake no changestotheir liquidityrisk profile orfundingstructure, asof June2011, the weightedaverageLiquidityCoverageRatio(LCR) for Group 1bankswouldhave been 90% while theweightedaverage LCR for Group 2banks was83%.TheweightedaverageNet StableFunding Ratio (NSFR) was94% forboth Group 1and Group 2banks.Banks haveuntil 2015to meet theLCR standard and until 2018to meettheNSFR standard.Solvency ii
  • 80. TheBCBS is currentlyinvestigatingthe casefor modifying a few keyaspectsof the LCR but will not materiallychangethe frameworksunderlying approach.TheBCBS will finaliseand subsequentlypublish itsrecommendationsintheseareasbythe end of 2012.2.4 Strengthening risk managementRiskmanagement functionsarethe first lineof defence in enhancingtheresilienceof financial institutions.In thisregard, theFSB, SSBs and national authoritiesare makingcontinuouseffortsto strengthenriskmanagement practicesthroughincreasedsupervisoryexpectations,enhancementsof risk disclosures(market discipline), and additional guidancefor national authoritiesandfinancial institutions.Acrossthe FSB member jurisdictions,supervisory expectationsfor riskgovernancehave increased, particularlyfor SIFIs, asthis wasan areathat exhibitedsignificant weaknessesin many financial institutionsduring theglobal financial crisis.Totake stock of changesunderwayin risk governancepractices, theFSB launcheda thematicreview on risk governancein March2012.Thepeer review will alsoassessprogressin addressingthe weaknessesin risk governance identified during the crisisat both nationalauthoritiesand at firms.Theinclusionof a firm-levelsurvey in thepeer review reinforcesthemessagethat a firm‟s board and senior management are responsibleformanagingitsrisk, while supervisorsareresponsiblefor assessingwhethera firm‟s risk governance framework and processesareadequate, appropriateand effectivefor managing the firm‟s risk profiles.Thepeer review report will be publishedin the first half of 2013.In addition, theFSBhosted a roundtableon risk disclosuresby financialinstitutionsin December 2011to encourage theprivate sector tojointlytake forward development of principlesand of leadingpracticedisclosuresthat will be relevant and informativegivencurrent marketconditionsand risks.Solvency ii
  • 81. Given the importance to market confidenceof useful disclosure byfinancial institutionsof their risk exposuresand risk managementpractices,the FSB facilitatedtheformation of a private-sector EnhancedDisclosureTask Force(EDTF) in May 2012.Theprimary objectivesof theEDTF areto:(i)Develop principlesfor enhanceddisclosures, basedon current marketconditionsand risks, includingwaysto enhancethecomparability ofdisclosures;and(ii)Toidentify leadingpractice riskdisclosures.Therecommendationsof theEDTF areexpected to be reportedtotheFSB and published in October 2012.TheBCBS issuedin May 2012a consultativedocument that set out arevisedmarket riskframeworkand proposed a number of specificmeasuresto improve tradingbook capital requirements.Theseproposalsareaimed at fundamentallystrengthening capitalstandardsfor market risk, an area whereweaknessesbecame apparentduring thecrisis.Thekey elementsof theproposalsinclude:a more objectiveboundarybetweenthetradingbook and bankingbook that materiallyreducesthescopefor regulatoryarbitrage;and the introduction of the expectedshortfall asa risk measure that better captures“tail risk” comparedtovalue-at-risk.TheBCBS alsoissueda consultativepaper on The InternalAuditFunctionin Banksin December 2011, whichprovidesguidancetohelpassessthe effectivenessof a banksinternal audit function.This is a revision of the BCBS‟2001document InternalAudit in BanksandSupervisor‟sRelationship withAuditors.Theproposed guidancereflectsdevelopmentsin supervisoryandbankingpracticesand incorporateslessonsdrawn from thefinancialcrisis.Tostrengthenliquidityrisk management practicesof collectiveinvestment schemes(CIS), theInternational Organisationof SecuritiesCommissions(IOSCO) published in April 2012a consultationreportSolvency ii
  • 82. entitledPrinciplesof LiquidityRisk Management for CollectiveInvestment Schemes.ThesePrinciplesare intendedtobe usedby both the industryandregulatorsin assessingthe qualityof regulation and industry practicesrelatingtoliquidityrisk management for CIS.Thefundamental requirement is toensure that the degreeof liquiditymanaged by an open-ended CIS enablesit tomeet redemptionobligationsand other liabilities.Theconsultation report describeshow compliancewith this requirementcan be achieved.IOSCO alsopublishedin January 2012Principleson SuspensionsofRedemptionsin CollectiveInvestment Schemes,a report that providesacommon approach and standardsfor usein an exceptional casewhereCISface seriousliquidityproblems.National authoritieshave alsobeen making effortstostrengthentheriskmanagement practicesof financial institutionsin their jurisdictions.In particular, many jurisdictionsare enhancingtheir liquidityriskmanagement and stresstestingpracticesin linewiththe Basel III rulesand BCBSguidelines,such as:- In Canada, OSFI‟sfinal LiquidityGuideline (B-6) which isin linewith BCBSrequirementshasbeen in forcesinceFebruary 2012.Financial institutions‟implementationof theB-6 guidelinewill bereviewedduring Q2 2012through a cross-system benchmarkingreview /self-assessment.Financial institutionsalsoperiodicallysubmit liquiditydata relatedtoBCBSliquiditystandards.- In Hong Kong, thesupervisory guidelineon stresstesting hasbeenrevisedtoincorporatethe BCBS guidanceand the recommendationsfrom other international organisationstoaddressdeficienciesin thisarea that wererevealed bythe global financial crisis.Solvency ii
  • 83. Therevised guidelinewasissuedon 9 May2012.14Ending “Too-Big-To-Fail”TheG20is determinedto make sure that no financial institution is “toobig tofail” and that taxpayers donot bear the costsof resolution of anyinstitutionthat doesfail (and cannot be put intoinsolvencyfor reasonsof systemic stability).Tothisend, the G20Leadersendorsed at the CannesSummit the FSB‟scomprehensivepolicyframework, comprisinga new internationalstandard for resolution regimes,more intensiveand effective supervision,and requirementsfor cross-border cooperation and recoveryandresolution planningaswell as, from 2016,additional lossabsorbencyforthosebanksdeterminedasglobal systemically important financialinstitutions(G-SIFIsor G-SIBs).3.1 Improving the capacity to resolve firmsin crisisTheFSB KeyAttributesof EffectiveResolution Regimesfor FinancialInstitutions(“theKeyAttributes”) form an international standard thatsetsout the essential elementsthat all resolution regimesshould have toensure that national authoritiescan resolve financial institutionsin anorderly manner that doesnot exposetaxpayersto the riskof loss.FSBmembershavecommitted to an ambitiousschedule for bringingtheir resolution regimesin linewith this new standard and forimplementinga range of G-SIFI specificrequirements,including(i)Theestablishment of CrisisManagement Groups,(ii)Theelaborationof recoveryand resolution plans(RRPs),(iii)Theconduct of resolvability assessments,(iv)Theadoption of institution-specificcross-border cooperationagreements(COAGs); and(v)Theestablishment of cooperation arrangementswith therelevantjurisdictionsthat are hoststosystemic operationsof a G-SIFI but arenotrepresented on itsCMG.Solvency ii
  • 84. Theprogressmade todate on implementingtheG-SIFI frameworkincludesthe followingkeyelements:(i) Effective resolution regimesAself-assessment byFSB membersindicated that national resolutionregimesare not fullyconsistent withtheKeyAttributesin many FSBmember jurisdictions.However, reformsare underwayto align theregimesmore closelywiththeKeyAttributes.For example, the implementationof theDodd-FrankAct (DFA) in theUS, whichprovidesfor powersto resolvesystemically importantfinancial institutionsand requiresthepreparation of resolution plans,constituted an important steptowardsimplementationof the KeyAttributes.Likewise,the European Commission(EC)‟s adoption of proposed EU-widerulesfor bank recovery and resolution is critical for advancingconsistent reformsacrosstheEU.FSB membershavecommitted to undergoa first thematicpeer review ofresolution regimesin the second half of 2012whichshould provide afuller picture of the statusof national reform and progressinimplementingthe FSBstandard.(ii) CrisisManagement Groups(CMGs)CMGshave been establishedfor 24G-SIFIs.Wherea CMG is not yet established, substantiveaction is planned. CMGmembership includesthe prudential supervisor, central bank and,whereit is a separateauthority, the resolution authorityof thehomecountry; in some, the financeministry of thehome or host jurisdictionparticipatesin a restricted manner.Thecountries representedin the CMGsare generallythe sameasthosein theG-SIFI‟score supervisorycollege.Solvency ii
  • 85. Senior level engagement hasproved critical for advancing cooperationand resolution planningwork within CMGs.Afew CMGshavediscussed detailed resolution strategiesand started todevelop operational plans toimplement them.(iii) Recoveryand resolution plans(RRPs).Advancing more detailed CMG workon resolutionplanning, resolvability assessmentsand cooperationagreementshasproveddifficult without a clearlyarticulatedresolution strategy – thatis, thespecificationof a high level, strategic approach to how a firmwouldbe resolved.TheFSB hastherefore givenpriority tothe development - led by homeauthorities- of high-level resolution strategiesby September 2012.Such strategiesinclude “singleentry” or “top down” approaches,wherea group is resolved through interventionat thelevel of theholdingcompany; or “multiple-entryresolution” approacheswhereseparateresolution actionmay be taken at thelevel of subsidiaries.Thechosen resolution strategiesshould provide sufficient direction toCMGsfor them toundertake more detailed workon the development ofcooperationagreements,RRPs and resolvabilityassessments.For each G-SIFI, home authoritieshave committed to lead thedevelopment within the CMGsof resolution plansthat set out in detailhow theresolution strategiescould be put intooperation by theend2012.(iv) Resolvability assessmentsResolvability assessmentsshould help identify any remaining barriers toresolution.Solvency ii
  • 86. Theyshould alsoinform thedevelopment and/ or improvement of theresolution plan.Discussionsof resolvabilityassessmentsof G-SIFIs are at very earlystages,duein part tothefact that resolutionstrategiesneed first to bedeveloped beforetheir feasibility and credibility can be assessed.CMGsshould conduct resolvabilityassessmentsin Q1 2013,after thedevelopment of basicresolutionstrategiesfor all G-SIFIs.(v)Institution-specific cooperation agreementsNo institution-specific cooperationagreementsconsistent withtheKeyAttributeshave asyet been agreed or put in placebetweenthemembersof a CMG, largely becausethe development of a resolution strategy isseen asa prerequisiteto such an agreement and alsobecausedifferingtermsand conditionsfor information sharing acrossjurisdictionscomplicatecross-border cooperation.TheFSB hastherefore initiatedfurther work toexaminehowtoaddressexistingobstaclestothe exchangeof information, and todevelopminimum common termsand content for informationsharing acrossjurisdictions.Thesetermsand content should be reflectedin thecooperationagreementsto be put in placefor all G-SIFIs in early2013.(vi)Coordination with host jurisdictions with systemic G-SIFIoperationsEffectivecooperation should be establishedwith therelevant hostauthoritiesthat arenot includedin the CMGs,but that assessthe localoperationsof a G-SIFI assystemically important tothe local financialsystem.Solvency ii
  • 87. TheFSB isthereforealsoproposingtodevelop further guidanceforarrangementsand proceduresfor cooperation and informationsharingwith suchhost authorities.TheFSB identifiedseveral areaswherefurther workis necessarytoadvancerecovery and resolution planningand improve resolvability.TheKeyAttributesstate the need for theeffectivesegregationof clientassetsand prompt accessto segregatedclient fundsin resolution.Further workwill be undertakenon thesetopics, in coordinationwithIOSCO and the FSB Shadow Banking work stream.Tofacilitateassessmentsby the IMF and World Bank of resolutionregimesagainsttheKeyAttributes, theFSB is developing a draftassessment methodologywiththe assistanceof a draftingteamcomposed of resolution experts from FSB member jurisdictions,EUinstitutions,IAIS, CPSSand IOSCO, whohave the appropriatesectoralexpertise,and from the IMF, the World Bank and InternationalAssociation of Deposit Insurers(IADI), whohaveparticularexperiencein thedevelopment and useof assessment methodologies.Given the statusof the KeyAttributesas “umb rella” standards forresolution regimesfor all types of financial institutionsthat canpotentiallybe systemically-important in failure, themethodologywillincorporatesector-specificconsiderations.Thedraft methodology will be submittedto all SSBs in the second half of2012to help todeterminewhetherthemethodologyissuitableforassessingresolutionregimesfor different types of firms, includingFMIs,insurersand securitiesand investment firms.Thequestionnaire tobe used for the FSB‟sthematic peer review ofresolution regimeswill be basedon thedraft assessment methodologyandthe findingsfrom that review will be taken intoaccount whenthemethodologyis finalisedin 2013.Solvency ii
  • 88. 3.2 Improving the intensity and effectivenessof SIFIsupervisionTheFSB continued toreview progresstowardsimplementationof the 32recommendationsset out in the November 2010report IntensityandEffectivenessof SIFI Supervision (SIE recommendations) relatingtosupervisorymandates,powers,resourcesand practicesfor making thesupervision of financial institutionsmore effective.Themajorityof these recommendationshavebeen implementedor areunderway.Thecoming year will seea completion of thiswork,aswell asimplementationof additional recommendationsset out in the2011ProgressReport on Implementing the Recommendationson EnhancedSupervision.Theseinclude raisingsupervisory expectationsabout firms‟abilitiestocollect and processdata togive an accurate picture of their firm-widerisk exposure, promotingstrong risk management, and ensuring thatsupervisorshave adequateresourcestosupervise SIFIseffectively.While discussionsamong FSBmemberson increasingthe intensityofsupervision arerelatedto all SIFIs, theyare generallyfocused oninstitutionsthat are important for theglobal system (i.e. G-SIFIs).TheFSB‟s agenda for improving the intensityand effectivenessofsupervision is focused on four main areas:(i) Holdingsupervisorsto higher standards;(ii) Improving supervisorytools and methods;(iii) Enhancingtheeffectivenessof supervisorycolleges;and(iv)Improving firms‟ risk data aggregation capabilities.Solvency ii
  • 89. Asummary of progressin each of theseareasis discussed below.(i) Holding supervisors to higher standards:At the core of strengthenedsupervisoryframeworksare theminimumstandardsset out by the BCBSfor sound supervisorypractices.TheBCBS publishedin December 2011a consultativedocument on theenhancedCore Principlesfor EffectiveBankingSupervision(BCBSCorePrinciples).In developing the revised BCBSCore Principles,closeattentionwasgiventoaddressingmany of the significant riskmanagementweaknessesand other vulnerabilitieshighlightedin the last crisis.Final principlesare expected to be published in thefall 2012.Nationalauthoritieswill be assessedaspart of theIM F-WorldBank FSAPsagainst the enhanced BCBSCore Principles,thusraising thebar forsupervisors.(ii) Improving supervisory tools and methods:Sincethe beginningof 2012,the FSBhasbeen workingto improve itsunderstandingof risk appetiteframeworks,resourcesneeded to intensifySIFI supervision, firms‟businessmodels, and supervisory methodsusedtooversee tradingoperations.Discussionshave revealedthat(a)MostG-SIFIs have a risk appetitestatement but both firms andsupervisorshave difficultydeterminingitssuitability;(b)Whileresourcesat supervisoryauthoritieshave increasedsincethefinancial crisis,thepaceof increasehasnot been commensurate withhigher regulatory and supervisorydemandsplacedon supervisors,suchassupervisorycollegesand CMGs;Solvency ii
  • 90. (c)Supervisoryapproachestounderstandingbusinessmodels vary inpart dueto resourceconstraintsand lack of expertise;and(d)Supervisorsseeoperational risk asthenext big risk whichcannot besolved entirelyby higher capital.While progressis beingmade in theseareas,more work is needed.TheFSB will be developingrecommendationson how to ensuresupervision of these areasis more intense, more effectiveand morereliableto promotefinancial stability.(iii) Enhancing the effectiveness of supervisory colleges:As recommended bytheSIE report, theBCBS and IAIS arestudyinghow toimprove theoperationsof supervisory collegesin order toensurea more rigorousand coordinatedassessment of the risksfacingtheG-SIFIs.In the second half of 2012,theFSB will alsobediscussingthemeanstoenhancethe effectivenessof supervisorycolleges, in particular for G-SIFIs.(iv)Improving firms‟ risk data aggregation capabilities:TheBCBS is actingon the SIE recommendation to develop supervisoryexpectationsfor firms‟risk data aggregation capabilities.Apaper settingout principlesfor effectiverisk data aggregation and riskreportingis under development.Theprincipleswill be finalisedby the end of the year and G-SIBs areexpectedto implement theseprinciplesby thebeginningof 2016,whichis the start of thephase-inperiod for theaddedlossabsorbencyrequirementsfor G-SIBs.Solvency ii
  • 91. Supervisorswill start discussingimplementation with seniormanagement of thesefirms from early2013and ensure that theG-SIBsdevelop strategiestomeet the principlesby early2016.3.3 Extending the SIFI frameworkAfter thecomprehensiveframeworkfor addressingthe “too-big-to-fail”problem wasagreedat the CannesSummit, the G20Leaders asked theFSB in consultationwith the BCBS, to extend expeditiouslythe G-SIFIframeworktoD-SIBs.TheIAIS wasasked with the development of an assessmentmethodologyfor theidentification of global systemically importantinsurers(G-SIIs) and to continue itswork on a common frameworkforthesupervisionof internationallyactiveinsurancegroups(ComFrame).TheG20 Leadersalsocalledonthe FSB topreparemethodologies toidentify global systemically-important non-bank financial entities(non-bank G-SIFIs) by end-2012in consultation withIOSCO.3.3.1 Domestic systemically important banksTheFSB, in consultationwiththe BCBS, submitted to the G20FinanceMinistersand Central Bank Governors inApril 2012a progressreport onthe modalitiestoextend the G-SIFI framework to D-SIBs.TheG-SIB framework assessesthe externalitiesfrom a globalperspective(i.e., wheredistressor failurewoulddisrupt theglobalfinancial system), makingno distinctionsabout impactson individualjurisdictions.Thepolicyframework envisaged for D-SIBs wouldtake the perspectiveof individual jurisdictions.That is, it addressesthe impact of failure associatedwiththelocalpresenceof a bank - whethera national or an internationally-activebank– in a given jurisdiction.TheD-SIB framework beingconsideredwouldbe based on assessmentsbylocalauthorities,whoare best placedtoidentify thebankswhicharesystemically-important relativeto thedomestic economy.Solvency ii
  • 92. An important aspect of a D-SIB framework relatestoits compatibilitywith the G-SIB framework,to ensure that adequate and consistentincentivestructuresare in placeat the domesticaswell asat theinternational level.Theprinciplesfor D-SIBs being consideredthereforeseek toestablishaminimum framework that wouldensurecompatibilitywiththe G-SIBframework,addressthecrossborder externalitiesthat the failure of a D-SIB may nonethelesspose, and preservea level playing field within andacrossjurisdictions.Theprincipleswouldincludeguidelinesfor national authorities to assessthesystemic importanceof banksin a domesticcontext.TheBCBS is developinga set of principlesasa common frameworkforD-SIBs, includingon theissuesof compatibility withthe G-SIBframework,home-hostcoordination, and the instrumentsandcomposition of additional lossabsorbency for D-SIBs.TheFSB and BCBSwill submit theoutcome of this worktotheG20FinanceMinistersand Central Governorsmeeting in November 2012.3.3.2 Systemically important insurersTheIAIS hasmade progressin developing a proposed assessmentmethodologyfor identifying G-SIIs.Aconsultationpaper wasissued in May2012on the proposed IAISassessment methodologyfor identifying G-SIIs.Thepaper includedsome initial thoughtson thepolicy measuresthatshould applytoG-SIIs and further development of potential policymeasuresis underway.Potential measuresincludeenhanced supervision, improved resolvability,structural measures,higher lossabsorbencyand restrictionson certainactivities.Aconsultationpaper on proposed policymeasureswill beissuedin September 2012.TheIAIS will deliver to the G20inApril 2013a consolidatedpaper on theassessment methodologyand thepolicymeasures.Solvency ii
  • 93. At that time, the FSB and national authorities,in consultationwiththeIAIS, will determinethe initial cohort of G-SIIs.Meanwhile, IAIS‟ work on developing a common frameworkforinternationallyactiveinsurancegroups(ComFrame) is progressinganditsdevelopment phaseis expected to becompleted in 2013.3.3.3 Systemically important non-bank financial entities23In responsetothe request of the G20Leaders,the FSB, in consultationwith IOSCO, is preparing methodologiesfor identifying non-bank G-SIFIs whosedistressor disorderlyfailure wouldcausesignificantdisruption to the widerfinancial system and economic activityat theglobal level.This is in linewith the methodologies developedfor identifying G-SIBsand alsowith that of G-SIIs issued for consultation by the IAIS in May.In developing the methodologies,the FSB will focuson detaileddesignissuessuch asthe scope of application, applicabilityof materialitycriteria, modusoperandi and data availability.At thenational level, meanwhile, theUSFinancial Stability OversightCouncil(FSOC) publishedin April 2012the final rule and theinterpretiveguidanceregardingthe processand criteria tobeused for designatingnon-bank financial institutionsfor consolidatedsupervision bytheFederal Reserve System and enhanced prudential standardsastheirmaterial financial distress– or thenature, scope, size, scale,concentration, interconnectedness, or mix of its activities– could poseathreat tothe US financial stability.Basedon thepublishedrule, the FSOC could make the first of thesedesignationsduring 2012.Strengthening the oversight and regulation of shadow bankingAt the CannesSummit, the G20Leadersagreedtostrengthen theoversight and regulation of the shadow bankingsystem, and endorsedtheFSB‟sinitial recommendationswitha workplan tofurther developthem in 2012.Solvency ii
  • 94. At the request of the G20, a progressreport on shadowbankingwassubmittedtotheG20 FinanceMinistersand Central Bank GovernorsinApril 2012.The“shadow banking system” whichcan be broadly described as“credit intermediationinvolving entitiesand activitiesoutsidetheregular banking system” hasbecome an integral part of themodernfinancial system that has an important rolein supportingtherealeconomy.However, the shadow banking system can alsoposeriskstothefinancialsystem, on itsown and through itslinkswith the regular banking system.TheFSB issuedinitial recommendationsin itsOctober 2011reportShadowBanking: StrengtheningOversight and Regulation to addresspotential risks in theshadow bankingsystem.It hasadopted a two-prongedapproach.First, the FSB will enhancethe monitoring frameworkthroughcontinuing its annual monitoring exerciseto assessglobal trendsandrisks, with more jurisdictionsparticipatingin the exercise.Second, the FSBwill develop recommendationsto strengthen theregulation of theshadowbanking system, wherenecessary, tomitigatethepotential systemic risks withspecificfocuson thefive areasexplainedin section 4.2.An initial integratedset of policy recommendationswill be developed bytheend of 2012.Aproperly structured and regulatedshadowbanking sector can makethefinancial system more robust, efficient and diversified; hence, thereforms in this area will seekto mitigatesystemic riskswhile preservingthescope for realisingthose benefits.4.1 Strengthening oversight of the shadow banking systemTheFSB hasset out recommendationsfor effectivemonitoring ofshadowbankingin itsOctober 2011Report and alsocommittedtoSolvency ii
  • 95. conduct annual monitoringexercisestoassessglobal trendsand risksintheshadowbankingsystem.Theglobal monitoring exerciseconductedin 2011coveredeleven FSBmember jurisdictionsand theeuroarea.Thecoverageof the2012monitoring exercise will be extended to covertheremainingFSB jurisdictions.Theannual monitoring exerciseis expectedto facilitatethenationalauthorities‟assessment of shadow bankingrisks based on the FSBrecommendations, and thesharing of experiencesamong authoritiesinorder to highlight trends in shadowbankingthat are of relevancetothestability of the global financial system.In addition toparticipation in the FSBannual monitoring exercise, a fewjurisdictionshave alsotaken stepstoenhancethemonitoringof shadowbankingin their jurisdictions.For example:- In Australia, the Reserve Bank ofAustralia (RBA) will provideanannual update on theshadowbankingsystem tothe Council ofFinancial Regulators(CFR).This should identify anyemerging risks,whichmay lead tochangestoregulatoryarrangementsif that is warranted.- In Canada, the Officeof theSuperintendent of Financial Institutions(OSFI) hasinitiated workto examineCanadianbanks‟interactionswith shadow bankingentities, in the context of the Canadianmarketplace.TheBank of Canada is alsoexpandingtheresourcesdevotedtoassessingrisks and vulnerabilitiesin the financial system, includingtheshadowbankingsystem.It is developinga shadowbankingmonitoring framework incoordinationwithother federal and provincial authorities,focusingSolvency ii
  • 96. on thechannelsthrough which shockscan be propagated throughthefinancial system.- TheEuropean Central Bank (ECB) hasproposedthecreation of anEU Central Databaseon Euro Reposasa joint effort by publicauthoritiesand the financial industry.This is toaddressthelack of granular data on therepomarket in theeuroarea, withthe aim to allowbetter monitoring from a financialstability perspective.- In the US, FSOC providesUSregulatorswitha surveillancemechanism and allowsfor a flexibleapproachtoaddresspotentialrisksin the shadow bankingsystem.Under the Dodd-Frank Act (DFA), FSOC hasthediscretiontosubject anynon-bank financial company to a detailed review if thecompany could posea threat to USfinancial stability.That companywouldthenbe subject toheightened prudentialstandards.TheDFA requiresthat FSOC‟sAnnual Report addresssignificantfinancial market and regulatory developments, along withanassessment of developmentson thestability of thefinancial system;potential emergingthreatsto financial stability; and,recommendationstoenhancethe integrity, efficiency,competitiveness.As a result of DFA, the SEC expanded itsregulatoryscope and isnow collectingadditional informationthrough Form PF on hedgefundsand privateequityfundsthat haveat least$150m in assetsunder management tobetter monitor their activities.Solvency ii
  • 97. 4.2 Strengthening regulation of the shadow banking systemBasedon theinitial recommendationsand work plansset out in theOctober 2011Report, five workstreamshavebeen launchedtoadvancetheworktodevelop proposed policyrecommendations.(i) Banks‟ interactions with shadow banking entities:With the objectiveof mitigatingthe spill-overeffectsbetweentheregularbankingsystem and theshadowbankingsystem, the BCBSwill propose,whereneeded, to regulate banks‟interactionswithshadowbankingentitiesbyJuly 2012.It is currentlyreviewingthe consolidationrulesfor prudential purposes;limitson thesize and nature of a bank‟sexposurestoshadow bankingentities;risk-based capital requirementsfor banks‟exposuresto shadowbankingentities;and the treatment of reputational risk and implicitsupport.(ii) Money market funds(MMFs):IOSCO wastasked todevelopby theautumn 2012policyrecommendationstoreduce thesusceptibility of MMFsto “runs”.IOSCO published in April 2012a consultationreport that providesananalysisof the systemic importanceof MMFsand their keyvulnerabilities,includingtheir susceptibilityto runs, and setsoutpossiblepolicy optionstoreinforcethe soundnessof MMFsand toaddresstheidentifiedsystemic vulnerabilities.Thepossiblepolicyoptionsinclude:a mandatorymove from constant tovariablenet asset value(NAV); enhancement of MMF valuation andpricingframework;enhancement of liquidityrisk management; andreduction in the importanceof ratingsin theMMF industry.Theseoptionsare not mutuallyexclusiveand some may be consideredin combination. IOSCO envisagesusing theoutcomesof theSolvency ii
  • 98. consultation to narrow down thepolicy optionsintopolicyrecommendations.(iii) Other shadow banking entities:An FSBworkstream is developing policy recommendationsbySeptember2012,whereappropriate, on theregulation of shadowbankingentitiesother than MMFstomitigate their systemic risks.The Workstream has completed a categorisation and data collectionexercise for a wide range of non-bank financial institutions (or OtherFinancial Intermediaries(OFIs)).After castingthe net widethrough thisexercise,the Workstream isadoptinga two-stepprioritisation processto narrow thescope to certaintypesof entitiesthat may need policy responses.Thefirst step is todevelop a list of entitytypes (filtered list) for closerscrutiny based on national experience(i.e. authorities‟judgements) andsize;thesecond step entails the detailedassessment of theshadowbankingrisk factors(e.g. maturitytransformation, liquiditytransformation and leverage) with respect to each entitytype in thefilteredlist.TheWorkstream planstoanalysethefilteredentitiesbylookingat theireconomicfunctionsrather than legal namesor forms.In thisway, theWorkstream aimsto develop potential policyrecommendationsthat can be applied acrossjurisdictionsto all entitiesthat have thesame economic function, while taking account of theheterogeneityof economic functionscarried out by different entitieswithin thesame sector.(iv) Securitisation:Toassessand align the incentivesassociatedwithsecuritisation toprevent it creatingexcessiveleveragein the financial system, IOSCO, incoordinationwiththeBCBS, is examiningtheSolvency ii
  • 99. (i)Retention requirementsand(ii)Measuresthat are aimed at enhancing transparencyandstandardisationrelatedto securitisation.As the first phaseof itswork, the European Commission (EC) and theUS Securitiesand ExchangeCommission (SEC) staff have completed acomparison of securitisationrulesin the EU and US.Buildingon thiswork, IOSCO hasconductedan analysis of globalregulatoryand industry initiativeson risk retention, transparencyandstandardisation, aswell asthe identificationand assessment of materialdifferencesin regulatory/ industry approachesand their impact.Draft policy recommendationsare set out in a consultationreportpublishedin June 2012.29Based on thecommentsreceived on theconsultation report, IOSCO will publishthe final report in late2012.(v) Securitieslending and repos:An FSBworkstream is examiningthe regulationof secured financingcontractssuch asrepos, and securitieslendingfrom a financial stabilityperspective, by theend of 2012.TheWorkstream published inApril 2012its interim report whichcoversan overview of the securitieslendingand repomarkets;key driversof thesecuritieslendingand repomarkets;itslocationwithin the shadowbankingsystem; overview of existingregulatory framework;and financialstabilityissues.Thefinancial stabilityissuesidentified by the Workstream include(i)Lack of transparency,(ii)Pro-cyclicalityof system leverageand interconnectednessthroughvaluation, haircutsand collateralre-use,(iii) Other issuesassociatedwith re-useof collaterals,(iv) Potential risksarisingfrom fire-saleof collateral assets,Solvency ii
  • 100. (v) Potential risksarisingfrom securities lendingactivities,(vi) Shadowbankingthrough cashcollateral reinvestment, and(vii) Insufficient rigour in collateral management and valuation.Basedon itsmapping of the marketsand identification of financialstability issues,the Workstream will develop policyrecommendationsasnecessaryby theend of 2012.In addition tothe policy-making work at theFSB-level, somenationaland regional authorities have embarkedon initiativesto addresspotential risks arisingfrom theshadowbankingsystem in theirrespectivejurisdictions.For example:- In Australia, theAustralian Securitiesand InvestmentsCommission(ASIC) will be producingan internal report by 30 June 2012onMMFs.Any further workin thissectorwill be informed by theinternalreport and itsconclusionsregarding whether or notappropriateregulation is in place.- In the EU, the EC issued in March2012a Green Paper on ShadowBankingthat drawsfrom the FSB‟s October 2011report. Thepapertakesstock of current developmentsand presentson-goingreflectionson thesubject togather viewsfrom thestakeholders,inorder toenabletheEC to actively respond and contributeto theglobal debate.- In the US, authoritieshave taken manystepsto addresspotentialsystemic risksto financial stability emanatingfrom the shadowbankingsystem.In additiontothe establishment of FSOC and itsauthoritytodesignatea non-bank financial firm for prudential supervision, theUS hastaken policy measuresthat seek toaddressrisksposed bymoneymarket funds, privateinvestment funds,securitisationactivitiesand the tri-partyrepomarket.Solvency ii
  • 101. For example, theSEC adopted new rules in February 2010to increasetheresilienceof MMFstoeconomic stresses, and reducethe risks ofrunsbytighteningmaturityand credit qualitystandardsand imposingnew liquidityrequirements.Thenew rules includeprovisionsto: improve liquidity, credit qualityanddisclosure,and require periodicstresstests.TheDFA imposesnew requirementsrelatingtoasset-backedsecurities,includingthosefor risk retention, disclosure, and conflictof interest.Creating continuouscore markets - OTC derivatives reformsIn September 2009in Pittsburgh, the G20Leadersagreedthat allstandardisedOTC derivativecontractsshould be traded on exchangesorelectronic tradingplatforms, whereappropriate, and clearedthroughcentral counterparties(CCPs) by end-2012at thelatest;OTC derivativecontractsshould be reportedtotrade repositories(TRs); and non-centrallycleared contractsshould be subject tohigher capitalrequirements.The FSB published a report, Implementing OTC Derivatives MarketsReforms, in October 2010 that set out 21 recommendations to addresspractical issuesin implementingthe G20Leaders‟commitments.TheFSB‟s OTC DerivativesWorking Group hasbeen monitoring theimplementationof theOTC derivativesmarketsreforms, with reportstotheFSB every six months.In October 2011, the FSB published itssecond progressreport on theimplementationof OTC derivativesreform, cautioningthat, withonlyjust over one year until the end-2012deadlinefor implementingtheG20commitments,few FSBmembershad thelegislationor regulationsinplacetoprovidetheframeworkfor operationalisingthe commitments.Sincethen, asnoted in the FSB‟sthird progressreport publishedin June2012,encouragingfurther progresshasbeen made in settinginternationalstandards, the advancement of national legislationandSolvency ii
  • 102. regulation by a number of jurisdictionsand practical implementationofreforms tomarket infrastructuresand activities.Thereport concludesthat all jurisdictionsand marketsneed toaggressivelypush ahead toachieve full implementationof marketchangesby end-2012to meet the G20 commitmentsin asmany reformareasaspossible. Jurisdictionshave sufficient information aboutinternational standardsand policiesto put in place the neededlegislationand regulation.Theyshould do sopromptly, and in a form flexibleenough torespond tocross-border consistencyand other issuesthat may arise.Broadly speaking, the jurisdictions currently with the largest markets inOTC derivatives– the EU, Japan and the US – are the most advanced instructuring their legislativeand regulatoryframeworks.Theyexpect tohaveregulatory frameworksin placeby end-2012andpractical implementationwithintheir marketsiswellunderway.Other jurisdictions are generally less advanced although, as the thirdprogress report indicates, progress has been made by many of them,particularlywithrespect to central clearingand reportingtoTRs.Thedevelopment of implementingregulationstorequire exchangeorelectronic platform trading, whereappropriate, is generallylessadvanced.National implementationof capital requirementsfor exposurestoCCPsandmargining requirementsfor non-centrallycleared contractsisawaitinginternational principlesthat arecurrentlyunder development.One reason for the slowertimetablesin some jurisdictionshasbeen thatauthoritieshad been waitingfor the keyelementsof the regulatoryframeworksin theEU, Japan and theUS to be finalised beforeputtingtheir ownlegislationin place,in an effort to be consistent withtheseframeworks.Additionally, some jurisdictionshavesought greater certaintyabout theapplication of international principlesand safeguardsto cross-borderfinancial market infrastructure,includingCCPs and TRs, soasto makeSolvency ii
  • 103. an informeddecision about the appropriate form of marketinfrastructurefor their jurisdiction.SincetheOctober 2011progressreport, SSBshavemade significantprogressin developing international policies,notably:- CPSSand IOSCO issued thePrinciplesfor FMIs(PFMIs)in April2012. These principles,whichharmonise, strengthen and replacethepreviouslyseparatesetsof principlesfor different typesof FM Is,arean important milestone in the global development of a sound basisfor central clearingof all standardised OTC derivatives.- IOSCO published itsReport on Requirementsfor MandatoryClearingin February2012, providingimportant guidanceforjurisdictionson the processfor settingthe scope of central clearingrequirements.- CPSSand IOSCO published in January 2012a Report onOTCderivativesdata reportingand aggregation requirements,recommending that TRs implement measuresto provide authoritieswith effectiveand practical access.- IOSCO published itsFinal Report on International StandardsforDerivativesMarket Intermediary Regulation in June 2012, whichrecommendshigh-level international standardsfor the regulationofmarket participantsthat are in the businessof dealing, making amarket or intermediatingtransactionsin OTC derivatives.Additionally, the Committeeon the Global Financial System (CGFS)published in November 2011a report Themacrofinancial implicationsofalternativeconfigurationsfor accesstocentral counterpartiesin OTCderivativesmarketsthat analysestheimplicationsfor financial stabilityofthealternativearrangementsfor accessto CCPs (such asthrough largeglobal or smallerregional or domestic CCPs) and assessesthepotentialtrade-offsinvolved.Solvency ii
  • 104. IOSCO published in January 2012additional analysis of thecharacteristicsof different types of organisedtrading platforms,followingon from itsFebruary 2011report.International workstreamsare alsoprogressingrapidlyto developframeworksfor a global LEI (seesection7.1); guidanceon resolution ofCCPs(seesection 3.1);capital adequacyrules for exposurestoCCPs;international standardson margin requirementsfor non-centrallyclearedderivatives;and work on regulatoryaccessto data from TRs.In January 2012, the FSB identifiedfour safeguardsfor a resilient andefficient environment for central clearing, on whichsubstantial progressshould be made bymid-2012tosupport national authoritiesin decidingwhetherto rely on domesticor global clearinginfrastructure tomeet theG20commitment to centrallyclear all standardisedOTC derivatives.Substantial progresshas nowbeen made, through SSB workstreamsandotherwise,toprovidethesesafeguardsand thusallowauthoritiesto maketheir decisions.Thesafeguards, and the stepstaken to achievethem, are:(i)Fair and open accessbymarket participantsto CCPs, based ontransparent and objectivecriteria (addressedwithin thePFMIs);(ii)Cooperativeoversight arrangementsbetweenall relevant authorities,both domesticallyand internationallyand on either a bilateral ormultilateral basis, that result in robust and consistentlyapplied regulationand oversight of global CCPs (addressed asa minimum standard throughtheresponsibilitiesfor authoritiesset out in the PFMIsand in practicethrough individual cooperativeagreementsin place or in development forCCPs);(iii)Resolution and recovery regimesthat ensure thecore functionsofCCPsare maintained during timesof crisisand that consider theinterestsof all jurisdictionswherethe CCP is systemically important(CPSSand IOSCO planto issuein Julya consultation paper on theapplication of the KeyAttributesof EffectiveResolution RegimestoCCPsand other FMIs);and(iv)Appropriate liquidityarrangementsfor CCPs in thecurrenciesinwhichtheyclear(addressedwithinthePFMIsand through conclusionsSolvency ii
  • 105. of the Economic ConsultativeCommitteeof theBank for InternationalSettlements(BIS)).TheFSB, through itsOTC DerivativesWorkingGroup, seeksto identifyanyoverlaps,gapsor conflictsin national frameworksor implementationthat might compromisethe achievement of theG20 commitments,particularlywherethere may be a risk that suchissueswill not besatisfactorilyresolved through existing bilateral or multilateral channels.Additionally, the FSB hasestablishedthe OTC DerivativesCoordinationGroup, comprisingthe chairs of the BCBS, CGFS, CPSS, IOSCO and theFSB, to discusson a regular basisthe coordinationof internationalworkstreamson OTC derivativesreforms.Theprogressachievedto dateis contributing to thebroader G20 goalsofimprovingtransparency, mitigatingsystemic risk and protectingagainstmarket abuse.This is an important part of FSB‟sbroader effortsto end “toobig tofail”andtosupport continuouslyopen markets.Toassist in doing so, the FSB will seektofurther improve data and othersurveyinformation on theextent to whichOTC derivativesare in practicestandardised, centrallycleared, traded on organisedplatformsandreportedto TRs.For thenext progressreport, the FSB intendsto put additional focusonthereadinessof infrastructuresto providecentral clearing, platformtradingand reportingof OTC derivatives,the practical abilityof industrytomeet the requirementsand theremainingstepsfor the industrytotake.At the Cannes Summit, the G20 Leaders requested IOSCO to assess thefunctioning of credit default swaps (CDS) markets and the role of thosemarketsin price formation of underlying assets.In responsetothe G20request, IOSCO hasprepared a report thatanalysestheCDSmarketsasa whole, includingboth corporate andsovereign CDSmarkets(prioritisingsovereignCDSmarkets) andencompasses:Solvency ii
  • 106. - An examinationof existingresearch on thefunctioningof CDSmarkets,notablyinformation about thetrading, pricingand clearingof CDS;- Thenature of the CDSmarkets,e.g. type or level of volatilityandliquidityand the linksto the cost of funding; and- Recent experience with the functioning of the CDS markets, e.g. theeffect of a 50% write down on Greek debt triggering or not triggeringa default for CDSpurposes.Creating continuouscore marketsStrengthening and converging accounting standardsAt the CannesSummit, G20Leadersreaffirmed their objectiveto achievea singleset of high qualityglobal accounting standardsand meet theobjectivesset at theLondon summit in April 2009, notablyasregards theimprovement of standardsfor the valuationof financial instruments.Theycalled on the InternationalAccounting StandardsBoard (IASB) andtheFinancial Accounting StandardsBoard (FASB) tocompletetheirconvergenceproject and requested a progressreport at the G20FinanceMinistersand Central Bank Governorsmeeting inApril 2012.Theyalsolooked forward tothe completionof proposalstoreform theIASB governanceframework.Nearlyall FSB member jurisdictionshave either adopted IASB standards(International Financial Reporting Standards - IFRS) or haveprogrammesunderwaytoconverge with, or consideradoptionof, IFRSbyend-2012.TheUS SEC continuestoworktowarddetermining whether toincorporateIFRSintothe financial reportingsystem for USissuers.Foreignprivate issuersin the US arealreadyallowedto followIFRS.As requestedby theG20 Leaders,a joint update report from the twostandard setterswasprovided to theFSB and tothe G20FinanceMinistersand Central Bank Governors inApril 2012.Solvency ii
  • 107. - While important improvementstotheir standardson financialinstruments‟fair valuesand off-balancesheet entitieswerefinalisedin 2011, the convergenceprocessistakinglonger than initiallyexpectedin some areas,such asclassification, measurement andprovisioning.Also, the Boards are not addressing hedge accounting issues jointly.At the Cannes Summit, the FSB encouraged the Boards to redoubletheir effortstoseek converged standardsin these important areas.- While delays have taken place, theIASB and FASB are makingprogresson projectstoconverge their standardson financialinstruments,includinga joint expected lossimpairment(“provisioning”) approach and a more converged approachtoclassificationand measurement.Consistent withearlier FSB recommendations, it will be importantthat the IASB and FASB final standard on expected lossimpairmentresult in improved provisioningpracticesthat will incorporateabroader range of available credit information than existingprovisioningrequirements,soasto recognisecredit lossesin loanportfoliosat an earlierstage.- The IASB and FASB will conduct further public consultations in thesecond half of 2012, and expect to issue final converged standards ina number of keyareasby mid-2013.ThetwoBoardshave extended certain project target completiondatesin order toallowsufficient time for extensiveoutreachandpublic comment onthe largenumber of plannedmajor ExposureDrafts, and for theBoards toreflectthat feedbackin high-qualityfinal standards.TheFSB supportsthe effortsof the IASB and FASB toachieveconvergencetoa globallyacceptedset of high-qualityaccountingstandardsand urgesthem toissuefinal converged standardson keyprojectsbytheir expectedtimeframe of mid-2013.Solvency ii
  • 108. Thenetting/ offsettingof derivativecontractsand other financial assetsand financial liabilitiesis another area wherethe FSBhasexpressedconcerns.In thiscase,different approachesresult in significant differencesin totalassetsand/ or total liabilitiesin balancesheetsof largefinancialinstitutions.After consideringthecommentsof stakeholdersthe Boardsdecidedtomaintaintheir current different offsettingaccounting modelsbut toimproveand converge relateddisclosurerequirements.After theCannesSummit the Boardsissued in December 2011newrequirementsfor common disclosuresabout grossand net positionsforderivativesand other financial instruments.This followedthe Boards‟issuanceof a joint proposal in January 2011ona converged accountingapproach to balancesheet netting.However, instead of supporting the joint 2011 proposal, commentersfrom the US generally supported the current FASB netting rules andthose using IFRS generally supported current IASB rules, with manyinvestorsseeking both grossand net information.Derivativesdealer banks, both insideand outsidethe US, generallywantedthe FASB (net) accountingapproach in order to avoid a verysignificant grossing-up of their balancesheets.TheFSB noted that differencesin theoffsetting/ nettingaccountingstandardswouldadverselyaffect the effortsto develop an internationallycomparable leverageratiofor capital purposes.However, from a bank supervisoryperspective,there may bemoreconvergencefor theBasel III leverageratiopurposethan is firstapparent.While the IASB and FASB havedecidedtomaintaintheir differentaccountingrulesfor netting/ offsetting, theFASB nettingapproach andthenetting approach that will be carriedforwardto the BaselIII leverageratio are similar in their effect becauseboth recognisenetting/ offsettingfor derivativesbased on legallyenforceablemasternettingagreementsSolvency ii
  • 109. without requiring theintent or abilitytonet in thenormal courseofbusiness.Followinga request at the CannesSummit, reforms wereannounced inFebruary2012bythe IFRSFoundation (IFRSF) Trusteesand theIFRSFMonitoring Board to improvethe governanceof theIASB.Theseincludeinternal organisational changesaswell asreformsthat seektoenhancethe involvement of keystakeholders,includingthosefromemergingmarket economies,and improve thetechnical dialogueof theIASB withmarket regulators, investorsand prudential authorities. Theinternal changesand reformsarebeing implementedin a manner thatwill enhancetheIASB‟sefficiencyand effectiveness.TheIASB provided a report on thesegovernance reformstothe G20FinanceMinistersand Central Bank Governorsin April 2012.7. Creating continuouscore markets– Other market reforms1. Building a common legal entity identifierAt the CannesSummit, the G20Leaderssupported thecreation of a globalLEI which uniquelyidentifiesparties to financial transactions,and calledontheFSB totake thelead in helpingcoordinateworkamong theregulatorycommunity to prepare recommendationsfor a governanceframeworkfor such a global LEI that isconsistent withthepublicinterest.Tomeet that request, theFSB hasprepared a report (LEI Report)containingrecommendationstoimplement a global LEI system.Theglobal LEI system wouldcontributeto and facilitatemany financialstability objectives,including:improved risk management in firms;betterassessment of micro and macro-prudential risks;facilitationoforderlyresolution;containingmarket abuseand curbing financial fraud;andenablinghigher qualityand accuracyof financial data overall.It wouldmitigateoperational risks withinfirms by reducingtheneed fortailoredsystems toreconcilethe identificationof entitiesand to supportaggregation of risk positionsand financial data, whichimposesubstantial deadweight costsacrosstheeconomy.Solvency ii
  • 110. It wouldalsofacilitatestraight-through-processing.TheLEI Report contains35recommendationsfor thedevelopment andimplementationof theglobal LEI system.Theserecommendationsare guidedby a set of “Global LEI SystemHigh Level Principles” whichset out theobjectivesthat thedesign of aglobal LEI system must meet.Thebroad goal of the proposalsisto put in placea strong globalgovernanceframework to protect thepublic interest, whilepromotinganopen, flexible,and adaptableoperational model for the global LEIsystem.Theproposalsdraw on input and advicefrom the FSB LEI IndustryAdvisory Panel.Thesuggestedcodeand initial referencedata are consistent with thestandard developed for the LEI by theInternational OrganizationforStandardization(ISO) through an industry consensusprocess(ISO17442:2012).Athree-tier structure for the global LEI system based on a federatedapproachisrecommended:- The first element is a Regulatory Oversight Committee (ROC). Thiswill carry the ultimate responsibility for the governance of the globalLEI system in thepublic interest.TheROC will be establishedby endorsement of a proposedglobalLEI Regulatory Oversight CommitteeCharter whichwill set out thegovernanceframework and arrangements.It will comprise authorities that support the High Level Principlesand purposes of the LEI, and will have an Executive Committee tosteer theworkunder guidelinestobe set out in the Charter.- Thesecond component isa Central Operating Unit (COU) whichwill form thepivotal operational arm of theglobal LEI system.Key tasksof theCOU will be toimplement agreedcentraloperational standardsthat ensure uniquenessof the LEI and thatSolvency ii
  • 111. delivera “logically” centraliseddatabaseof high qualityreferencedata (such asname and address, and, over time, information onownershiprelationships).In legal form, theCOU will be a not-for-profit foundation (orequivalent).It will be composed of privateindustry representativesfrom thevariousgeographic regionsand sectors.- Thethird part of thesystem will be federated Local OperatingUnits(LOUs).TheLOUswill be thelocalimplementersof theglobal system.Theywill conduct local registrationof legal entities and will beresponsiblefor the validationand maintenanceof the high qualityreferencedata. Usinglocalsystems will facilitatetheuseof locallanguagesand operational types.LOUs may alsobuild on localinfrastructuresuch asbusinessregistriesand numberingagencies.LOUs may be operated either byprivate or public bodies.Theywill, however,need to adhere to theagreed global standardstoensure that thesystem delivershigh qualityand consistentinformation.In thiscontext, interim localsolutionscould be subsequentlyintegratedintotheproposedglobal LEI framework.TheFSB‟s objectiveis tohavea fullyfunctioningself-standinggovernanceand operational framework for the global LEI system byMarch2013.Thetimelineand deliverablesin moving towardsthat objectiveareasfollows:Solvency ii
  • 112. - Submissionof the Global LEI ROC Charter totheFSB in October2012or theG20 in November 2012for endorsement;- Development of thenecessarylegal framework for the functioningoftheROC and the COU; and- Development of thelegal and technologicalframework for theproposed global LEI foundation and operational model.An ImplementationGroup, comprised of expertsfrom theglobalregulatorycommunity is beingformed to advancethisworkplan. TheImplementation Group will workin closecoordination with expertsfromprivate industry.7.2 Reducing reliance on credit ratings and improving oversightof credit rating agenciesIn February 2012theFSB conducted a review of itsmembers‟compliancewiththe FSB Principlesfor ReducingRelianceon CreditRatingAgency (CRA) Ratings.Theaim of thesePrinciples,issued in October 2010,is toreducemechanistic relianceon CRA ratingsthat can amplify procyclicality andcontributeto systemic disruption through herdingbehaviour and selloffsof securitieswhentheyare abruptlydowngraded(“cliff effects”).In the period since the FSB Principleswere issued, widespread CRArating downgrades have further underscored the importance of theseissues.TheFSB Principlesencouragebanks,institutional investorsand othermarket participantstodevelop their owninternal risk managementcapabilitiestoavoid mechanistic relianceon external credit ratings.CRAratingsshould be an input, but no more than that, to theriskassessment process.Solvency ii
  • 113. Creating the right incentives for market participants to develop their riskmanagement capabilities includes reducing the use (or “hard wiring”) ofCRAratingsin regulatoryregimes.Thehard wiringof CRA ratingshasbeen wronglyinterpreted asprovidingthem withan official “sealof approval” and hascontributed toan undesirablereductionin firms‟own capacityfor credit risk assessmentand duediligence.Specifically, the report found that:- Afew jurisdictionshavepassed, or proposed, wide-ranginglegislativeor regulatorymeasurestoreducerelianceon CRAratings,but arefacingdifficultiesin detailedimplementation.- International standard settershave taken stepstoexaminethereferencestoCRA ratingsin their standardsand, in somecases,todiscourageunduerelianceon CRAratingswithin thosestandards.Ina number of cases,study of theissuewaseither ongoingor wasonlyjust getting under way.- Themodest progressdescribed in the report wasdue in part tothechallengeof developingalternativerisk assessment capabilitiesandprocesses.Theseare essential topermit individual firms and official bodies toreducetheir relianceon CRAswhile maintainingadequatemanagement of credit risk.When the Principles were written it was recognised that thiswouldtake time, and for some market participants the processcould takeseveral years.However, the report concluded that the authoritiescan domore tofacilitate this processby identifying thechangesin practicesthatneed to be made, sharing experiencesand effectivepracticesindeveloping reformsbearingin mind theneed for internationalSolvency ii
  • 114. consistency, and establishing timetablesand milestonesfor thetransition.Thereport calledfor clear milestonestobe set out for the transition to areducedreliance on CRA ratingsover themedium term; in many casesthosemilestonesremain tobe defined.Among the stepsit recommended are:- Further actionsby national and regional regulatorstoencourage theappropriateuseof CRA ratingsasan input, but no more than that, totheriskassessment process.- Setting standardsthat actively promote theuseof marketparticipants‟own risk management capabilitiesrather than relianceon CRA ratings.- SSBsshould promotethe sharingof successful practicestostrengthencredit risk capabilities.- Official sector bodiesshould publicly explain their approach tocreditrisk assessment in their market and investment operationsand thefurther stepsplanned to align their practiceswiththe FSB Principles.- Further comparativeanalysisof actionstoidentify hindrancestoremovingreferencesto CRA ratingsin standards,lawsandregulations,aswell ashelp re-align national workplanswiththe FSBPrinciples.To encourage further progress on the above issues, the FSB will organisea workshop in September 2012 that will bring together SSBs and nationalexpertsto review progressand agree on thenext steps.Theoutput from theworkshopwill feed intoa further progressreport fortheG20 FinanceMinistersand Central Bank Governorsmeeting inNovember.Solvency ii
  • 115. Other than theeffortsto reducemechanistic relianceon CRA ratings,most FSB membershavealreadyput in placerequirementsfor theregistration of CRAs.Regulatoryaction is still in progressin twojurisdictions.- In Mexico, CRAshave been required to be authorisedsince1999. InFebruary2012,draft regulationswerepublished toenhancetherequirementsfor authorisation, includingimprovementsonstructuredfinanceratingsand transparency.- SaudiArabia is currentlydeveloping itsCRA Regulations,whichwillspecify the proceduresand conditionsfor obtaining an authorisation.Theseregulationswill be in linewithIOSCO‟sCode of ConductFundamentalsfor Credit RatingAgencies.Asignificant proportion of FSB membershave alsotaken actionstoimproveCRA practicesand procedures,such asthe adoptionof theIOSCO CRA Code, inclusion in relevant rules/regulationsof therequirementsfor assuring thetransparencyand qualityof theratingprocess, and providingfull disclosure of their ratingstrack record.7.3 Enhancing market disclosure and functioningThe financial markets are a potential transmission mechanism forsystemic crisis, especially when market participants are faced withsignificant uncertainty, and engagein panic behaviour.In thisregard, IOSCO hastaken stepstostrengthenmarket disclosureand enhanceinvestor protection.IOSCO published in February 2012a consultationreport PrinciplesforOngoingDisclosureforAsset-Backed Securitiesthat providesguidancefor securitiesregulatorswhoare developing or reviewingtheir regulatoryregimesfor ongoing disclosure for asset-backed securities(ABS) soastoenhanceinvestorprotection.Solvency ii
  • 116. IOSCO issued in March2012a consultation report on Principlesfor theRegulation of ExchangeTraded Fundswhich listedsome commonprinciplesand guidelinesrelatingtoETFs on investor protection, soundfunctioningof marketsand financial stability.In responsetothe G20Leaders‟request at the CannesSummit, IOSCOalsopublished in March2012aconsultation report containingproposalstoimprove thefunctioningand oversight of Price ReportingAgencies intheoil marketsand hasalsopublisheditsupdatereport totheG20 inJune2012.In addition, IOSCO published in February 2012a consultation report onSuitability Requirementswithrespect tothe Distributionof ComplexFinancial Products,seeking viewson common principlesrelatingtosuitability and disclosurestandards for market intermediariesin relationtothe distributionof compEnhancing compensation practicesThe2011FSB peer review on compensation indicatedthat good progresshadbeen made in implementingthe FSB Principlesand StandardsonSound Compensation Practices(“Principlesand Standards”, P&S), butthat more workwasnecessaryto overcome constraintstofullimplementationby individual national authorities and to addressconcernsby firmsof an unevenplaying field.In responsetotheG20 Leaders‟request, theFSB establishedaCompensationMonitoring Contact Group (CMCG) comprisingnationalexpertsfrom member jurisdictionswith regulatory or supervisoryresponsibilityon compensation practices.TheCMCG is responsiblefor monitoringand reportingto theFSB onnational implementationof the P&S.Theprogressreport sent separately toG20Leadersis thefirst outcomeof this monitoring exercise,which is not asdeep asa peer review.Theprogressreport describesthedevelopmentsin implementingtheP&S sincethe October 2011thematicpeer review.Solvency ii
  • 117. Almost all FSB member jurisdictionshave now completedtheimplementationof theP&Sin their national regulation or supervisoryguidance.Thosejurisdictionsthat still showedsignificant gapsat the time of the2011peer review (Argentina, India, Indonesia, Russia, and SouthAfrica)haveprogressed in their implementationefforts.However, in the caseof Indonesia and Russia, the relevant regulation iscurrentlyunder review and it hasnot yet been issued.Moreover, some other jurisdictions(Argentina, Brazil, China, India, andTurkey) have electednot to implement one or more Standardsrelatedtothealignment of compensation withrisk taking, either becausetheyarenot deemed applicableor becauseof domestic constraints(e.g. labourlaws).All jurisdictionsthat have not fullyimplementedthe P&S will need tocontinuetheir effortsto overcome impedimentstofull implementationinorder to ensure an outcomethat is fullyconsistent withthe objectivesoftheP&S.Thereasonsfor not implementingspecificPrinciplesor Standards, aswell asthe nature of the actionstaken toaddressidentifiedimpediments,will be reportedtothe FSB by the relevant jurisdictionsand will be described in thenext progressreport.In many jurisdictionssupervisoryattentioncontinuesto increase–indeed, a high level of supervisoryengagement isreported to contributetogreater attention tocompensation issuesby firms.Most authoritiesreport that firmsin their jurisdictionhavemadegoodprogressand generallyconfirm that especiallysignificant firms donotshow major implementationgaps, although some challengesremainwheremore progressis needed,in particular in the area of alignment ofcompensation withex-anterisk takingand withex-postperformanceand concerningidentificationof material risk takers.Especiallyin theseareasmore supervisorycooperationwouldbebeneficial.TheFSB hasalsoestablishedin early2012a mechanismfor nationalsupervisorsfrom FSB member jurisdictionstobilaterallyreport, verifySolvency ii
  • 118. and, if necessary, addressspecific compensation-relatedcomplaintsbyfinancial institutionsthat derivefrom level playing field concerns.All FSB membershave informed the relevant financial institutionsoperatingin their jurisdictionof themain featuresof the BilateralComplaint HandlingProcess(BCHP).Although it is not possibleto estimatea priori thevolume of complaintsthat will be received, theprocessitselfis designed to createtherightincentivesfor implementationof the P&Sby firmsand to dispel theirconcernsrelatingto lack of information or adequateprocessestoaddresslevel playing field issues.Thefindingsof the ongoing monitoringconfirm that achievinglastingchangein behaviour and culture withinfirms is a long-term challengerequiringa sustained commitment and that additional time isneeded foreffectiveand consistent implementationof the P&S totakeplace.TheFSB will continueto monitor and report on progresssoastogeneratesubstantiveand relevant informationthat providesfurtherimpetustoaligningcompensation practicestoprudent risk takingbehaviour.Building and implementing macroprudential frameworksandtoolsTheG20 Leadersstatedat the CannesSummit that “We are developingmacroprudential policy frameworksand toolstolimit the build-up ofrisksin the financial sector, buildingon theongoingworkof the FSB-BIS-IMF on thissubject.”While a small number of jurisdictions(e.g. UK, US, EU) haveestablishednew institutional structureswith macroprudential mandates,many othersareimplementingenhancementswithinthe existinginstitutionalarrangements.Anumber of jurisdictionsare enhancingtheir macroprudentialframeworksand powerstogather data that are needed for monitoringsystemic risk, for example:Solvency ii
  • 119. - In Switzerland, theFinancial Stability WorkingGroup (MoF, SNB,FINMA) published in March2012a report on proposalstoamendmentsof regulatorysystems.With respect to this, two amendmentstothe CapitalAdequacyOrdinanceareplanned: the earlyintroduction of a countercyclicalcapital buffer; and an increasein capital requirementsfor riskymortgagelendingbusiness.Furthermore, a majority of the group hasrecommended thecreationof a right to direct accessfor the SNB to informationon financialmarket participantswhichgoesbeyond itsexisting entitlement tostatistical data.- In the US, the DFA created the FSOC to provide comprehensivemonitoringof riskstofinancial stability, promotemarket discipline,and respond to emergingthreats.TheFSOC‟s assessment of threatstothe financial system is acollaborativeprocess,driven by review of the best informationavailableand expertisefrom FSOC members and their agencies andstaff.TheFSOC hasa number of toolstoaddressthreatstofinancialstability, includingitsauthoritytodesignate non-bank financialcompanies and financial market utilitiesfor enhanced prudentialstandardsand supervision.TheFSOC alsohastheability toprovidefor more stringentregulation of a financial activityby issuingrecommendationstofinancial regulatoryagenciestoapplynew or heightened standardsand safeguards.In addition, FSOC membershave manytools at their disposal toaddressvulnerabilitiesand threats,owingto their involvement insupervision and regulation, consumer and investor protection, andmarket and infrastructureoversight.Solvency ii
  • 120. - In the EU, theEuropean Systemic RiskBoard (ESRB), themacroprudential authorityfor the EU, published in January 2012a setof recommendationsaddressed tothe EU Member Stateson themacroprudential mandateof national authorities.Under the recommendation, MemberStatesshould designateanauthorityin national legislationtoconduct macroprudential policy,takingdue consideration of national institutional frameworks.Further, theESRB recommendedthat EU Member Statesbestowthemacroprudential authoritywiththepowersto conductmacroprudential policy on itsown initiativeor asa follow-uptorecommendationsor warningsfrom theESRB.Thenational authority should alsohave full accessto all thenecessarystatisticalinformation and policyinstruments.EU Member States are also called upon to confer on the authority thenecessary independence for it to fulfil itstasks, to ensure an adequatelevel of accountabilityand toreserve themaximum of transparency.TheEU Member Statesare required to communicatetheir intentionswith respect to implementationby June2012and to take thenecessaryactionsbefore 1July2013.The BCBS published in May 2012 two working papers arising from itsResearch Task Force Transmission Channel project that help to buildtheknowledgebasein the areaof macroprudential policies.Thefirst workingpaper, Thepolicy implicationsof transmission channelsbetweenthefinancial system and the real economy, analysesthe linkbetweenthereal economy and the financial sector, and channelsthroughwhichthe financial system may transmit instabilitytotherealeconomy.Thesecond workingpaper, Modelsand toolsfor macroprudentialanalysis,focuseson themethodological progressand modellingadvancementsaimed at improving financial stabilitymonitoringand theidentificationof systemic riskpotential.Solvency ii
  • 121. Thesecond workingpaper, in particular,discussesanalytical methodsused to measurethe impact of macro-financial shockson therealeconomy; developmentsin modellingfinancial sector liquidityriskincludingthe potential for contagion;methodsfor measuring thepotential for systemic risk; and bank behavioural responsestochangingcentral bank and macroprudential policiesand macroeconomicconditions.Strengthening adherence to international financial standardsTheFSB, in collaborationwiththeSSBs, establisheda frameworkinOctober 2011– theCFIM – for monitoringand reportingon theimplementationof theG20 financial reforms.TheCFIM wassubsequentlyendorsedbythe G20 Leadersat the CannesSummit asa wayto “intensify our monitoring of financial regulatoryreforms,report on our progressand track our deficiencies”.The framework highlights priority areas that will undergo more intensivemonitoring and detailed reporting via periodic progress reports and peerreviews.It also outlines a process to facilitate ongoing consultation andcollaboration between the FSB and the SSBs by clarifying theirrespectiverolesin monitoring national implementationefforts.This consultation processis important toensure that theplansforimplementationmonitoring are consistent withG20 reportingrequirementsasdescribed in theCFIM.TheFSB hasundertaken a number of stepssincethe adoption of theCFIM in October 2011to put it in operation.In priorityareaswherethepolicy development workislargelycompleted, the FSB is workingwithrelevant SSBsto ensure that thescopeand approach of implementationmonitoring and reportingaresufficientlycomprehensiveand rigoroustosatisfy G20and FSBinformation requirements.Solvency ii
  • 122. This is complementedby theFSB‟sIMN, whichis taskedwithcollectinginformationfrom national authorities and reporting on theimplementationof financial reforms in other areas.All implementationprogressreportsfor the priority areasand thecompleted IMN national/ regional responseson theprogressin otherareasare availableon the FSB website.In addition toperiodic progressreports,the FSBmonitorstheimplementationand effectivenessof international financial standardsandpoliciesvia its peer review programme.Peer reviewsare an important institutional mechanismtopromotecompleteand consistent implementationand area meansof fosteringaraceto thetop by FSB member jurisdictions.Theyprovide an opportunityfor FSB membersto engage in dialoguewith their peersand toshare lessonsand experiences.TheFSB completedin December 2011a review of experienceto datewith FSB peer reviews.Thereview identified lessonsand recommended certain refinementstothefunctioningof the programme in order tofurther enhanceitseffectivenessand value-added, whichhave been incorporatedin theHandbook for FSBPeer Reviews.Sincethe CannesSummit, the FSB hascompleted a thematicpeerreview ondeposit insurancesystems (DISs) usingthe BCBS-IADI CorePrinciplesfor EffectiveDeposit InsuranceSystems asa benchmark.Thereview confirmed the importanceand necessity of an effectiveDISandnoted that the crisis resultedin greater convergencein practicesacrossjurisdictionsand an emergingconsensusabout appropriate DISdesignfeatures.While the reviewedDISs in FSBmember jurisdictionswerefound to bebroadly consistent withthestandard, thereremain some areaswherethereappear tobe divergencesfrom (or inconsistencieswith) the CorePrinciples.In some areas,more preciseguidancemay be needed to achieveeffectivecomplianceor to better reflect leadingpractices.Solvency ii
  • 123. Thereport containsa number of recommendationstoaddresstheseissues.Therecommendationsof pastthematic peer reviewsarealsoleadingtoconcretefollow-upactivitiesby relevant parties.In the caseof compensation practices, an ongoing monitoringmechanism hasbeen established by theFSB tofollow up on remaininggapsand impedimentsto full implementationaswell ason actionstakenin responsetothe peer review‟srecommendations(see section8).In the caseof risk disclosures,an FSBroundtablewithrelevant marketparticipantswasorganisedin December 2011and the EnhancedDisclosureTask Force(EDTF) will take forwardtheworktoidentifyleadingpracticesand develop principlesfor risk disclosures.In responsetothe recommendationsfrom the peer review of residentialmortgageunderwritingpractices, the FSB hasissuedan internationalprinciples-basedframework for sound underwritingin this area.Finally, in the caseof the peer review on deposit insurancesystems, theIADI is updatingitsguidancethat pre-datesthe financial crisisanddeveloping additional guidancein certain areascoveredby theCorePrinciples.TheFSB hasalsorecently completedthecountry peer reviewsof CanadaandSwitzerland.Three more peer reviews– thematicreviewsof risk governanceandresolution regimesaswellasthe country review of SouthAfrica – will becompleted by early2013.All completedpeer review reportsare availableon theFSB website.FSB members‟adherencetointernational standardsis essential toreinforcethe credibilityof the FSB‟s effortsto strengthen adherencebyall countriesand jurisdictions.Tolead by example, member jurisdictionshave agreedtopublishinformation on the commitmentstheymadeunder the FSBFrameworkfor StrengtheningAdherence toInternational Standards.In March2010,the FSBlaunched an initiativeto encouragetheadherenceof all jurisdictionstoregulatory and supervisorystandardsonSolvency ii
  • 124. international cooperationand informationexchange, includingbyidentifying non-cooperativejurisdictionsand assistingthem to improvetheir adherence.Theinitiativerespondedtoa call by the G20 Leadersat theirApril 2009Summit for the FSB todevelop a toolbox of measuresto promoteadherencetoprudential standards and cooperation.TheFSB hasprioritisedabout 60 jurisdictionsfor evaluation, includingall 24 FSB member jurisdictionsand non-FSB jurisdictionsthat rankhighly in financial importance.Torecognisethe progressthat jurisdictionshavemade towardaddressingweaknessesin international cooperation and informationexchange, andtoincentiviseimprovementsbythosejurisdictionsnot cooperatingfully,theFSB published on 2November 2011informationon the jurisdictionsevaluatedtodate.Sincethen, China and Saudi Arabia havedemonstrated, through theresultsof their IMF-WorldBank assessments,sufficientlystrongadherencetothe relevant standards.TheFSB will publish updatedinformation in November 2012on alljurisdictionsthat have been evaluated under the initiative.11.Strengthening FSB governance11.1Strengthening FSB‟scapacity, resourcesand governanceTomeet the mandategiven by the G20Leadersat the CannesSummit tostrengthen the FSB‟scapacity, resourcesand governance, including itsestablishment on an enduringorganisational footing while preserving itsstrongand well-functioninglinkswiththe BIS, theFSBestablishedaHigh-Level WorkingGroup on FSB Capacity, ResourcesandGovernance.TheFSB hassubmitteditsrecommendationsalong with a revisedFSBCharter totheLosCabosSummit for G20 Leaders‟endorsement.Themain recommendationsof the Working Group include:(i) Preservingthe FSB‟sflexible, responsive, member-driven, multi-institutional and multi-disciplinarycharacter, active involvement ofSolvency ii
  • 125. senior-level officialsfrom financeministries, central banks andsupervisoryauthorities,and nexusbetweenthepoliticallevel andregulatorypolicy making of the SSBs;(ii)Pursuinga gradual approach to the institutionalisationof the FSBbyestablishingit asan associationunder theSwisslaw to provide it a legalpersonality, with thefunctional immunitiesneeded for itseffectiveoperation asa policymaking body whilemaintainingstrong and well-functioninglinkswiththeBIS;(iii)Strengtheningitscontinuingrole in reducing the likelihoodof financialcrisesthrough vulnerabilityassessment, effectiveand forwardlookingcoordinationof international standard setting, reviewingregulatorypolicieswithina macroprudential perspectiveand comprehensivemonitoringof members‟implementationof international financialstandardsand agreed G20 and FSB commitmentsand recommendations;(iv)Asneededtoregulatory gapsthat poserisk tofinancial stability,developing or coordinatingdevelopment of standardsand principles, incollaborationwiththerelevant SSBsand other stakeholders,aswarranted,in areaswhichdonot fall within the functional domain of anotherinternational standard-settingbody, or on issuesthat havecross- sectoralimplications, in linewiththe current practice;and(v)Improving itsgovernance, transparencyand accountabilityarrangementsthrough amendmentsto itscharter, setting up RulesofProcedure and establishinga StandingCommitteeon Budget andResourcesfor effectivefinancial governance.Theimplementation of therecommendationswouldcommence shortlyafter the G20‟sendorsement.As part of the ongoing governancereforms, in January2012,theFSB alsoreconstituteditsSteeringCommitteeto rebalanceitscompositionintermsof institutional and geographic representation.11.2 Increasing outreach through the FSB regional consultativegroupsSolvency ii
  • 126. In responsetotheG20 Leaders‟call at theTorontoSummit for the FSBtoexpand and formalise its outreach beyond itsmembership, the FSBestablished in 2011Regional ConsultativeGroups(RCGs) for theAmericas,Asia, theCommonwealthof IndependentStates,Europe, MiddleEast & NorthAfrica, and Sub-SaharanAfrica.TheRCGs bring together financial sector authoritiesfrom FSB memberand non-member jurisdictionsto exchangeviewson vulnerabilitiesaffectingfinancial systems and on initiativestopromote financialstability.Membership in theRCGs includesministriesof finance, central banksand supervisory authoritiesin 65FSBnon-member jurisdictionsandtheir counterpartsin FSB member jurisdictions.All of the RCGs have met at least once and some have set up workinggroups to study financial stability issues of interest to their respectiveregion.RCGs have presented the output of the working groups to the FSBPlenary as a part of the consultative feedback provided by non-FSBmembers.12. Other issues12.1Addressing data gapsIn the global financial crisisthat began in 2007, the lack oftimely, accurateand consistent information on largesystemicallyimportant bankshasproved very costly.Thecritical initiativesunderwaytoreform and strengthenthefinancialsystem all require better data, beit tosupport more intensivesupervision, to identify risk concentrationsand thebuild-upof systemicrisk, or to assist authoritiesin crisissituations.In thisregard, the FSBData GapsProject aimstoprovidea consistentframeworktopool and share relevant data on the major bilaterallinkagesbetweenlargeinternational financial institutions,and on their commonexposurestoand funding dependencieson countries, sectorsandfinancial instruments.Solvency ii
  • 127. As part of a wider initiativeto improvedata tosupport financial stability,theFSB wastasked with improving theavailability, qualityandconsistencyof data on major global financial institutionsand financialinter-linkages.Totake this forward, theFSB hasset up a workinggroup of experts fromnational authoritiesand international institutions,with the mandatetodevelop proposalsfor a new common data templatefor globallysystemicinstitutions.Theworkinggroup isconducting extensivepreparatory work, includinga thorough examination of legalissueson the sharing of dataand acontinued consultationwiththe industryon the common template.TheFSB istakingan incremental approach for the FSB Data GapsProject with three distinct phasescharacterisedby a progressiveincreasein thegranularity of thedata and in the sharing of information.TheFSB hasapproved the implementation of the initial phaseof theproject (“Phase1”) for a start in March2013.This phase foresees the creation of a central hub to be hosted by the BISfor the storage and management of data collected and the sharing of thisinformation among relevant supervisoryauthorities.Implementation work for Phase1is on track, both on the data side, withtheplanned finalisation of thePhase1templatevery shortly, and on thegovernanceside, wherekeyprinciplesunderpinning exchangeofinformation in Phase 1have been developed.Regardingthenext phasesof theproject, preparatory work isongoing ondata templatesand on thefeasibilityof widerdata sharing.TheFSB will decideon the implementation of Phases2 and 3 after thispreparatorywork is completed, asthere is noautomaticitybetweenPhases1,2 and 3.12.2Identifying unintended consequencesof regulatory reformson EMDEsIn February 2012,the G20Finance Ministersand Central Bank GovernorsaskedtheFSB to coordinate, with the IMF and World Bank, aSolvency ii
  • 128. studytoidentify theextent towhichthe agreedregulatory reforms mayhaveunintended consequencesfor emergingmarket and developingeconomies(EMDEs).Theintent of the studyis not tore-open recent internationallyagreedregulatoryreformsbut tobetter understand thepossibleeffectsof thosereforms in thecontext of broader post-crisisdevelopmentson EMDEs.National authoritiesfrom EMDEs that are membersof theFSB or of anFSB RCG weresurveyed for thispurpose, while an FSBReview Groupcomprising FSB membersand co-chairsof RCGsprovidedguidanceontheselection and analysisof theissuesincluded in thestudyaswell asonitsmain messages.There is widespreadsupport among EMDEs for the objectivesof theagreedreforms.At the same time, there is a broad range of viewsregarding the extent towhich these reforms are having, or expected to have, an impact on theirfinancial systems.This heterogeneityin perspectivescan be attributedtothe earlystage ofimplementationof the reformsand to the diversityof EMDE financialsystems, whichgiverise to different considerationsand concerns.Thoserespondentsthat did identify unintended consequencesfocusedon a few keyareas:the Basel III capital and liquidityframework; policymeasures– includingresolution frameworks– for G-SIFIs; and OTCderivativesreforms.Somerespondentsalsoidentifiedother national/ regional regulatoryreforms – such ashigher capital requirementsby the European BankingAuthority (EBA) for largebanks in the EU, and the Volcker Rulein theUS – asgiving rise tospilloversand/ or extraterritorial effectsthat maylead to unintended consequences.Anumber of theconcernsraised by EMDEs relate tocross-bordereffectsand perceived home bias in thedesign or implementation ofreforms.Solvency ii
  • 129. Several of the keyconcernshavealsobeen raised by advancedeconomiesand arebeingaddressed by relevant international bodiesduring policydevelopment and implementation.Theresponsesreflect some implementationchallengesfor EMDEs andraisethe issueof clearlyidentifying intended versusunintendedconsequences.It is tooearlyto assessfullythe materialityand persistenceof theeffectsofregulatory reformson EMDEs, and it wouldbe useful tocontinuetomonitorthe effectsof those reformsaswell asto share experiencesandimplementationlessons.The findings also highlight the importance of ongoing dialogue andcooperative relationships among national authorities from EMDEs,SSBs and international financial institutions in order to facilitate themitigation of unintended consequences from the implementation ofagreedreformsin EMDEs.12.3Enhancing consumer finance protectionTheglobal financial crisisdemonstrated theneed tostrengthenconsumer protectionpoliciesand frameworkstoensure that the use(ormisuse) of individual financial productsdonot become a sourceoffinancial instability.Asignificant contributortothat crisiswaspoorlyunderwrittenresidential mortgages, whichoften represent the largest component ofhousehold and consumer debt.In response,a number of FSB membershaveencouraged prudentunderwritingpracticestolimit the risksthat mortgagemarketsposetofinancial stabilityand to better safeguard consumersand investors.TheFSB Principlesfor Sound Residential MortgageUnderwritingPracticesreleased in April 2012provide a frameworkfor jurisdictionstoset minimum acceptableunderwritingstandards.After providingsufficient time for implementation, theFSB will conducta thematic review toassessprogressmade in implementingtheframework.The Principleswill assist FSB members in their effortstoimprovefinancial stabilityand prudential standards.Solvency ii
  • 130. Theyalsorefer toconsumer protection issuesthat contributetotheseobjectives,but the Principlesare not intended tobe a statement ofconsumer protectionstandards.Jurisdictionswill want toadopt the consumer protection standardsthatare appropriatetothem, including the Organisationfor EconomicCooperation and Development‟s (OECD) High-level PrinciplesonFinancial Consumer Protection whichwereendorsedby theG20 Leadersat the CannesSummit.The OECD high-level principles are designed to help its memberjurisdictions and other interested economies to enhance financialconsumer protection.Several FSB membershave alreadyself-assessedtheir consumerprotection frameworksagainst thesehigh-levelprinciplesand found thattheyare in linewiththe recommendations(e.g. Australia, Canada, andFrance).However, an even larger number of jurisdictionswouldlike additionalinformation to support their effortstowardimplementation, particularlyon thefollowingprinciples:- Disclosureand Transparency(principle4)- ResponsibleBusinessConduct of Financial ServicesProvidersandAuthorisedAgents(principle6)- ComplaintsHandlingand Redress(principle9)The OECD, in collaboration with the FSB and SSBs, have developed anaction plan to identify, within 24 months, a set of relevant approaches tosupport the effectiveimplementationof the high-levelprinciples.Tohelp advanceconsumer financeprotectionefforts,the FSB report onconsumer financeprotection with aparticular focuson credit endorsedbyG20Leadersat theCannesSummitset out three options, includingsupporting a global platform for consumer protection authorities toexchangeviewson experiencesaswell aslessonslearnt from the crisistoSolvency ii
  • 131. help strengthenconsumer protection policiesacrosstheFSBmembershipand beyond.In thisregard, the importanceof the Financial Consumer ProtectionNetwork(FinCoNet) asa global network of market conduct financialauthoritieswasrecognised by the G20 FinanceMinistersand CentralBank GovernorsinApril 2012.FinCoNet is currentlyrefiningits mandateto enhanceitslegitimacyastheinternational organisationof consumer protection authorities.Theseeffortswill help maintain the momentum towardstrengtheningconsumer financeprotection frameworksasseveral jurisdictionsareconsideringsignificant changesto their frameworks,includingstrengtheningthe institutional arrangementsfor consumer protectionauthorities(e.g. China), legislativechanges(e.g. Korea) aswell asenhancementstoexistingregulatoryframeworks(e.g. Switzerland).Solvency ii
  • 132. Regulating in a new era of professionalism:what doesthe FSAwant to see from theindustry?14Jun 2012Speechby CliveAdamson, Director ofSupervision, Conduct BusinessUnit, FSAtotheMarketforceand theIEA‟s 15thAnnual ConferenceGood morning and thank you toMarketforceand the InstituteofEconomicAffairs for invitingme tospeak toyou today on „Regulatingina new era of professionalism‟.I will begin by giving you a high level view of the changestaking placein UK regulation, how we expect professionalism to play a part in this,and what this meansfor you.UK regulatory changesTheeventsexperienceddue toNorthern Rock meant our focusasregulatorswasfocusedon ensuringthe bankingsystem wasstableandprudential regulation appropriate tosafeguard the UK‟sfinancialstability.Theconsequenceof this, in some cases,wassubstantiallylessfocusonhow firmstreated their customersand greater focuson the firm‟ssolvency.As time moved on, it wasrecognisedthat thisapproach could notcontinuein the longterm.During the last few months, the FSAbegan takingstepsto separateprudential and conduct regulationin preparationfor the creationof thenew Financial ConductAuthority and the Prudential RegulatoryAuthority, in early2013,and shaping what thesetworegulatorsaregoingtolook like.Solvency ii
  • 133. Internally, the first major milestone wasthe on April 2011, when we splitinto two business units – the Prudential Business Unit and the ConductBusinessUnit.Our second major milestonewasApril this year when wesplit bankingand insurancesupervisionintothe Prudential and Conduct Units, sothatwenow essentiallyoperateinternallyunder theFSAumbrella how we willoperatewhenwearelegallyformed in 2013.Today, I will talk to you from the perspectiveof theFCA, leavingmycolleaguesin thePRAtotalk from their perspectiveat other events.Thestrategicobjectiveof theFCA isto „makingmarketswork well‟.Additionally, it hasthree operational objectivesof ensuringconsumerprotection, market integrityand competitionis in the interestsofconsumers.Of these, thenewest for usin the FCAis the latter.As a primary statutory objectivewewill be under the obligation toconsider the roleof competition(or lackof it) asa driver of pooroutcomesin marketsand workout howaddresstheseproblems.What wehave learnt from thepast is that thingsgowrongwhenbusinessmodelsare not based on a sound foundation of fair treatment ofconsumers, and a strong culturethat supportsthis, leadingto productsbeingsold that are not suitablefor thosebuying them.Our previoussupervisoryapproach wastoofocused on disclosureat thepoint of sale, creatingsituationswheresubstantial amountsofinformation werebeingprovidedtoconsumerswhonot alwaysunderstood what wasbeing presented tothem.This, combined withsalesprocessesthat often incentivisedstaff tosellproductsthat wereprofitabletothe firm rather than suitedtotheconsumer, made it almost inevitablethat detriment took place.It is our intention that the FCA will look and feel different from theFSA.Solvency ii
  • 134. In brief, weaim tomove awayfrom a primarily reactivestyle tobe ajudgement based, confident and pre-emptiveregulatorthat actstoensure consumersget a better deal and marketsare fair and orderly.Thenew supervisoryapproach will comprise of five main elements:- Tobe more forward-lookingin assessment of potential problems.Looking at how wecan tackleissuesbeforethey start togowrong.Increasingly, wewill continuetomove towardschallengingfirmsabout whethertheir businessmodels deliver good outcomesforconsumersand, wherewedisagreewithmanagement, havetheconfidencein our judgement to require firms tochangetheirbusinessmodels.- Interveneearlier whenweseeproblems.Thepoint I want to make here is that theFCA will have greaterappetitefor earlier intervention, particularlyin the productdevelopment lifecycle, than the FSAhashad.Tomake it clear, it isnot our intention tobecome aproduct approvalregulator, but wewill consider and takeaction whennecessary, whenwefeel certain productsare toorisky for their target audiencesor soldin thewrongway.- Addressthe underlying causesof problemsthat wesee, not just thesymptoms.It wouldbe relativelyeasyfor usto caseindividual examplesof poorconduct behaviour, but our experienceisthat thesewill continuetobemanifested unlessthe underlying causesof theseproblemsaresatisfactorilydealt with.Solvency ii
  • 135. As a result, wewill be applying a particular focus to identifying andmitigatingthe underlying root problems – not just patch up thesymptoms.- Secure redressfor consumersif failuresdooccurFor example, what wesawwithpayment protection insurance.We are askingthosefirmsthat mistreat their customerstotakemeasuresto rectify things.In practice, thismeansa combination of appropriateredressforconsumers,changesin their systemsand controlsand ensuringthatpost-salesprocessesdeliver a fair outcome for their consumers.- Take meaningful actionAgainst firmsthat fail tomeet our standards, through levelsof finesthat have a credibledeterrence.Wherewedonot seeimprovementsin firms followingouractions,wewill consider takingtougher action, includingstoppingfirmstakingon new business.Let‟s take insider dealing as an example – increasingly we are usingour powers to prohibit individuals from the industry and continuingtofocuson senior management responsibility.How doesprofessionalism fit into this approach?A key component of the FCA‟s approach is to continue implementingthe work that the FSA has already started around professionalism andprovision of advice.Solvency ii
  • 136. TheRetail Distribution Review,which iscomingintoeffect on 31December thisyear, is a clearexampleof action being taken tofulfil oneof the FCA‟s operational objectives– consumer protection.It continuesto be our view that consumersshould have:- clarityin the servicetheyreceive;- a transparent and fair chargingsystem for the advicereceived; and- advicefrom respectedand professional advisors.- This is particularlyimportant in thecaseof long-term savings,forexample.TheRDR aimsto createa resilient, effective, and attractiveretailinvestment market that consumerscan have confidencein and trustat a time whentheyneed more help and advicethan ever with theirretirement and investment planning.Given that long-term savingsare long-term commitments,the qualityof adviceand product suitabilityis keyasoften it may takeyears forsignsof detriment tomanifest itself.- TheRetail Conduct RiskOutlook document, which wepublishedsomeweeksback, alsosetsout our viewson how professionalismneedsto be at thecore of advicefor long-term savings, includingpensionsand retirement planning.Practically, this means:- assecuring financial wellbeingduring retirement isparamount tomost pension investors,thequalityof advice and product suitabilityfor pensionand retirement planningbecome of significant regulatoryconcern and interest;- as retirement planning involves complex decisions, it creates the riskthat poor advice results in lower retirement income and/ or purchaseof productswithexcessiverisks;andSolvency ii
  • 137. - that the impact of detriment is compoundedby limitedmeanstorecover from financial loss, especiallyamongvulnerable groups(e.g.theelderly) that have lowerearningopportunityor financialflexibility.Sowhat do we want to see from the industry?I want tomakeit clear that our aim is not to take awaythe consumers‟responsibility.We want them tomake decisionsfor themselves,but ensure that thedecision theymake isan informed one.This is whereyou, the industry, come in.Both the RDR and regulatory reform give us all huge opportunitiesto dothingsbetter.Togive consumersmore confidencein theadvice theyare receiving, it isimportant that adviserslook at their customersasuniqueindividuals,consider their personal situationsand fullyunderstand their objectivesandpotential financial needs.Questionsthat you should be askingyourselves are:- Have you decided if you are going to be independent advisoryorrestricted?This ispossiblyone of the most important decisionsyouneed to make.- Is your pricing structure clear?And doyou have thesystems in placetoensureyour clientsfullyunderstand how your advice translatesintocoststo them?- If you are advising on high-risk investments,dothe individualsprovidingthat advicehave sufficient understandingof theproductsbeingoffered?- Are you lookingat undertaking a wider rangeof business?If so, haveyou identified all therisks associated withthese products?Theseare justsome of themany questionsI hope you are askingyourselves.Solvency ii
  • 138. For us, adviceshould be just that, advice – not a sales/ product drivenprocess.It should be about:- providingthe right product for the right person withthe rightinformation;- firmsensuringcustomer treatment is at the core of their businessmodel;and- firmsprovide common sense, professional and clear advice totheircustomers.Professionalismalsomeansthat what you do should be properlyrecognised asa professionby settingminimum standards.This is whyit is important that adviserscontinuetopressahead andachieveappropriateLevel 4 RDR qualificationand then obtain aStatement of Professional Standing.I can tell you that 93% of advisersbelievethey are on track tocompletetheir qualificationson time and 71% of advisersalreadyhaveappropriatequalifications.This is very encouragingnewsand I want tothank you for thetremendousworkyou aredoing to get therequired qualifications.Thosewhoarecurrentlyappointed representativesshould bear in mindthat it istheir responsibilitytoensuretheyreach therequired standardsandthe responsibilityof principal firmstoensure their appointedrepresentativeshavethe required qualifications.ConclusionsI hope, however, that I have given you some food for thought.It is clearthat firmshavemade goodprogress,but wewant toseemoreof you gettingthe appropriatequalificationand making thenecessaryinternalarrangementssooner rather than later.Solvency ii
  • 139. If you haven‟t done soalready, you alsoneed to fully consider whetherprovidingan independent or restrictedadvicemodel best suitsyourclient base;and wewant to seeyou start to test and implement suitableadviserchargingstructuresnow.I believe the next few months, as we continue to move towards thecreation of the FCA and the implementation date for RDR, will beextremelyinteresting.We will be increasing our communication around what theFCAwill beandhow it will operate aspart of a moretransparent approach to bothfirmsand consumers,and welcomeopportunities like thisto engagewith the regulatedcommunityand communicateour viewson how wecan ensure that, together, wecontinuetoput customersat the heart ofwhat wedo.Thank youSolvency ii
  • 140. Addressing “Too Big To Fail”The SwissSIFI Policy1BackgroundTwoof theSwissbanks arenot onlysystemically important for theSwisseconomy, but may alsobe consideredasinstitutionsof considerableimportancefor financial stabilityat global level.Although theyhavesignificantlyreduced their exposuresin theaftermath of the crisis, thesize of their balancesheetscontinuestoamount to a multipleof theoutput of theSwisseconomy.Both banksare consideredasGloballySystemicallyImportant FinancialInstitutions(G-SIFIs) and “Toobig toFail”.Hence, the issueof “Toobig to fail” (TBTF) is of great relevanceforSwitzerland.TheSwissFederal Government, theSwissFinancial Market SupervisoryAuthority FINMA and theSwissNational Bank have therefore decidedtomove rapidlytowardsmeasuresstrengtheningthe resilienceof theSwissSystemically Important Financial Institutions(SIFIs), limitingtheeconomicimpact of crisisin thefinancial system and promotingfinancial stability.Solvency ii
  • 141. Thestarting point of theSwissinitiativesis the workof the commissionof experts commissioned by the SwissFederal Government todeveloppolicy optionson how to mitigaterisksemerging from TBTFinstitutionsin theSwisseconomy.On 4October 2010,thecommission agreedon a proposal for a SwissSIFI policy framework.What distinguishesthe policyproposalsisthat expertsweredrawn notonlyfrom therelevant authorities and the sciencecommunity, but alsoincludedmembers from the twoSwissbig banks and from theinsurancesector.All membersof the commission endorsed the results.Currently, FINMA, SNB and theSwissFederal Department of Financeare workingon thepractical implementationof theseresultsintoSwisslaw.The necessarylegal changesweresent toParliament on 20April2011.This report describesthe SwissSIFI policyframework basedon theproposalof the commission of expertsand the dispatch of the FederalCouncilon strengtheningfinancial sector stability.TheSwissTBTF initiativesare embedded in the global framework,inparticular that of the Financial StabilityBoard and theBasel Committee.Aglobal alignment isparamount given the fact that SIFIsare active atinternational level and that any substantial regulatory arbitragemayimpact financial stability from a domestic and global perspective.However, each country hasto consider itsownspecific situation.Not onlyis the failure of a big institutiona risk for theSwisseconomy:theinternational exposure of theSwissfinancial centre and itscompanies bearsa greater responsibilityfor global financial stability.Solvency ii
  • 142. Switzerland hasto implement the globallyagreed regulationswitha“Swiss fin ish ” and todevelop and put itsinitiativesintoeffect assoonaspossible, ahead of thoseof several peer countries.2 Defining systemic importance1. Functional perspectiveIt is broadlyagreed that the systemic importanceof a financialinstitution arisesout of the financial functionsit providestothegeneraleconomy.At the same time, suchfinancial institutionsprovide a plethora offunctionsand serviceswhichare not systemically important or can besubstitutedeasily and quickly.Theproper classification of functionsisof vital importance.While theset of systemically important functionsshould not be toonarrow tosufficientlyprotect the economy from the fallout of a bankingcrisis, an excessivelybroad definitioncomplicatescrisismanagementand resolution actions,setsfalseincentivesand reducespressure tocomeup with market-based solutionsin a crisisscenario.Switzerland aimsfor a simple, straight-forwardyet narrow definition ofsystemically important functions.Accordingtocurrent discussions,the followingfunctionswillpresumablyfall under thisdefinition:Payment operations;Domestic depositstoensure accessto liquidityfor paymenttransactions;Loansand credit linestonon-financial enterprises;Domestic mortgageswitha maturity of lessthan 1year.Solvency ii
  • 143. However, the measuresproposed arenot limitedto the systemicallyimportant functionsassuch, but eventuallylead to institutionalrequirements.When determiningcapital surcharges,all activitiesof a SIFI are tobeconsidered, aslosseswill most probablynot be contained in a particularbusinessline, but may impair systemically important functionsaswell.Also, when assessingthe resolvability of a company, it is not only thesystemically important activitieswhichare lookedat, but rather allfunctionsthe company performs, alsofrom a cross-border perspective.2. Institutional perspectiveA company is deemed systemically important if it performs services thatare essential to the overall economy and which cannot be substituted byother market participantswithin a reasonabletime frame.Thecurrent Swissinitiativesthereforefocus on banks.Toassessthe systemic importanceof banks,the evaluation frameworkhasbeen substantiatedto includethe followingcriteria:- Market share in systemically important businessactivitiessuch asdeposits,loansand clearing;- Valueof deposits not coveredbythe deposit insuranceregime;- Relationbetweenthebalance sheet sizeand the grossdomesticproduct;- Riskprofile of the company.Evaluating thesecriteria naturallyleadstodesignatingthetwobigglobal Swissbanks, the Credit SuisseGroup and UBS, asgloballyanddomesticallysystemically important.Switzerland hasdecidedtofocusitsinitiativeson thesetwobanks. Oncetheframeworkisin place,theinitiativesmay beextended toincludedomestic SIFIs.Solvency ii
  • 144. Given the fact that such D-SIFIs (Domestic Systemically ImportantFinancial Institutions)operatein an environment and under conditionswhichare very different from those of a globallyactivebank, it isunlikelythat a frameworkadequate for G-SIFIs can be directlyadoptedfor D-SIFIs.However, the rationale– ensuringthat D-SIFIs can fail withoutdisruptingsystemically important functionsand without theneed forextraordinarypublic support – is the same.Financial infrastructureproviders, suchassettlementorganizations,exchangesand central counterparties,are alsosystemically important.However, the riskstheyhandle arequitedifferent from thosebanks areconfronted with.Thepolicyframework outlinedin thispaper is thereforenot directlyappropriatetodeal with infrastructureproviders.3 Policy mixSIFIs and the financial system asa wholemust be capableof survivingcrises,even of larger scale, without public support and taxpayers‟ money.TheSwissSIFI policyframeworkfocuseson twomajor objectives.Thefirst objective, reducingthe probabilitythat a TBTF institutionfails, is pursuedby twokey measures:CapitalLiquidityThesecond objective, reducingthepotential systemic fallout of a failureof a TBTF institution, is pursued withmeasuresincreasingtheresolvability of thosecompanies:Organization, andRiskdiversification.Solvency ii
  • 145. Thekey measures- capital, liquidity, organizationand diversification -are not isolated, but constitute an integratedpolicy mix.Capital and liquiditynot onlyhelp to prevent crises, but alsoto set asideresourcesnecessarytoimplement recovery measuresor ultimatelyenablean orderlyresolution of the company.Furthermore, the measuresare totake effect at all phases.Capital and liquiditymeasures,whichallowfor easierrestructuringorresolution by thesupervisoryauthorityfor a bank in distress, provideincentivesfor thebank‟smanagement toreducesystemic risk when thecompany is still a goingconcern.Organizational measures,whichfacilitaterecoveryand limit the impactof failure, need tobedesigned, preparedand implementedwhenthere isstill enough time for diligent action.Box 1:Pure size limits regarded asineffectiveThemost appropriatewayto tacklethe TBTF issuewouldbe to preventinstitutionsfrom becoming sobig that the consequencesof a failurewouldbe toodangerousfor the economy.Size limitscould be expressedby imposing restrictionson the size of thebalancesheet (absoluteor relative, e.g. asa fraction of the country‟syearly grossdomestic product), on the market share or thelevel ofinterconnectionswithother financial institutionsor the economy asawhole.Banksexceeding theselimitswouldbeordered bylawtoreducetheirexposure.While thisconcept soundssimple, theeffectivenessmay not be evident.Solvency ii
  • 146. From a macroeconomic perspective, the size of a financial system is notonlydriven by supply.Reducingthe exposure of singleinstitutionsmay not lead to acontraction of thesize of thefinancial system, but rather wouldcausefragmentationand diversification betweenmany smaller marketparticipants.Such a diversificationmay help to mitigaterisksof isolatedissues,butwouldnot be suitableto deal with systemic crises.Businessconcentratedon a few bigcompanieswouldmigrateto smallercompanies, all of them pursuingsimilar strategiesand exposingsimilarrisk behaviour.Crisesof a larger scalewouldcauseproblemsat many of those smallercompanies and, at the same time, wouldrender a group of smallcompanies “systemic in a herd”.Strict limitationson the sizeof businessactivitieshave thereforeonly alimitedpotential toreduce thesystemic risk, but may heavily complicateanycrisismanagement, assuchmeasureswouldthen have tobe appliedtoseveral companiesat the same time.Of course,economiesof scaleand other efficiencyconsiderationsmayalsofavour larger companies.However, such benefitsarehard toquantify and did not play a substantial rolein our considerations.As a result, wecame to the conclusion that imposing hard sizerestrictionsisnot an appropriate approachto strengthen theresilienceofthefinancial system.Solvency ii
  • 147. 4 Capital and liquidity – reducing the probability of failureHigher solvencyand liquidityrequirementsreducethe probability thatbanksfall below minimum levelsof capital and liquidityand thereforereducetheprobabilityof failure.In addition, more solvencyand liquiditymay significantlyfacilitatecrisismanagement, resolution or, in a worst casescenario, theliquidationof acompany.Finally, ascapital and liquidityrequirementsmostlydepend on thevolume and risk of a bank‟sbusinessactivities,theyalsocreateincentivesto reducesizeand risk.Havinga lowerprobabilityof failure, more flexibilityfor crisismanagement and greater incentivesfor size and risk reduction isespeciallyimportant for systemically important institutions.Solvency ii
  • 148. Thesecompanies should thereforebe subject tostricter requirements.For some years, large Swissbankshavebeen subject to a surchargeontop of the regular capital requirements,expressedasa multipleof thePillar I level.In the wakeof thecrisis,higher liquidityrequirementswerequicklyimposed.It is now proposedthat theexistingPillar II measuresare replacedby asystem whichallowsfor improved calibrationand to better reflectsystemic importance.The new system defines surcharges on the Basel baseline requirements(capital quantity), but also prescribes the capital instruments to be used(capital quality).Both dimensionshave to be looked at in parallel.While theproposal significantlyraisestheminimum capital quantity, italsoensuresthat there is a safetynet toenablerecovery and resolutionandthat this safetynet cannot be used, or even depleted, for day-to-daybusinessactivities.This allowsfor restructuringa bank without forcing it intoliquidation.That way, thewholecompany, or at least parts of it, may have a realisticfutureafter a crisis, whichis paramount tosecure the commitment ofinvestors,clients and counterparties.4.1Quantity of capitalSwitzerland proposesthat thecapitalization of systemically importantbanksshould bedefinedby three componentsof capital whichcomplement each other, but havedistinct objectives.Solvency ii
  • 149. While thebaseline requirementsareused asgoing concern capital, thebuffer helps tofend off crises.Thesurchargeservesasa reservetorestructure or resolvethe company.Thecalculationof thecomponentsand thecapital instrumentsemployed are structured in accordancetothesepurposes.1. Basel III asa baseline requirementJust asevery bankinginstitution, SwissSIFIshave to fulfil the baselinecapital requirementsasdefinedin the Basel framework and itsSwissdomestic implementation.Thebaselinerequirement amountsto 8% of thecompany‟srisk weightedassets(RWA).TheBasel Committeehasproposed substantial amendmentstoitscapital accord (Basel III).Switzerland is committed to implement theBasel III proposalswithintheinternationallyagreedtime frame.Therevised ruleswill be applicabletoall banksin Switzerlandregardlessof their systemic relevance.Switzerland implementedahead of timea subset of the rules,mostlycentred around tradingbook rules(“Basel 2.5”).All banks concerned are already required to meet theseextendedrulessince1January 2011.2. Buffer to increase lossabsorbencyThelast crisisrevealedthat banks meetingor even exceedingthestatutorycapital requirementsmay experiencelossesat such a scaleandSolvency ii
  • 150. speedthat theymay significantlyfall below theminimum capital levelswithin ashort period of time.Countermeasuresimplemented by companies,such asfiresalesof liquidassets,acceleratedthesedevelopments, caused contagion to otherfinancial companies and market segments,and could onlybe impededbyvast interventionsundertakenby governmentsand central banks.Hence, while capital levelsasrequired by Basel II / I II and nationalregimeswerenever designed to absorb tail risksof large, internationallyactiveinstitutions,theyweretoosmall to prevent a system-widecontagion.By increasingcapital requirementsfor systemically important financialinstitutions,contagion could be bounded or at least slowed.Switzerland will thereforeimplement a capital conservation buffer of8.5% RWA on top of theBasel III minimum capital requirementsfor allbanksof 4.5% RWA.This buffer will be limitedtosystemically important financialinstitutions,asthe contagionpotential of smaller or mid-sizefirms iscurtailed.However, aspart of thesupervisoryprocess, wealsowill require specificbuffersfor non-SIFI banksif their size, businessactivitiesand risk profilemandate capital resourcesexceedingthe Basel baselinerules.In contrast to the countercyclical buffer discussed by the BaselCommittee, neither sizenor usageof theSwisscapital conservationbuffer is directlydependent on the macroeconomicenvironment.Thebankshavetoschedulewhen and how they increasetheir capital inso-called“good times” abovethe requestedthreshold.However, a bank will be allowedtomake use of thebuffer in badtimes(e.g. whenit facessignificant losses).Solvency ii
  • 151. As soon asthe profit situationimproves, thebuffer hastobe refilled. Thesizeof the buffer hasbeen calibrated consideringthe experiencesofpreviouscrisesand model calculations.3. Systemic surchargeBanks with a higher systemic importanceshould maintain a highersolvency.Additional solvencygivesthebank‟smanagement, counterparties andregulatorsalike more timeto act, especiallyto protect thebank‟ssystemically important functions.Higher systemic importanceoften comeswitha more complexorganizational set-up and multifacetedbusinessactivitieswhich in turnlead to more difficult and time-consumingcrisismanagement measures.In addition, linking systemic importance with solvency requirementsmakes systemic importance expensive and provides for incentives toreduceit.As a third major component, a progressivesystemic surcharge consistingof twopartsisthereforeproposed:Market share-basedsurchargetakingintoaccount a bank‟ssharein theSwissdomesticloan and deposit market; andAsize-based surchargethat considersthesize of a bank‟sbalancesheet.Therelationshipbetweenmarket share, size and the resultingsurchargeis linear.Given the current situation of the Swiss big banks, both components ofthe systemic surcharge will result in ***additional capital requirementsamountingto6% of the riskweightedassets***.Solvency ii
  • 152. Total capital will demand 19% of RWAs (i.e. 4.5% RWAminimumcapital requirementsunder Basel III, thecapital conservation buffer of8.5% RWA, aswell asthe progressivesurcharge of 6% RWAbased oncurrent calibration).Box 2: Capital planning enablesbanks to fulfil upcomingrequirementsAs part of the regular supervisoryrequirements,FINMA expectscompanies toperform a prospectivecapital planning.Part of thisprocessisa systematic gap analysisof the institution‟scurrent capital situation and future capital needs, taking intoaccountregulatoryrequirements,the strategy and the risk situation of acompany, aswellasitsprojectedprofitability in the economiccycle.FINMA hasbeen closelyfollowingthe capital planningprocessand itsimplementationof thesystemically important banks.Even if the proposed TBTF frameworkhasnot yet been enacted,FINMA hasalreadyrequestedthesebanks to aggressivelybuild upcapital in order tofulfil upcoming requirementsalong a front-loadedtransitionpath.4.2 Quality of capital4.2.1 Common equityThenew Basel III rulesincludesubstantial measuresto increasethequalityof capital on whichtheSwissSIFI framework draws.4.5% of risk-weightedassetsof thebaselinerequirementsand 5.5% oftheRWAof thebuffer have to be held in common equity.This resultsin at least 10% of risk-weightedassetsto beheld in commonequity.Solvency ii
  • 153. 4.2.2 Contingent convertible bonds(CoCos)Contingent convertiblebonds(CoCos) are debt obligationsthat convertor become convertibleto equity if a specified event occurs.Once converted, CoCosare fullylossabsorbingwithout triggeringthecompany default.Thetrigger may be discretionaryor welldefinedupon issuanceof thebond.TheSwissSIFI framework proposesCoCoswhich ***automaticallytrigger if thecommon equitytier 1capital ratio(CET1) of a companyfallsbelow predefined levels***.Sincethe thresholdsare predefined, pricingmodels for such instrumentscan be applied accordingly.In order tobe acceptedunder theSwissSIFI policy, CoCoshavetobestructuredsothat theyare eligibleasa Baselcapital instrument.Depending on the actual triggerpoint, CoCoshavedifferentcharacteristics.CoCoswithlowtriggers(5% CET1) convert toequityjustbefore acomp any‟s cap ital sit u at ion falls b elow th e min imum requireme nt s.The contribution of low-trigger CoCos to the stability of the company islimited, as the capital ratio may exceed the regulatory minimum even inseverecrisis situations.However, if thesituation deterioratesrapidly, low-triggerCoCosgeneratecapital necessary toimplement crisismanagement measures,mayprevent the bank from beingput in receivership and, in a worstcasescenario, providefundsfor an orderly resolution.Solvency ii
  • 154. Sincetheytrigger just beforeresolutionprocedureswouldhavetostart,it is ensured that the capital is not used for goingconcern businessactivities.Because the conversion takes place just before resolution or even beforeliquidation procedures commence, the risk premium of a low-triggeringCoCois rather small.CoCoswithhigh triggers(7% CET1) convert whenthe company‟scapital situationis deteriorating, but thecompany is still well above theminimum requirements.High-trigger CoCosfurther improve the lossabsorbing capacityof acompany.In thisway, high-triggerCoCoscontributetothe stabilizationof acompany beforeharsher restructuringactionsare necessary.Theconversion alsocontributestosystemic stability. CoCo holdersmayeven benefit from a subsequent recovery of thecompany astheyparticipatein theupsidepotential of equity.However, it is paramount that the company‟smanagement is rapidlyableto regain thetrust of its investors.Theconversion of CoCosmay thereforeserve asan important wakeupcall for the management, the company‟sstakeholdersand regulators,and alsohelp tostrengthenmarket transparency.Of course, the risk premium of high-trigger CoCos is nearer to that ofequity and is expected to be substantially higher than the premium ofnon-convertibledebt instruments.Theusage of CoCoseligible under the proposedregime is strictlylimited.Solvency ii
  • 155. On top of the Baseland Swissminimum capital requirement of 4.5%CET1,the Swissadditional capital conservation buffer of 8.5% RWAmayconsist of CoCostoa maximum of 3% RWA.TheseCoCosmust have a high trigger, forcing conversion whenthecompany‟scapital ratioundercuts7% CET1.Theprogressivesurcharge of 6% RWAisplanned to includeonly CoCos.As part of the resolutionscheme, thoseCoCosconceptuallyconvert at acapital ratioof 5% CET1.Thecharacteristicsof CoCosare crucial to determinethe viability oftheseinstruments.This includesconsiderationson theissuingprice, the event triggeringconversion, theconversion ratioaswell asthe legal set-up of theinstrument.Instrumentswithinappropriatetermshavethepotential todestabilizeinstitutionsand marketsin a crisis situation, rather than improvingresilience.FINMA hasthereforedecidedtofollow theissuanceof such instrumentsclosely. In order tobecomerecognizedunder thecapital framework,FINMA hastoapprove theterm sheetsof the actual issues.Experiencehasshownthat supervisoryguidanceon thismatterfacilitates findingan adequatebalancebetweeninterestsof theissuingbank, investorsand supervisoryobjectives.4.2.3 Write-off bondsTheSwisspolicy proposal alsoincludeswrite-offbonds(bondswithclaims waiver).Solvency ii
  • 156. Theseare deemed equivalent toCoCos, provided that their termslead toequivalent positionsof counterpartiesfrom an economic point of viewwhichalsomeansthat the conditionstriggeringa write-downwouldbesimilar tothosecausinga conversion of CoCos.Write-down bonds would be recognized under the capital requirementsframework to the extent that an actual write-down improves the capitalratio of a company.Consequently, in order tobe recognizedunder the capital requirementsregime, thetermsof such prescriptionswouldhavetobe approved byFINMA.Theconcept of write-off bondswasprimarily introduced to openup thepossibilityof enhancingcapitalizationby contingent instrumentsalsoforfirmsthat are not stock companies and thereforecannot issueshares.This ensured that all firms can benefit from theintroductionofcontingent instrumentsintothecapital requirementsframework.Solvency ii
  • 157. Box 3: Bail-insAt international level, theconcept of “bail-ins”hasgained significanttraction.Under a statutorybail-inregime, certaindebt classeswouldbe convertedtoequitytriggeredby a discretionarydecisionof the bank‟ssupervisor,while thebank isstill a goingconcern.Thelossabsorbingpotential of equitywouldbe effectivelyextended todebt and subsequentlyto the wholebalancesheet without forcingthebank intobankruptcy.In theory, the concept iselegant:it completelyremovesthe possibilityofa TBTF bank failure asit could employbail-instosufficientlygeneratecapital.In practice, however, the concept hasseveral drawbacks.Substantial parts of a bank‟sdebt would not be available for a bail-in.This especially holds true for big retail banks, which to a large extentrefinancethemselvesby deposits(insured or uninsured).In reality, debt holderswouldhave toknow from thebeginningthat theirclaims can be bailedin, resultingin an “opt-in” arrangement, such astheissuanceof bail-in able bonds.Also, theconcept of bail-inscomeswithconsiderable legal challenges, astheinherent discrimination of certain debtor classesmay be difficult touphold.Moreconvergenceon international level in regard tokey issuessuch asthe definition of triggers,thepoint of non-viabilityaswell asa commonunderstandingon debt classesavailablefor bail-in wouldhave thepotential to significantlyenhancethe viability of thebail-inconcept inan international context.Solvency ii
  • 158. Whereasat international level bail-insseem to trigger onlyasa “last lineof defense”, i.e. justbeforethebank stopsfulfillingthestatutorycapitalrequirementsand, in normal circumstances, wouldhave togointoliquidation, the SwissSIFI frameworkprovidesfor a significant stake oflowtrigger CoCosat a level of 5% CET1.Theseinstrumentswill be alsoactivatedwhenthere is reasonableconcern that thebank is heading towardsover-indebtedness, facingseriousliquidityproblemsor doesnot fulfill its refinancingobligationsanymore (equivalent withthe point of non-viability).As a result, the probabilityof a conversion of a bail-in ablebond (viaadministrativewritedown or debt-to-equityswap) is onlyslightlyhigherthan that of a normal bond of a bank without anybail-inarrangements.Hence, the riskpremium of a bail-in ablebond may be rather small.While thisoutcome may be welcomedby companies and theirshareholders,theincentivetoreduce thesize and riskof a company‟sbusinessactivitiesmay be toolittleor non-existent.In addition, becausebail-in proceedingsare proposed for significantfinancial institutionsonly, smaller and mid-size firmsmay faceacompetitivedisadvantagein favour of big and systemically importantcompanies, effectivelyamplifying the TBTF issuerather than mitigatingit.For all that, Switzerlandhasdecided to includea bail-in mechanisminitsSwissSIFI frameworkin compliancewiththe international initiatives(e.g. FSB), but to stay, at themoment, withitsdefinitionsof the triggersandpoint of non-viability.This decision may be reassessedin faceof a possibleinternationalconsensusand thefuture availabilityof a cross-borderresolutionframework.Solvency ii
  • 159. 4.3 LiquidityThelast financial crisismade it very clear that the existingliquidityrequirementshad substantial deficiencies.TheSwissregime did not takeintoaccount the special situationof large,complex and internationallyactivebanking institutions.Today, thesituationhaschanged. In Switzerland, FINMAhastightenedtheliquidityrequirementsfor big banks, applying stressscenariosmodelledon the experiencesof the recent crisis.Thenew requirementsare already in forceand banks areimplementingthem.TheSwissimplementation is largely basedon the Basel consultationpaper of December 2009and goesbeyond that proposal in certain areas.Compared totheDecember 2009proposition, thecurrent Baselinitiativeshave beendiluted.This will result in the SwissSIFI liquidityregime significantlyextendinga future international consensus.5 Improving resolvability – reducing the impact of failureAlthough the probability of failure of a SIFI is effectivelyreduced by thecapital measuresasdescribedabove, failure of a SIFI is still possible.Thereforearrangementsshould be in placewhereby, if prevention fails, aSIFI can exit the market in a controlledmanner.Contagion or damagestothefinancial system and the economy asawholehavetobe reduced asmuch aspossible.Thebest measure toreach thiswouldbe an internationallyharmonizedresolution and insolvencyregime for SIFIs or banks in general.Solvency ii
  • 160. However, chancesof successin thenear future are small.Either way, even such a resolution regimewouldnot solveproblemsarisingout of theinterconnectednessof SIFIs and would thereforebeonlyone element on thewayto reducingtheimpact of failure.5.1Organizational requirements to support recovery andresolutionThelast crisishasshownthat thelack of preparednessof the privatesector and authoritiesalike to dissolveSIFIs in crisisscenariosis a maindriver of the TBTF issue.Hence, solutionsareneeded tomanageoperational and legal complexityof big banksin “going concern” aswellas“gone concern” scenarios.This involvesmeasuresto improve recovery and resolution of a SIFI aswell asa sound and effectiveframeworkfor crisismanagement.TheSwissTBTF proposal is threefold.First, systemically important bankswill be required todemonstrate theirresolvability not onlywithregard tosystemically important functions,butglobally.Second, theproposal doesnot only focuson theresolutionphasebutalsoconsiderseffectiverecoveryarrangementsasequallyimportant.It is crucial that companiesprepareand implement measureswhichareableto effectivelystabilize banksin a crisisand avoid resolutionscenariosto thegreatest extent possible.Third, supervisory authorities acquire an explicit role in preparingrecovery and resolution aswell asits implementation.Solvency ii
  • 161. If banks fall short of the supervisoryrequirementsand expectations,FINMA hasthepower toorder the implementationof measuresimproving resolvability.5.1.1Preconditions for effective resolutionTheeffectivenessof resolution proceduresis subject tovariouspreconditionswhichhave tobe implemented significantlybeforeanactual resolution casehastobe solved.First, there must bea viablelegal frameworkfor resolution of financialintermediariesin placeon national level.Such a regime should not only providethe appropriate tools toauthorities,but should alsogovern responsibilities– ideallybydesignatinga singleresolutionauthorityand therebyallowingfor swiftintervention without national coordinationissues.Switzerland alreadyhassuch a regime in place, not only for SIFIs,butfor banks in general.Second, therehastobe a better understandingof how nationalresolution regimesinteract in a cross-border crisisscenario.While supervisors and resolution authorities may be able to mitigatesuch issues by entering into formal or informal agreements, they canonlydo sowithintheir national frameworks.It is thereforeimportant to understand the interplayof national regimesin a cross-bordercontext and to set up appropriatepre- and in-crisiscoordinationprocedures.For itsSIFIs, the Swissauthoritieshave a long-standingtraditionofcooperationwithkeyjurisdictions.Solvency ii
  • 162. Thesearrangementshave recentlybeen formalized withincrisismanagement groupsand supervisorycolleges.However, actual resolvabilityis ultimatelya characteristic of a singlecompany operatingunder several defined legal frameworks.Henceand finally, firmshavetopreparethemselvesto allowfor theireffectiveresolution in both systemic aswell asidiosyncraticcrisisscenarioswith the ultimateobjectivebeing to protect systemicallyimportant functions.This involvesthe organizationand legal set-up of thecompany, itsgovernanceand control processes,intra-group interdependenciesregardingcapital and liquidityaswell as, ultimately, their positionvis-à-vis their counterparties.5.1.2 Preparing for recovery and resolutionTheSwissproposal requiresbanksto be organizedat any time in a waythat facilitatesresolutionin a crisissituation.Theultimateobjectiveis toprotect thenarrowlydefined systemicallyimportant functionsof a SIFI, not thebank itself.SIFIs are expectedtoprepare their organizational, operational andstructural set-up sothat their specific recovery and resolutionplan canbeexecutedrapidlyand effectively.While theSwissproposal doesnot prescribe how to reach theseobjectives,SIFIs are required todemonstrate their recovery andresolution plans(RRPs) to the regulator in detail.TheRRP processplacesthe responsibilityto define plansfor recoveryand resolution on the companies.Current Swissresolution framework for banksSolvency ii
  • 163. Failures of domestic banksin the 1990sdemonstrated the ineffectivenessof general bankruptcyproceduresand toolstohandlebank insolvencycasesand eventuallyledto thedevelopment of a specializedresolutionregimefor banks.Effectivesince2004, the regime hasbeenapplied successfullyin severalcases,includingthosein a cross-bordercontext.FINMA asthesolebank resolution authority:As a supervisoryauthority, FINMA hasexclusiveresponsibilityfor bankbankruptcyand restructuringproceedings.It hasa widerangeof toolsat itsdisposal to enableit to takepreventivemeasureswhenthe requirementsof prudent practice are not compliedwith, and to rectify existingirregularities.In the event of persistent capital inadequacyor liquidityproblems,FINMA can takemeasuresthat may lead to restructuringor bankruptcyproceedings.Thefact that sole responsibilitylies withFINMA ensures continuityandrapid action, asit knowsthebank concernedand already hascomprehensiveinformationabout it.FINMA isalsosolelyresponsiblefor theentire bankruptcyandrestructuringproceedings.It appointsand overseestheliquidatorsor thoseentrustedwithrestructuring.If necessary, it can alsobecome involved in theliquidationitself.Earlyintervention:FINMA can step in assoon asa bank isunableto complywith thecapital adequacyrequirementsfor an extendedperiod or experiencesSolvency ii
  • 164. liquidityproblems,or if there areother indicationsof impendinginsolvency.No formal evidence of over-indebtedness or inability to meet paymentobligations is required before restructuring or liquidation proceedingsare initiated.Tailor-madesolutions:Theindividual measures can be tailoredtothesituation at hand, and canbeimplementedeither individuallyor jointlyin restructuringorbankruptcyproceedings.Theydonot have tobe carried out in a particularorder.Theinitiationof restructuringproceedingsdoesnot necessarily require amoratorium.As long astheinterestsof itscreditorsare safeguarded, thebank canremainin business.Moreover, themeasuresdo not need to be madepublic unlesstheydirectlyaffect the rightsof third parties.Restructuring asan alternativeto liquidation:If there is a realisticprospect of success, FINMA can carry out arestructuringplan.Decisions taken in restructuring that fall within the powers of the annualgeneral meeting, such as capital increases, do not require the agreementof the shareholders.Theaim of theseprovisionsisto speed up the restructuring proceedings.Onlythe creditorsmay reject a restructuringplan, and then onlyif theyrepresent more thanhalf of the non-privilegedclaims.Solvency ii
  • 165. In thiscase,FINMAwill order the bank‟sliquidation(bankbankruptcy).Recognition of foreign insolvencymeasures:If a foreign authority takes measures concerning a foreign bank orsecurities dealer with a branch or assetsin Switzerland, FINMA isresponsiblefor recognisingthosemeasures.Once the claimsof thosecreditorswhoseclaimsareprotected andprivilegedunder Swisslaw have been satisfied, theproceedsof theliquidation of assetslocated in Switzerlandareturned over tothe foreignproceedings.Equal treatment of Swissand foreign creditors:All creditorsof thebank and of itsforeign branchesare entitledtoparticipatein thebank bankruptcyproceedingsinitiated in Switzerland,and aretobe accordedthe same privileges.They must, however, allow any sums they have received in foreignproceedings against the bank or itsassets to be offset against theirentitlement in Switzerland.5.1.3 Evaluating resolvabilityFINMA will develop criteria on how to assesstheviability of recoveryand resolution plans.While thedetails will be definedby a future revision of the BankingOrdinance, FINMAhasalreadycome up witha catalogueof criteriatobeimplemented witha scorecardapproach.This will alsoenabletheconstruction of a “Resolution EffectivenessTest” (RET) asan objectiveand transparent benchmark.Solvency ii
  • 166. Theassessment of a company‟sresolvability will drive twosupervisorydecisions:First, the Swissframework will definea minimum standard every SwissSIFI hasto fulfil.If a company fallsshort of theseexpectations,FINMA will have thepowertointerveneand order theimplementationof measureswhichwillbring thecompany on par withtheminimum requirements.Second, if banksdemonstratesthat theyhave significantlyincreasedtheir resolvabilityin excessof theminimum requirements, theymay beeligiblefor a capital rebateon the systemic surcharge.Such a rebate wouldbe subject to strict conditions.Banks wouldhave toprove that theyhave implemented comprehensiveand effectivemeasurestofacilitateresolvabilityand to limit the impactof failure for all of their businessactivitiesat a domesticandinternational level.Specifically, limitingthe impact on systemically important functionsalonewouldnot qualify for a rebate.ASIFI‟sRRP may favour systemicallyimportant functionsanddiscriminateother SIFI stakeholdersin Switzerlandand abroad.This is deemed acceptableto protect theoverall economy. However,theRRP plan is not isolated, but hastobe seen within thecontext of thesignificantlyextendedcapital requirements.Thesereducetheprobability of failure and, therefore,shrink thepotential of discrimination.Also, equal treatment and adequatecapitalizationin a globalperspective, i.e. of all parts of a companyeven in a resolution scenario,will be considered asan element of the resolution effectivenessSolvency ii
  • 167. assessment.Box 5: Bank leviesand resolution fundsdeemed ineffectiveFor implementationof the emergencyplan in crisissituations,bankscandraw on the capital held asa systemic surcharge.Just protectingsystemically important functionskeepsthecapitalintensity of a resolution plan reasonablylowwhichin turn allowsregulatorstorequirebanks tohold thenecessarycapital on their own intheform of a systemic surcharge.Under this arrangement, system-wideresolution fundsare consideredneither necessarynor efficient.Havinganalyzed theseideas,it isbelieved that in an acceptabletimeframe fundsmay never be of a size tocopewithsystemic crises.Requiringbankstobuild up capital for contingencymeasureson theirownbalancesheet alsoreducesmoral hazard.5.2 Minimum diversification to reduce concentration riskHavingfew bigbanks may lead to riskconcentration and a “singlepointof failure” in the financial system, assmaller and mid-size marketparticipantsmay become dependent on theservicesof SIFIs and pronetocontagion.Hence, diversification improvesfinancial stabilityand reducesthe TBTFissue.Consistent withthenew EU-regulation Switzerlandwill improve theexistingregulation of limitson risk concentration betweenbanksbyimposingper counterparty limitson interbank exposureswherebytherisk weight of exceedingexposures isincreased.Solvency ii
  • 168. However, the new risk concentration limitsaffect all banks and notmerelySIFIs.Further measuresare to bedevelopedtoreduceinterconnectedness.Operational interconnectednesshasto be considered aswell, asmanysmallerbanks haveoutsourced operationstoSIFIsor accessthefinancial infrastructurethrough them.Box 6: No restrictions on businessactivities“Volcker Rule” - likerestrictionsare not beingproposed.Narrowlydefined restrictionshave the potential tocrowdout businessactivitiesintoother market segments, eventuallybuilding upsystemically important risksbeyond thescope of financial marketregulation and supervision.Therefore, havingbanksconductingsuch activitiesin a controlledmanner and in observanceof appropriate capital requirementsisfavoured.Companieswill be ableto continuesuch operations,provided theyareableto fulfil the correspondingcapital requirementsand that theimpactand consequencesof such activitiesare consideredin the recoveryandresolution planningprocess.6Additional measures6.1Leverage ratioAll capital components(baselinerequirement, buffer, systemicsurcharge) are defined in referencetorisk-weightedassetsand arethereforedirectlydependent on thevaluation and risk assessment of theexposure.Solvency ii
  • 169. In order toput a backstop on the expansion of a company‟s balancesheetand tomitigatedeficienciesin therisk assessment models, a risk- neutralmeasureshould supplement therisk-based capital requirements.Switzerlandimplementeda leverageratioasa risk-neutral backstopmeasureback in 2008.As part of the SIFI policy, the leveragemeasurewill have to be redefinedbased on the BaselIII leverageratiodefinition.Independentlyfrom challengesresultingfrom the accountingmethodologyand thetermination of exceptionalmeasuresto thenational economy, recalibration hasto take intoaccount the systemicimportanceof thebanks concerned.Thenew calibrationcriteria are supposedto includethesizeof the bankbyimposingprogressiverequirements.6.2 Intense supervision and international cooperationIntensesupervisionof SIFIs is important in all phasesof the economiccycle asisinternational coordination.TheSwisssupervisor hasimplemented a risk-basedapproach fordecidingon the intensityof supervision.By definition, SIFIsbelong tothe most intensely supervisedcompanies.Given the international exposure of SIFIs,Switzerlandwill continuetoworkcloselywithhost supervisorsof thosecountrieswhereSwissSIFIshavea substantial market position.This cooperation hasalreadybeen formallyestablished withinsupervisorycolleges.Solvency ii
  • 170. In addition tothesecollegeswhich deal with day-to-day supervisoryissues,crisismanagement collegeshavebeen created to discuss,improveand assessrecovery and resolution preparationsof a SIFI in aninternational scope.7 ConclusionTheSwissSIFI policyframeworkdescribesa diversepolicy mix ofpreventiveand curativemeasures.Increasedcapital requirementsstrengthen the solvencyof SIFIs andtheir loss-bearingcapacity, while at thesame timeprovidingincentivestoreducesystemic importance.If prevention fails, capital instruments, which arealreadyavailableon thebank‟sbalancesheet, can be used to restructure thecompany and toprotect a narrow set of systemically important functions.Organizational requirementsmitigatethecurrent lack of effectiveresolution frameworksat least to a certainextent.Completed by improved riskconcentrationlimitsand liquidityrequirements,the SwissSIFI proposal reducescontagion risk andimprovespreparation for effectivecrisismanagement.Today, however, financial stability isa global issuewhich cannot betackledby one country alone, particularlyin the caseof globallyoperatingbanks.It isthereforeessential that the international initiativescontinueand eventuallycome up withan effectiveframeworkfor SIFIs.Solvency ii
  • 171. IntroductionLast year, the UK financial servicesindustry faced regulatorychange ona sweepingscale.At thenational level the last UK government introduced theFinancialServicesAct 2010,whichresulted in a number of changestoourobjectives,powersand duties,in particulargivingus a new financialstability objectiveand additional enforcement powers.In June 2010,the current UK coalitiongovernment announced that theFSAwill be split up.Theprudential supervisionof banks and insurerswill be moved toa newoperationallyindependent subsidiaryof theBank of England: thePrudential RegulationAuthority (PRA).TheFSAwill be renamed the Financial Conduct Authority (FCA) andwill focuson consumer protection and marketsoversight.Thegovernment alsoestablished a new committee of the Bank ofEngland with responsibilityfor deliveringfinancial stability: theFinancial PolicyCommittee(FPC).Solvency ii
  • 172. TheEuropean Union (EU), meanwhile, created three pan-Europeanagenciestoaddressthe riskof regulatoryarbitrageand improve thequalityof national supervision of banks, securitiesmarketsand theinsuranceindustry.TheEU alsocreateda new advisorybody, the European Systemic RiskBoard (ESRB), to identify systemic risksand make recommendationsformitigatingthem.Europe‟snew regulatory architecturebecame operational in January 2011and will fundamentallychangethewayin whichnational supervisoryauthoritiesoperate.Asignificant majorityof regulatory requirementswill be determinedsolelyat the EU level and national supervisorswill play a keyrole innegotiatingand agreeingthese,but their roleasdecision makerswillcentre on their function assupervisorsof firms and markets.The Financial Services Act 2010TheFinancial ServicesAct 2010(theAct), whichreceived royal assenton8April 2010,resultedin a number of changes:Consumer protectionTheAct removed theFSA‟spublic awarenessobjectiveand required ustoset up an independent bodyto take forward consumer educationwork.TheAct alsoprovidesfor more funding tobe made availableforconsumer education work.TheAct gaveusadditional powersfor theFSAtorequire consumerredress.This allowsusto make sure that consumersreceiveredressin casesinvolvinglarge-scaleconsumer mis-sellingor other failures.Solvency ii
  • 173. Financial stabilityTheAct gaveusa new financial stability objectivetocontributetoprotectingand enhancingUK financial stability.We are required tocooperate appropriatelywith the Treasury, the Bankof England and other relevant bodiesin pursuing this objective.TheAct requiresusto have and keepunder review a financial stabilitystrategy.It enablesusto gather information from entities,includingunregulatedentitiesfor financialstability purposes.It alsorequires ustoconsiderthe impact that international eventsandcircumstancescould have on financial stabilityin the UK.Enhanced powersTheAct extendsthescopeof our keyregulatorypowersto make rulesandtoalter authorisedfirms‟regulatory permissions,sowemay usethepowersin pursuit of any of our regulatoryobjectives,includingthe newfinancial stabilityobjective.We have new rule-makingpowersfor:•Remuneration:wenow havethepowertospecify that remunerationagreementsin breach of our rulesare void;• Recovery and resolution plans;• Short selling;and• Consumer redressschemes.We have new enforcement powersto:Solvency ii
  • 174. •restrict or suspendthe carrying on of regulated activitiesfor up to12months;•suspend or imposerestrictionson an approved personfor up totwoyears;•imposea financial penaltyat the same timeascancellinga firm‟spermission;•penaliseany person whoperformsa controlledfunction4withoutapproval;and•issuea warningnotice against an individual threeyears from the timewefirst became awareof themisconduct (increasedfrom twoyears).Financial Services Compensation Scheme (FSCS)TheAct containsprovisionsthat will enabletheFSCStoact asa singlepoint of contact and topay redresstoconsumerswhereredressis due tothem under other schemes,such asschemesestablished outsidethe UK.UK regulatory reformOver the past nine months, the FSA hasbegun the processof aligningthe organisation to ensure it is ready to cut over to the new regulatorystructure.As a result, weincurredapproximately£1mof direct costslast financialyear:• Programme management support £0.33m;• Regulatorydesign £0.10m;• IT design £0.33m; andSolvency ii
  • 175. •Other (e.g. HR and other central functions)£0.24m.Shortlyafter the end of our financial year in April 2011, wereplaced ourRiskand Supervision businessunitswithtwonew ones:theConductBusinessUnit, whichbroadlyaligns withtheregulatory activitiestobeundertaken bythe FCA, other than enforcement; and the PrudentialBusinessUnit, whichbroadlyaligns withthe regulatoryactivitiesof thePRA, other than enforcement. Central serviceswill continue for thelifetimeof theFSAtobe structured on an unitary basis.We are confident that our programme remains on track and furtherprogresswill be made during 2011/ 12.Anew European supervisory structureEuropean Supervisory Authorities (ESAs) and the EuropeanSystemic Risk Board (ESRB)Thecreation of ESRB and thethree new ESAsmarks a significantchangeto the wayin whichfinancial servicesregulation will bedeveloped and deliveredacrossEurope.TheESRB will undertake macro-prudential analysisat EU level toidentify riskstoEU financial stabilityand will make recommendationstoaddressthese risks.European SupervisoryAuthorities (ESAs)TheESAs became operational in January 2011.Theyare:• TheEuropean BankingAuthority (EBA);•TheEuropean Insuranceand Occupational PensionsAuthority(EIOPA); and• TheEuropean Securitiesand MarketsAuthority (ESMA).Solvency ii
  • 176. Theyreplace:•TheCommitteeof European BankingSupervisors(CEBS);•TheCommitteeof European Insuranceand Occupational PensionsSupervisors(CEIOPS); and• TheCommitteeof European SecuritiesRegulators(CESR).TheESAs areresponsiblefor developing a largeproportionof the rulesthat applyto the financial servicessector in theUK.Thesewill be issuedasEU regulations,sowill be directlyapplicableacrossthe EU.As well asdevelopingbinding rules, theESAshave powersto:• imposea temporaryban on financial activities;• investigateallegedbreachesof EU rules;• take bindingdecisionsin emergencies;• arbitratein disputesbetweennational supervisors;• play a coordinatingrole within collegesof supervisors;• undertakepeer review;• directlysupervise credit rating agencies(ESMA only); and•require information to be passed tothem that isnecessaryfordischargingtheir responsibilities.In 2010/11, wedevoted significant resource during thenegotiation of theESAlegislationtoensure that the ESApackageasa wholesecured thekey objectivesof:Solvency ii
  • 177. •protectingthe singlemarket;• addressingthe risksarisingfrom regulatory arbitrage;• raisingstandardsof supervision among national supervisors; while•retainingresponsibility for day-to-day supervision at thenational level.Once the ESAlegislativepackagewasagreedin theAutumn of 2010, ourfocus shifted topreparing for thenew European order. During 2010/11,we:• influencedthe ESAsregulatoryframeworkand operatingmodel;• adaptedour operatingmodel to work effectivelywiththe ESAs;•enhanced our secondmentsstrategyand identifiedtrainingrequirements;and• developed systems tohandleESAdata requests.Financial stabilityIntroductionDuring 2010/ 11theFSA‟s mandatewassignificantlyextended.FromApril 2010,weweregiven a new statutoryobjective, whichmademore explicit the responsibilitiesfor promotingfinancial stability that wehadbeen exercisingunder the „market confidence‟objectivemandatedunder FSMA.At the same time, our supervisoryapproachcontinued to progresstowardintensivesupervision and proactivechallenge, laying thegroundworkfor thepreventativeinteraction frameworkthat will guidethePRA.Solvency ii
  • 178. We continuedtoembed theorganisational and cultural change neededto implement intensivesupervision, moving our regulatory approachfrom retrospectiveinterventiontoproactivechallenge.Our supervisorsmade judgementson firms‟businessmodels;interveningearlyif theyanticipatedanyrisksthat might arisefrom firms‟businessstrategiesand approachestofunding and capital.This approachhasdemanded qualitystaff, industry knowledgeand thewill to challengethe industry robustlywherepotential threatswereidentified.We contributed significantlyto thedevelopment of a robust policyreform programme, driven by the initiativesand issuesidentified in TheTurner Review and the widerpolicy agendamandated by the EU.And the FSAcontinuedtoplaya leadingrole in influencingregulatoryreform on the global stage, while ensuringthat theUK arrangementson,for example, key issuesof capital and liquiditywere consistent withthedirection of international standards.This section describesthe workweaccomplished in theseareas, undertheseheadings:•TheFinancial ServicesAct – our new financial stabilityobjective;• FSAsupervision – a major intensificationof approach;•Progresson reformingthe internationaland European regulatoryframework– policyand practice;and• Specificmeasurestostrengthen firms‟resilience.We alsoincludetheprincipal metricsweuse toassessour supervisoryeffectivenessin relation toour financial stabilityobjectiveand to gaugefinancial stabilitygenerally.Solvency ii
  • 179. Theseare:Supervisory effectivenessChart 1:SupervisoryissuesclosedChart 2: Firm feedback on thequalityof FSAsupervisoryriskassessmentsMeasuresof financial stabilityChart 3: Cost of creditChart 4: FSAfirm cancellationsChart 5: MajorUK banks– CDSspreads,five-year seniordebtSolvency ii
  • 180. Acentral tool in supervisionisidentifying the risk mitigationactionsfirmsmust take.Looking at the quantityidentified and speed whichwiththeseare closedgivesa perspectiveon the intensityand effectivenessof our supervision.Thenumber of issuesclosed in Q4 2010/11is 439(from 303in Q32010/11);thisrepresents17% (12%in Q3 2010/11) of thepopulation ofopen issues.This showsan absolute and proportional increasein thenumber ofissuesclosed than previouslyreported.Theproportion of high-risk issuesclosed wasslightlyhigher than otherissuesat 18%, reflectingusprioritising issueswiththe most risk.Also, about 40% of the issues(recordedand closed) werein respect ofhigh-impact firms, reflectingthe enhancedfocusof our riskassessmentandmitigationworkon thesefirms.From our regulated firms‟perspective, the qualityof our risk assessmentin thelast six monthshasreduced slightlyfrom 5.2down to4.9, withtheSolvency ii
  • 181. most significant reductionsin our MajorRetail GroupsDivision andRetail Division.Riskmitigationis scored more positively at 5.3, but again thisrepresentsa fall againstthe5.6recorded for the six monthstoJune.However, scoresremain positivein thecontext of a 1-7scoring system,where4 is neutral.Thedeteriorationmay have been driven by the amount and pace ofregulatorychange, which hascontinued to put pressure on both sidesofthefirm-supervisoryrelationship.Thecurrent cost of interbank borrowing(measured by the Libor-OISspread) – in a context and relativeto the extremesof 2008– isnotexcessive.Solvency ii
  • 182. However, spreadshaverecentlyentereda slightlymore volatile period,driven bymovement in the OISswaprate.In part, this reflectsuncertaintyabout theshort-term outlookfor thebank rate, amid persistent above target inflation and variableinformation about theperformanceof theeconomy.This chart showsthenumber of authorisedfirmsthis year that havecancelledtheir authorisation with theFSA.Not all cancellationsare necessarilyfailuresand not all failures areregulatoryfailures.Solvency ii
  • 183. Nevertheless, thischart givessome indicationof the level of distressinthesystem.During 2010/ 11, therewasa significant reductionin thecancellationrateamong significant impact firms.UK banks‟credit default swaps(CDS) spreadsare a measureof howinvestorsperceivethe default risk posedby thesefirms.UK banks‟CDSspreadsrosein November, asthe Irishsovereign crisispushed up CDSspreadsfor Eurozone sovereigns.Spreadsfor some of thebanks fell back after the EU and IMF bailoutwasannounced.HSBC and Standard Chartered haveseen swapratesrise in early2011duetoconcernsin the aftermath of theJapaneseearthquake.Solvency ii
  • 184. Nevertheless, usingabsoluteCDSasan indicator, theyremain thebankswith the lowestperceived credit risk, driven in part by their strength inemergingmarket economies.Solvency IIAs wesaid in our BusinessPlan for 2010/11, SolvencyII is a fundamentalchangeof the prudential regime for theEuropean insuranceindustry.It aimstoestablisha revised set of EU-wideriskmanagement standardsand capital requirementsthat will replaceand harmonisethecurrentarrangements.Policy in this area continuestobe developed in Europe.There havebeen delays tothetimelinethat have affected our ownconsultation and shortenedthe windowfor implementation.Asa result, weare lookingfor waystomanagethis uncertainty.At the same time, wehave continuedtocontributeto the development oftheDirective, such asthrough our involvement in the workof EuropeanInsuranceand Occupational PensionsAuthority (EIOPA).We continueto lead someof theworkinggroups, and Hector Sants wasappointedto the EIOPA Management Board in January 2011.Our work with the UK industryWe have maintained closecontact withtheUK insuranceindustry onboth policyand implementation issues.We continuedin 2010to engagewithfirms tounderstand how thedeveloping requirementsaffect them and inform our contributionstoEIOPA.Solvency ii
  • 185. We alsohad ongoingdiscussionswithfirms about how prepared theyarefor the new regime.Thefifth quantitativeimpact study (QIS5) helped usincreaseourdialoguewith firmson both fronts.We gavebriefingsand ran workshopstoeducatefirms about theimportanceof taking part in QIS5.We encouraged firms of all sizes and types to participate in the exerciseto provide a robust evidence base to inform the ongoing development oftheSolvencyII landscape.During the exercise, weanswered over 600queries,and the UK report toEIOPA wascompiled withsubmissionsfrom 267solofirmsand 35groups,representingover 70% of the market.We alsohad discussionswithfirms about thepractical implicationsforthem and wewill continueto dosoin therun up toimplementation.We have continued tomake progresswith the internal model approvalprocess(IM AP).We publishedan updatein April 2010settingout the pre-applicationprocessfor firms, and thefindingsof thethematic review in February2011.At the end of March2011, started thenext phaseof IM AP asweendeavour togive asmany firmsaspossiblea decisionon their modelfor day one.We further detailed our approach at our SolvencyII ConferenceinApril2011– more informationabout thisis available on thededicatedSolvencyII pagesof theFSAwebsite.As stated above, wehad startedto prepare our consultations;however,the publication of the OmnibusII proposalsto amend theSolvencyIISolvency ii
  • 186. Directivetobring it in linewiththenew European regulatory structureand allowfor transitional provisionshasmeant that our consultationtimetablehasbeen affected.Our consultation processwill relate to the transpositionof the level 1textof the Directive and consequential changestothe Handbook.We expect topublish the first ConsultationPaper later thisyear.We will review theEuropean policy timelinesregularly, and publish ourownconsultation timelineon our websitein due course.Internally, wedevelopedand delivered technical training for supervisorsand other specialistsworkingon SolvencyII.At the end of March, wehad trained over 450people.Todeliver SolvencyII wehave increasedour resourcessignificantly,with recruitment ongoingto providethe skillsand processesto supportand deliver the implementationof theDirective.Most recently, we shared our current thinking on the policy issues andimplementation approach, with approximately 550 people from the UKinsuranceindustry at our Solvency II Conferenceon 18April 2011.•We outlined our two-tier approach tothewaywewould allocateresourcestofirms in thepre-applicationphaseof IM AP.•We discussed the main policy uncertainties, which we also set out inthe accompanying conference document Delivering Solvency II, April2011.•We outlined the keydates,includingour assumptionsthat fullimplementationwill be on 1January 2013, and that wewouldbe open toreceiveapplicationson the provisionsof the Directivethat require ourapproval.Solvency ii
  • 187. •We underlinedthe importanceof the UK industry‟scontinuedinvolvement in developingthe approach toimplementation in EuropeandtheUK.We will do this through a number of different fora, including the existingInsurance Standing Group and its sub-groups, which has over 100 peopleregisteredtoreceiveinformation.We will alsocreatenew onesasneeded.We publishedan overall updateon SolvencyII in June 2010on all pillarsof the Directivetoinform and motivate firms to take action asneeded.We have tailoredour information for smallerinsurersthrough our eventsand our website,includingthingsfor firmstoconsider whencreatingtheir implementationplans.We alsogavebriefingsto market analystsand ratingsagencies(February2011), and to non-executivedirectorsof insuranceand reinsurance firms(JanuaryandApril 2011) aspart of our educational programme.2011/ 12is criticalin our preparationsfor implementingSolvencyII, inEurope and the UK.We are confident that our implementation approach will help us deliverour SolvencyII programme and carryout our obligationsfully.Solvency ii
  • 188. Interview with Gabriel Bernardino,Chairman of EIOPA, conducted by JanWagner, Versicherungsmagazin(Germany)TheEU‟snew regulatory regime for insurers,knownasSolvencyII, will take effect from 2014.Although hailed by EU regulatorsasaninnovation, the regime hascome under sharpcriticism from smallerinsurers,includingseveral in Germany.Theycomplain that thescheme favorsbiggerinsurerswhohavethe resourcesto easily adjusttothe new regime.Wrong says Gabriel Bernardino, whoaschairman of the EU insuranceandpension regulator EIOPA will be SolvencyII‟schief enforcer.Versicherungsmagazin spoketohim at length.WhyisSolvency II needed?Has not Solvency I ensured for awell (functioning insurance industry?I know of no casesinGermany where the insured lost their money whenan insurerwent under.Theideawasnever that SolvencyII wouldfix themarket becauseSolvencyI failed, or becauseinsurersneededmore capital.Theideawasrather a move toward a risk_based system.Theproblem isthat thereis misallocationof capital among companies.Somehave more capital than theyneed, and some have less.This hasnegative consequencesfor protectionand pricing.Solvency ii
  • 189. Toillustratethis, let ustaketwoinsurancefirms withthe sameliabilitiesbut twodifferent investment strategies.One is based onsharesand the other isbased on bonds.From a market perspective, you wouldconcludethat thefirm with asharedriven strategywouldneed to hold more capital than theone witha bond driven one.But the current regime doesn‟t require this! The riskson theasset sideare not taken intoaccount, and that‟swhat Solvency II aims toresolve.Are European insurers prepared for the transition to SolvencyII?When SolvencyII beginsin 2014,there will be no „Big Bang.‟That‟sbecausesome of its elementsare already in the system.In Germany for example, incentivesfor better risk management andgovernanceare embeddedin MaRisk, whichis alreadyin force.Theobjectiveis not to force insurerstohavemore capital. It israther tohavecapital better aligned with therisks.You will have companiesthat havemore capital than theyneed under arisk basedsystem and othersthat dohave lessthan theyneed.For thosewhohave less, it‟sfair to askthem to raisemore capital.But even in the latter situation, SolvencyII is accommodating.You don‟t need toapplyit immediately from 2014,soyou have timetoraisethe capital you need.Another exampleis thelife businesswherea transitionperiod applies toSolvency ii
  • 190. calculationsof the liabilitiesaccordingtoSolvencyII.Isn‟t it true though that big listed insurershave an advantageover mutuals, asthey will be able to raise the capital they needunder Solvency II more easily?If you look at mutualsaround Europe, theycollectivelyhave much morecapital than public companies.I thereforedon‟t think SolvencyII will be a big burden for them.Moreover:If theycan demonstrate totheregulator that theyeffectivelymanagethe riskson their investments,theymay deviatefrom thestandard model withits set of risk chargesand use an internalone whichis more flexible.Sosmaller insurers have nothing to fear from Solvency II?I‟m not saying that the introductionof SolvencyII will have no effect onthe market.Somethinglike thisalwaysdoes.One possibleconsequenceof SolvencyII is that there will be someconcentration in certain markets. But we‟reseeingthis already!Some insurers complain that Solvency II will compel them toinvest in safe, but low yielding instruments like bonds, astheycarry no risk charge.Clearlythat‟snot what wehaveseen and that‟snot what wewill see.TheUS asset manager Black Rock did asurveysome monthsagoinwhichit asked European insurerswhat asset classestheywouldtargeteven under SolvencyII.Solvency ii
  • 191. Theyreplied that theywouldinvest more in alternativeinvestmentslikehedgefunds, venture capital and project finance.And why?In a lowinterest rate environment insurershave to find waysof boostingreturns.No one is saying that withSolvencyII you have to invest more in this orthat asset class.We‟re merely saying that if you have more risk, you should have morecapital.Given the European debt crisis, doesit still make sense torequire no risk charge for sovereign bonds. Greek bondscanhardly be considered safe instruments…Although there is a zero risk charge for sovereignbonds, SolvencyIIdealswiththe specificityof the variousasset classesin that marketvaluationsare used.This is different than in thebankingsector.If sovereign debt in theportfoliosof insurersweretobe assessedunderSolvencyII, it wouldneed to be ratedaccordingtotherisk that themarketsperceivenowadays.And that perception hasdefinitelychanged withthe debt crisis, noquestion.Soif sayGerman Bundsdecreasein value, this isimmediatelyreflectedon theportfolios of the insurers,and this is the figure you takeintoaccount in order tocalculatethedifferencebetweenyour assetsandliabilities.Solvency ii
  • 192. If thereforean insurerhasa 100percent solvency requirement, but themarketspenalizesome bondson the portfolio, then the assetsdiminishvalueand your solvencydiminishes.Soyou see, SolvencyII doestakethe risk associatedwithsovereignbondsintoaccount.For assetswhicharemore volatile like sharesand real estate, a furtherrisk chargeapplies.Will the reporting requirementsunder Solvency II be a burdenfor smaller insurers?Therequirementsare harmonized around Europe, sothismakesthingseasierfor crossborder companies.But thisis alsogood for medium sized oneswithbusinessin twoorthreecountries.Havingone system of reporting providesa hugecost benefit for allinsurersdoing crossborder business.Theideais tobring more commonalitytosupervision.Secondly, we‟vegot theprincipleof proportionalityappliedtotheultimate extent.There will be of coursemore complexityfor those insurerswhoareinvestedin saystructured productsor use derivatives.But if you don‟t invest in thesekindsof instrumentsyour reportingwillbelesscomplex.There will be annual reporting, whichismore comprehensive, aswell asquarterlyreportingon the most important elements.Solvency ii
  • 193. But for smallercompanieswhoserisk profile doesn‟t reallychange, theregulatorshave theoption of waivingthequarterly reportingrequirement.Will Solvency II be applied to pension funds?As I have alwayssaid, thisis not a copy_paste exercise.There areelementsof SolvencyII that make lotsof sensefor pensionfunds,such asgovernance, transparencyand riskmanagement.Theseare knownasthe second and third pillarsof SolvencyII.In termsof thecapital requirements, or the first pillar of the regime, weconcluded that there is great diversity among pension plansin Europe.There areplansthat are basicallyinsurancetype contracts, and in thoseyou should have a regimelike SolvencyII.But thereare alsoemployer sponsoredplanswherethe risk is nottransferredtothe insured.This is a different type of system than theinsurancetype, and it makeslittlesense to applyexactlythesame capital requirements.Solvency ii
  • 194. Hearing on the ESRB before the Committee on Economic andMonetaryAffairsof the European ParliamentIntroductorystatement by Mario Draghi, Chair of the ESRBBrussels,31May2012Dear Madam Chair,Dear Honourable Members,I am very pleased to appearbeforethis Committeetoday to present thefirst annual report on the activitiesof theEuropean Systemic Risk Board(ESRB) – of whichyou have all receiveda copy and whichisbeingpublished asI speak.In my remarkstoday, I will refrain from repeatingthe content of thereport and will instead focuson threekey areasof the ESRB‟sworkoverthepast year, whichwill alsokeep usbusy for the foreseeablefuture.Theseare:i)Theassessment of systemic risks;ii)Theestablishment of a sound macro-prudential frameworkin the EU;andiii)Medium-term structural developmentsin the EU financial system. Iwill thenbe at your disposal for questions.1.Assessment of systemic risks in the EU financial systemIt is lessthan a year sincetheESRB cautionedthat theriskstotheEUfinancial system had become systemic.Solvency ii
  • 195. After a period of stabilisationon theback of actionsbycentral banks andother institutionsearlier thisyear, more recentlythere have been renewedboutsof volatilityand uncertainty, although not at the same levelsreachedin November 2011.Fundamental challengespersist. In my view, theseinclude:i)Limitingcontagion betweenMemberStatesacrossthe EU; andii)Promoting a macroeconomicstrategythat, together withfiscalconsolidation, supportsgrowth and furthersthe competivenessadjustmentsneeded to tacklethe economicimbalanceswithin the EU.Addressing thesechallengesin a decisiveand sustainablemanner is aprerequisitefor the successof measurestoensure a more resilientfinancial system capableof supplying, on a sustainablebasis, thefinancial servicesnecessarytosupport economic activity.From a macro-prudential point of view,suchmeasuresinclude:i)Implementingcrediblemechanismsfor the recapitalisationandrestructuringof banks, whereneeded; andii)Improving bankingsupervision and resolution at theEuropean level.In the past, the ESRB hasunderlined theneed for all national andEuropean authoritiesto act, and todosoin unison, withspeed, ambitionand a total commitment tosafeguardfinancial stability.Today, I reiteratethiscall, whileacknowledgingthe effortsundertakensofar.Withinthe broader economicand financial context, the financial systemcontinuesto facethe challengeof adjustment in order to addressimbalancesaccumulated in thepast.Solvency ii
  • 196. For banks, progresshasalreadybeen made on some fronts, but more isneeded. For other financial sectors, it is important that international andEU reforms, designedto improvetheir resilience,are fullyimplementedand adhered to– an issuethat I will return to later.TheESRB is concernedwith twoaspectsof banks‟adjustment.First, it shouldbe carried out in an orderly wayto support economicgrowthtothe full extent necessary, without exacerbatingmarket fragilityandthepositionsof othersin the financial system.Second, the degree of adjustment planned by the EU banking sectorover the coming years must be sufficient to restore confidence in thestrength of banks‟balancesheets.With regard tothe first point, official data and surveys from manycountriesacrosstheEU indicatesome overall stabilisationin financialconditionsin the earlypart of this year.However, the recent turbulencehighlightstheuncertaintysurroundingtheoutlook for thesefinancial conditions, given their link tothesoundnessof EU banks‟balancesheetsand, in turn, the direct orindirect connectionsbetweenthosebalancesheetsand sovereignvulnerabilities.Concerningthe second point, closemonitoring and a systemicassessment of thefeasibilityand nature of the adjustment bybanks, aswell aswithin thefinancial system more broadly, is crucial.In thisregard, the ESRB hascalledupon its partnerswithin theEuropeanSystem of Financial Supervision – supervisoryauthoritiesat the nationaland EU level – toregularlycollect detailed, ex anteinformation frombanksand other key players in thesystem, and report it tothe ESRB.TheGeneral Board will review the latest developments– and theirimplications– at itsmeetingin June.Solvency ii
  • 197. 2. Asound macro-prudential framework for the EULet me nowturn to the workundertaken toestablish a frameworkcapableof addressing thedeficienciesof thepre-crisisframeworkinpreventingand mitigatingsystemic risksin the EU.While the launch of the ESRB wasa first, and necessary, stepin thisrespect, it is vital todevelop a sound and comprehensivemacro-prudential framework for both theEU asa wholeand the individualMemberStates.As indicated in theAnnual Report, this hasbeen one of the ESRB‟sprioritiessinceitsinception.First, in order to create a solid foundation for pre-emptive action againstsystemic risks, it is essential to develop macro-prudential mandates andtools.In its recommendation published in January, the ESRB highlightedtheneed for well-definedmacro-prudential mandatesfor national authoritiestoact either on their owninitiative,or in responseto theESRB‟sadvice.In accordancewiththe ESRB‟sduty tofollowup on itsrecommendations, the first reportsfrom the Member Statesoutliningtheir progressthusfar are expected by theend of Juneunder the ESRB‟s“complyor explain” mechanism.Akey lesson from the past is that financial or systemic stabilitymandatesmust be accompaniedby the meanstoact.Macro-prudential authoritieswill need tobe equippedwitheffectivepolicy toolstorespond, in a pre-emptiveway, tothe complex and ever-changingvarietyof systemic risks.TheESRB is currentlyworkingon identifying the minimum set of toolsnecessaryfor conducting macro-prudential policiesthroughout theEU.Solvency ii
  • 198. Second, it is crucial toensurethat macro-prudential issuesare taken intoconsiderationwhendeveloping EU legislationfor thefinancial sector,giventhe impact that such regulationscould have on incentiveswithinthefinancial system.In thisregard, I wouldlike to touch on a number of important piecesofEU legislationthat theESRB hasbeen following:i)Adraft directiveand regulation on capital requirementsfor creditinstitutions(the“CRD/CRR”);ii)Theproposal for a regulation on OTC derivatives,centralcounterpartiesand trade repositories(“EMIR”);andiii)Thepart of the proposal for the OmnibusII directivethat concernstheregulationof theinsurancesector.With regard to the CRD/CRR, I very much welcome the recent progressmade by thisCommittee, as well as by the EU Council, on advancing theproposalsput forth by theCommissionlessthan a year ago.Your worktogether with theCouncil providesa promisingbasisfor theestablishment of important macro-prudential instrumentsfor addressingsystemic risksin thebanking sector.Toassist you, and the Council, in your workon theCRD/CRR, theESRB wrote toyou in Marchoutlininga number of macro-prudentialprinciples.I urge you toconsider theseprinciplesin order to ensure that macro-prudential authorities,at both theEU and national level, are fullyequippedwitha flexibleset of policytoolsand sufficient scope to actearlyand effectivelytoprevent the build-up of systemic risksin thefuture.Solvency ii
  • 199. Obviously, discretion to pursuemacro-prudential policiesrequiresefficient coordinationasa safeguard against potential negativeexternalitiesor unintendedconsequences.TheESRB is readytoplay a central role in this respect, and work isunder waytoestablisha general framework for thecoordination ofnational macro-prudential policiesbytheESRB, wheresuch policiesgiverise to material spilloversacrossborders.Theagreement on EM IR wasalsoan important step forwardinimplementinglessonsfrom thecrisis, and it includesa number of usefulelementsto safeguard financial stabilityin the EU.TheESRB hasstartedpreparationsfor performingthe tasksassignedtoit under EMIR.From a macro-prudential perspective, however, I should point out that, intheview of theESRB, EMIR doesnot addresstheissuesraisedbythepossiblepro-cyclical effects of either easingor tighteningof collateraleligibilityand of requirementsfor transactionssubjectto centralcounterpartyclearing.In accordancewithitsresponsibilities, theESRB continuestoexaminewhetherand how collateral requirementscould be applied asa macro-prudential tool at a later stage.Thenew regulatoryframework for insuranceactivitiesiscurrentlybeingfinalised.Someimportant aspectsof thisframework – suchasthoserelatedtothetreatment of long-term guarantees– are beingdiscussed over thenext fewdaysaspart of the “OmnibusII trialogue” discussions,in whichthisCommitteeisactivelyinvolved.TheESRB is awarethat several of the issuesat stake are potentiallyrelevant from a macro-prudential point of view.Solvency ii
  • 200. In particular, the new regulatory framework (Solvency II) may amplifythe procyclicality of insurers‟ balance sheets and, in particular, capitallevels.This hasbeen recognised by thelegislator, whichis designingseveralpolicy instruments(includingsome of a macro-prudential nature) tomitigateprocyclicalityand other factors.It is crucial that such instrumentsare designed to deliver a clearandcredibleobjectiveand that their interactionis duly consideredto ensurethat the useof theseinstrumentshastheintended effect.3. Structural developments in the EU financial systemFinally, I wouldlike tohighlight some medium-term, structuraldevelopmentsthat the ESRB is currentlylookingat, witha view togainingabetter understandingof their implicationsfor systemic risk andtoidentifying appropriate policyresponsesfor deliveringamore resilientfinancial system.TheESRB is devoting particular attentionto structural aspectsof boththetraditional banking sector and the shadowbankingsector.Before commenting on developmentsin thesesectors,I wouldlike tobrieflysaya few wordson thewholefinancial system, whichis currentlyundergoing a regulatoryreform in all its segments.An important goal of suchreformsisto ensure a sustainablesupplyoffinancial servicesfrom the system totherest of the economy.In Europe, the financial sector hastraditionallybeen centred aroundbanks.However, some activitiesmay shift toother – maybe lessregulated – partsof the system in the yearsto come, perhapsasa direct consequenceof thecurrent crisisor asa result of the overhaul of standardsfor regulatedactivitiesand entities.Solvency ii
  • 201. While such developmentscan, in principle, be of benefit to the system,theymust be monitored closelyin order tolimit the emergenceof newvulnerabilities,for examplethose stemmingfrom shifts driven byregulatoryarbitrage.Turning to thebankingsector, the onset of the financial crisisrevealedsignificant shortcomingsin banks‟funding structures– part of thenecessaryadjustment I referred to earlier involvesa transition tomoresustainablefundingstructures.However, banks‟abilityto managethis adjustment is beinghamperedbyconditionsin European interbank and unsecured credit markets.As a result, there hasbeen a rise in banks‟recourseto securedfundingmarketsand innovativefunding instruments.TheESRB is analysing theseshiftsin funding behaviour carefullyfrom amacro-prudential perspective, toensure that unintended consequencesornew systemic vulnerabilitiesassociatedwithsuch behaviour donot goundetected.Theincreasedrelianceon secured fundingraisesconcernsabout theextent towhichbanks‟assetsbecome encumbered.If taken too far, insufficient amountsof unencumberedbank assetsin thefuture could reducethe stabilityof fundingwithin the system and, in aself-fulfillingmanner, reinforcethe lack of accesstoprivateunsecuredmarketstoday.Furthermore, innovativesourcesof privatefunding for banks– such asliquidityswapsbetweenbanksand other parts of thefinancial system –could have implicationsfor thelevel of interconnectednessin the system,aswell asthe durabilityof funding during future downturnsor stressperiods.Turning to theshadow banking sector, the instabilitiesthat can arisefrom a highly interconnectedsystem wereexposed by the financial crisis.Solvency ii
  • 202. Shadowbankingactivitieswerea major contributor tothatinterconnectedness,in particular given theinterlinkagesbetweentheregular bankingsectorand thecomplex, and opaquechainsof financialintermediationthat emerged withinthesystem.Theyalso, directlyand indirectly, helped to facilitatethesubstantial risesin leveragein some economies.As indicatedin theAnnual Report, theESRB hasalreadybegun work inthisarea.This hasinvolved, for example, identifyingand assessingpotentialsystemic risksassociatedwithEuropean money market funds, on whicha report issoon tobe publishedasan ESRB Occasional Paper.TheESRB is alsofinalisingits replytothe consultation launchedby theEuropean Commission through itsGreen Paper on Shadow Banking,whichwaspublished earlier this year.Looking ahead, from a policyperspective, measuresto tacklesystemicrisksassociated withtheshadowbankingsystem will need tobe tailoredtothe specific risksstemmingfrom the different activitiesconductedunder the shadowbankingumbrella.It is important that horizontal focusbeplaced on the economicnature offinancial activities,i.e. on ensuringthat activitiescarried out within thesystem, and whichinvolve maturity and liquiditymismatches,leverageand/ orincompleterisk transfer, fulfil theappropriate prudentialrequirements,irrespectiveof wheretheyare carried out or by whom.Finally, it will be important toensure global consistencyand thereforethefull and consistent transposition in the EU of policy initiativesagreedat theinternational level, notablythoseduetobe announced bytheFinancial StabilityBoard.In thisregard, theESRB standsreadytoworktogether with the relevantinternational and EU institutionsand bodies.Solvency ii
  • 203. ***Let me nowconcludeby stressing that all the ESRB activitiesthat I havepresentedhere todayhave been carriedout withthe full involvement andsupport of all ESRB member institutionsand bodies– notablytheAdvisory Scientific CommitteeandAdvisory Technical Committee– andin closecooperation with the three European SupervisoryAuthorities.For this weare grateful and look forwardto a continued fruitfulcooperationin the future. Thank you very much for your attention. I amnow at your disposalfor questions.Solvency ii
  • 204. Course TitleCertified Solvency ii Professional (CSiiP):Preparing for the Solvency ii Directive of the EU (3 days)Objectives:This coursehasbeen designed toprovidewiththe knowledgeand skillsneeded to understand and support compliancewiththeSolvencyiiDirectiveof theEuropean Union.TargetAudience:This course isintendedfor decision makers, managers, professionalsand consultantsthat:A.Work in Insuranceor Reinsurancefirmsof EEAcountries.B.Work in Groups- Financial Conglomerates(FC), Financial HoldingCompanies(FHC), MixedFinancial HoldingCompanies (MFHC),InsuranceHolding Companies(IH C) - providing insuranceand/ orreinsuranceservicesin the EEA, whoseparent islocated in acountry oftheEEA.C.Want tounderstand thechallengesand the opportunitiesafter theSolvencyii Directive.This course ishighlyrecommendedfor supervisorsof EEA countriesthat want to understand how countriesseeSolvencyII asa CompetitiveAdvantage.This course is also recommended for all decision makers, managers,professionals and consultants of insurance and/ or reinsurance firmsinvolvedin risk and compliancemanagement.About the CourseINTRODUCTIONTheEuropean Union‟sLegislativeProcessSolvency ii
  • 205. Directivesand RegulationsTheFinancial ServicesAction Plan (FSAP) of theEUExtraterritorialApplication of European LawExtraterritorialApplication of the SolvencyII DirectiveSolvencyii and theLamfalussyProcessLevel 1: FrameworkPrinciplesLevel 2: Detailed Technical MeasuresLevel3: StrengtheningCooperationAmong RegulatorsLevel 4: EnforcementWeaknessesof SolvencyIFrom SolvencyI toSolvencyIISolvencyii PlayersSolvencyii ObjectivesTHE SOLVENCY II DIRECTIVEAUnified LegislativeBasisfor Prudential Regulation of InsurersandReinsurersRisk-BasedCapitalAllocationScope of theApplicationImportant DefinitionsValue-at-Riskin SolvencyIIAuthorisationCorporateGovernanceGovernanceFunctionsRiskManagementCorporateGovernanceand Risk Management - Level 2Fit and proper requirementsfor personswhoeffectivelyrun theundertakingor haveother key functionsInternal ControlsInternalAuditActuarial FunctionOutsourcingBoard of Directors:Role and Solvencyii ResponsibilitiesSolvency ii
  • 206. 12Principles– System of Governance (Level 2)PILLAR 2SupervisoryReview Process(SRP)Focuson Risk Management and Operational RiskOwnRisk and SolvencyAssessment (ORSA)ORSA- TheInternal Assessment ProcessORSA- TheSupervisoryToolORSA- Not a Third SolvencyCapital RequirementCapital add-onPILLAR 3DisclosureRequirementsTheSolvencyand Financial Condition Report (SFC)PILLAR IValuationOf AssetsAnd LiabilitiesTechnicalProvisionsTheSolvencyCapital Requirement (SCR)TheValue-at-RiskMeasureCalibratedtoa 99.5% ConfidenceLevel over a 1-year TimeHorizonTheStandardApproachTheInternal ModelsTheCollectionofAdditional HistoricalDataExternal DataThe Minimum Capital Requirement (MCR)Non-Compliancewiththe Minimum Capital RequirementNon-CompliancewiththeSolvencyCapital RequirementOwn FundsInvestment RulesINTERNAL MODEL APPROVALCEIOPSLevel 2 - Testsand Standardsfor Internal ModelApprovalSolvency ii
  • 207. CEIOPSLevel 2 - The procedure tobefollowedfor the approval ofan internal modelInternal ModelsGovernanceGroup internal modelsStatistical qualitystandardsCalibrationand validationstandardsDocumentation standardsSOLVENCY II, GROUP SUPERVISION AND TH IRD COUNTRIESSolvencyI: SoloPlusApproachGroup Supervisionunder SolvencyIIRightsand dutiesof the group supervisorGroup Solvency - Methodsof calculationMethod1(Default method):Accounting consolidation-basedmethodMethod2 (Alternative method): Deduction and aggregationmethodParent UndertakingsOutsidethe Community - Verification ofEquivalenceParent UndertakingsOutsidethe Community - Absence ofEquivalenceThehead of thegroup isin theEEA and the third country regimeis not equivalentThehead of thegroup isin theEEA and the third country regimeis equivalentThehead of thegroup isoutsidethe EEAand the third country isnot equivalentThehead of thegroup isoutsidethe EEAand the third countryregimeisequivalentSmall and Medium-SizedInsurers:TheProportionalityPrincipleCaptivesand SolvencyIIEQUIVALENCE WITH SOLVENCY II AROUND THE WORLDSolvencyii and Countriesoutsidethe European EconomicAreaSolvency ii
  • 208. TheInternationalAssociation of InsuranceSupervisors(IAIS)TheSwissSolvencyTest (SST) and Solvencyii:Solvencyii and theOffshoreFinancial Centers(OFCs)Solvencyii and theUSASolvencyii and theUS NationalAssociation of InsuranceCommissioners(NAIC) - The Federal InsuranceOffice createdunder the Dodd-Frank Wall Street Reform and ConsumerProtectionAct in theUSA, and the ORSAin theUSAFROM THE REINSURANCE DIRECTIVE TO THE SOLVENCY IIDIRECTIVEDirective2005/ 68/ EC of 16November 2005on Reinsurance- TheReinsuranceDirective(RID)CLOSINGTheImpact of Solvencyii OutsidetheEEAProvidingInsuranceServicestotheEuropean ClientCompeting withBanksLearningfrom theBasel ii FrameworkRegulatoryArbitrage:AMajorRisk for Countriesthat seeComplianceasan Obligation, not anOpportunityBasel II, Basel III, SolvencyII and RegulatoryArbitrageChallengesand Opportunities:What is nextRegulatoryShopping after SolvencyIITolearnmore about Certified_Solvency_ii_Training.htmSolvency ii
  • 209. Solvency ii