Solvency ii News March 2012


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Solvency ii News March 2012

  1. 1. Solvency ii Association1200 G Street NW Suite 800 Washington, DC 20005-6705 USATel: 202-449-9750 www.solvency-ii-association.comSolvency II News, March 2012Dear member,Todaywewill start from Michel Barnier“We areall sufferingthe effectsof the ongoingfinancial crisis. It beganin thebankingsector and hasspread to public finances.It hasled to necessaryausterityprogrammesand impactedhard on thereal economy.Solvency ii
  2. 2. Financial reform has a key role to play in stabilising the financialsector, removing the inadequacies and abuses which existed, andpreventing or mitigatingfuture crises.TheEU isin theend phaseof itsbiggest ever programme for financialservicesreforms.Around thirty measureshave been proposedor adopted, includingalmost all thekey onesagreed at theG20.My goal is for all new legislationto be in force by 2013.It is an achievablegoal.But financial reform is about more than prevention of thenext crisis.It can alsoplaya rolein remedying the present crisis, by favouringgrowth.This booklet explainsour reforms, howtheywill contributetostabilityand growth and how theyhelpto re-establisha prosperousEurope.”Solvency ii
  3. 3. TheEuropean Commission hasproposed all the main piecesoflegislationlinked to G20 commitmentThebulk of thesenew rules is alreadygoing through thelegislativeprocess.Theyensure safefinancial institutions,efficient and resilient marketsand appropriate consumer protection.The programme isnot yet finished, there is still a challenging roadahead, but the European Union is on the right track to have a newlegislativeframework for financial servicesin place by2013.Aproperly supervised financial systemStrict supervision of thefinancesectoris essential. The crisisexposedseriousdeficienciesin cooperation betweennational supervisors.Solvency ii
  4. 4. Toaddressthis,theEU hasestablishednew European SupervisoryAuthorities(ESAs), operational sinceJanuary 2011:the EuropeanBankingAuthority (EBA), theEuropean Insuranceand OccupationalPensionsAuthority (EIOPA)and the European Securitiesand MarketsAuthority (ESMA).Thesenew European institutionswork together withMember States’supervisors fosteringharmonised rulesand ensuring strict and coherentimplementation.Morespecifically, theycan:• draw up specific rulesfor national authoritiesand financial institutions,• take action in emergencies, including banningcertain products,• mediateand settledisputesbetweennational supervisorsand• ensureconsistent application of EU lawIn addition, theEuropean SupervisoryAuthorities have extensivepowersin emergencies.If the EU Council decidesthat turbulent market conditionswarrant theiruse,theycoordinatenational supervisorsand imposethe necessaryactionsin a harmonised wayacrossEurope.Such measurescan includebanson short sellingof securitiesforexample.AEuropean Systemic Risk Board (ESRB) wasalsoestablishedtomonitorthreatstothe stabilityof the financial system.TheESRB providesearlywarningsof system-widerisksthat may bebuildingup and issuesrecommendationsto deal withthem.Solvency ii
  5. 5. Solvency ii
  6. 6. We will continuewith the letter from theEIOPA Chairman toMichelBarnier, European Commissioner for InternalMarket and Services,ontheimplementationof SolvencyIISolvency ii
  7. 7. Solvency ii
  8. 8. Solvency ii
  9. 9. EIOPA haspublished its Action Plan 2012for CollegesofSupervisors.Thedocument representsa followup onsubstantial effortsalready madeby supervisorsand EIOPA in preparing, organizingand contributingtothecollegesduring 2011.The two key targets of the Action Plan 2012 are preparation for theimplementation of Solvency II and exchange of information withincolleges.Thedocument foreseesthat collegesof supervisorswill establish a workplanrelatedtotheactivitiesof thecollege for an insurancegroup’sinternalmodel application.Thecollegeswill alsosummarize thetasksthat should be performed inrelationtogroup supervision under SolvencyII.TheAction Plan 2012envisagesthat supervisorsstart implementingEIOPA’sguidelineson a regular exchangeof quantitativeandqualitativeinformation withincolleges.Theyare alsoexpectedto set up a coordinationarrangement for theirsupervisoryactivities.Accordingtothedocument, collegesof supervisorsshould set up anemergencyplan of information exchangeand crisismanagement in caseof financial turbulencethat a group or asoloundertaking might face.EIOPA alsomade publicly availabletheReport on the functioningofcollegesin 2011.Thedocument inter alia statesthat despitethe lack of thefinal legalbasisfor the implementationof SolvencyII, collegesare making greateffortsto prepare for thenew regulatory regime.Solvency ii
  10. 10. NextTheFinancial StabilityBoard (FSB) published the peer review report ondeposit insurancesystems.FSB publishes peer review on deposit insurance systemsTheglobal financial crisisillustratedtheimportanceof effectivedepositorcompensationarrangements.In response,the Basel Committee on BankingSupervision (BCBS) andtheInternationalAssociation of Deposit Insurers(IADI) jointlyissued inJune2009the Core Principlesfor EffectiveDeposit InsuranceSystems.Usingthe Core Principlesasa benchmark, the peer review takesstock ofdeposit insurancesystems (DISs) in FSB member jurisdictionsand drawslessonsabout theeffectivenessof reforms in responsetothecrisis.Thespeedyadoption by many jurisdictionsof extraordinaryarrangementstoenhancedepositors’confidence during thefinancialcrisissignals theimportanceand necessityof having an effectiveDIS.Explicit limiteddeposit insurancehasbecomethe preferred choiceamongFSBmember jurisdictions.Thecrisisresulted in greater convergencein practicesacrossjurisdictionsand anemerging consensusabout appropriate DIS designfeatures.Theseincludehigher coveragelevels;theeliminationof co-insurance;improvementsin the payout process;greater depositor awareness;theadoptionof ex-antefundingby more jurisdictions;and thestrengtheningof information sharing and coordinationwithother safety net participants.Solvency ii
  11. 11. Themandatesof deposit insurersalsoevolved, withmore of themassumingresponsibilitiesbeyond a paybox function toincludeinvolvement in failure resolution.ThereviewedDISs are broadly consistent withthe CorePrinciples,particularlyin areassuch asmandates,membershiparrangementsand adequacyof coverage.However, there remain some areaswherethereappear tobe divergencesfrom, or inconsistencieswith, the Core Principlesthat need more timeand effort to address.Theseincludeavoidingunlimited deposit coveragethat could adverselyaffect theDIS’s effectiveness;ensuring that resources(includingback-up funding options) are adequateand immediatelyavailabletomeetfinancingrequirements;establishingand publicly communicatingaprompt target timeframe for reimbursingdepositors;adjustinggovernancearrangementsin deposit insuranceagenciesto ensureadequatepublic oversight and to mitigatethe potential for conflictsofinterest;and formalisinginformation sharing and coordinationarrangementswithother safety-net participants.Further enhancementsof DISs may benecessaryin theseareas.In addition, there are certain areas in the Core Principles where moreprecise guidance may be needed to achieve effective compliance or tobetter reflect leadingpractices.Theseincludedeveloping benchmarkstomonitor theeffectivenessandadequacyof coveragelevels; identifying instrumentsand good practicesthat can help mitigatemoral hazard; ensuring that there is effectivecoordinationacrosssystems in jurisdictionswithmultiple DISs and thatanydifferencesin depositor coverageacrossinstitutionsoperating withinthat jurisdictiondo not adverselyaffect thesystems’effectiveness;conducting regular scenarioplanningand simulationsto assesstheSolvency ii
  12. 12. capabilityof making prompt payout; exploring the feasibilityanddesirabilityof greater useof ex-antefunding;and developingappropriatemechanismstoregularlymonitor public awarenessof the DIS.Additional guidancein these areasby relevant standard-settingbodieswouldfurther enhancethe effectivenessof DISs.Thereport containsfour recommendations:Note DIS = Deposit InsuranceSystem1. FSB member jurisdictions without an explicit DIS should establishone in order to maintain financial stability by protecting depositorsandpreventingbank runs;2. FSB member jurisdictionswithan explicit DIS shouldundertakeactionstofullyalign their DIS withthe Core Principlesin areaswherethere appear tobe divergencesfrom, or inconsistencieswith, thoseprinciples;3. IADI should, in consultationwiththe BCBSand other relevantbodies whereappropriate, updateitsguidancethat pre-datesthefinancial crisis.It should alsoconsider developingadditional guidance toaddressareaswherethe Core Principlesmay need more precision toachieveeffectivecomplianceor tobetter reflect leadingpractices;and4. TheFSB should review and evaluatetheactionstaken by itsmembersin responseto the recommendationsin this report.Mark Carney, Chairman of the FSB, said “National authorities havemadegood progressin strengtheningtheir deposit insurancesystems.Solvency ii
  13. 13. However, there is still room for improvement and effortsto achievefulland consistent implementationshould continue.”Tiff Macklem, Chairman of theFSB’sStandingCommitteeon StandardsImplementation (SCSI), said“Thefinancial crisisprovided a number ofuseful lessonson deposit insurance.We will monitor progressmade by our membersin adoptingthe report’srecommendationstofurther strengthen their deposit insurancesystems, particularlygiven thelinkswiththe FSB’songoing worktodevelop effectiveresolution regimesfor financial institutions.”Solvency ii
  14. 14. EIOPA PUBLISHES FINAL ADVICE ON THE IORPDIRECTIVE REVIEW- EIOPA proposesa “holistic balancesheet” asa meansof developinga Europe widesupervisoryregime for IORPs- EIOPA suggestsenhanced qualitativerequirementsfor governanceand risk management of IORPs- EIOPA proposesstrengthened and consistent informationrequirementsfor defined contribution schemesFrankfurt, 15 February, 2012– TheEuropean InsuranceandOccupational PensionsAuthority (EIOPA) published today its finalresponseto theEuropean Commission’sCall forAdvice (CfA) on thereview of the IORP Directive.In its CfAthe Commission expressed theintention tointroduceaharmonised, risk basedprudential regimefor IORPs.Theobjectiveof theregime is toincreasethenumber of pan Europeanpension fundsfrom itscurrent lowlevel.In addition, thenew framework should ensure regulatoryconsistencybetweensectorsand enhanceprotectionof members and beneficiaries.Akey proposal of EIOPA isthe “holisticbalancesheet”, asa waytoachievethe Commission’saim for harmonisation.It will enableIORPsto take intoaccount thevariousadjustmentmechanisms(conditional indexation, reduction of accrued rights) andsecuritymechanisms(regulatoryown funds, sponsorsupport, pensionprotection funds) in an explicit way.In other words,the approachproposed by EIOPAis toacknowledgetheexistingdiversityof occupational pension systems in theEU MemberSolvency ii
  15. 15. States,while capturingall thesesystems intoa singlebalancesheet.In its advice EIOPAunderlinestheimportanceof a quantitativeimpactstudy(QIS) becauseit is crucial tofurther explorethe possibleimpact onthefinancial requirementsfor pensionfundsthat theholistic balancesheet and thevariouspolicy optionswithin that approach might have.EIOPA is currentlypreparingfor a QIS exerciseand aimsto publishresultsin thesecond half of 2012.Besides thequantitativerequirements, EIOPA’sadvice alsocontainsproposalstoenhancequalitativerequirementsin such areasasgovernanceand risk management.Thesehave been modelled on SolvencyII withthe necessaryadjustmentsfor IORPs.EIOPA advice callsfor the strengtheningof fit and proper criteria andfor a proportionate, i.e. adjustedfor the nature, size and complexityofIORPs, implementationof robust internal and external controlsandsoundrisk management frameworks.In addition, thedocument addressesinformationprovision and memberprotection, particularlyin defined contribution (DC) schemes.AccordingtoEIOPAadvice, information needsto berelevant, correct, understandableand not misleading.EIOPA callsfor theintroduction of a Key Information Document for alldefinedcontribution schemeswhich wouldallowmemberstohaveconfidencein the scheme irrespectiveof whereit is locatedin theEU.Gabriel Bernardino, Chairman of EIOPA, said:“I am pleasedthat wehavebeen ableto make marked progressin theareaof Europeanregulation of DC schemes.Solvency ii
  16. 16. At themoment, 60million people rely on DC schemesand I have nodoubt that thisnumber will continuetogrow in the coming decades.However, thisis not theend of the processof developing a Europeanframeworkfor occupational pensions, but merelythe beginning”, headded. “In particular, wehave to ascertain ourselvesvia theQIS that theproposed approach stimulatesaffordableyet secure occupational pensionprovision in Europe”.Note:IORP Directive - Directiveon theactivitiesand supervision ofinstitutionsfor occupational retirement provisionIn April 2011theEuropean Commission asked EIOPAfor advice on theEU widelegislativeframeworkfor IORPs.Thepublication of EIOPA FinalAdvice followsan extensiveperiod ofstakeholder consultation.EIOPA made publicfor consultation a first draft responseon 8July 2011coveringnine out of twentythree areasof the CfAon scopeandgovernanceand a second draft responsetothe CfAaswholeon 25October 2011.The last consultation – which ran until 2 January 2012 – was commentedupon by 170 stakeholders from fourteen Member States and 20 Europeanand international organisations.TheEuropean Insuranceand Occupational PensionsAuthority(EIOPA) wasestablishedasa result of thereformstothestructure ofsupervision of the financial sector in theEuropean Union.Thereform wasinitiatedby theEuropean Commission, followingtherecommendationsof a Committee of Wise Men, chaired by Mr. deLarosière,and supported by theEuropean Council and Parliament.Solvency ii
  17. 17. EIOPA is part of theEuropeanSystem of Financial Supervisionconsistingof three European SupervisoryAuthorities, the NationalSupervisoryAuthorities and the European Systemic Risk Board.It is an independent advisorybody to the European Parliament and theCouncilof theEuropean Union.EIOPA’score responsibilitiesare tosupport thestabilityof the financialsystem, transparencyof marketsand financial productsaswell astheprotection of insurancepolicyholders, pension schememembers andbeneficiaries.Cayman’sInsurance Law is almost thereTheCayman Island’snew InsuranceLaw 2010will tocome intoeffect inMarch2012.As of November 2011,theCayman Islandsis home to 731captiveswithgrosspremiumstotalingUS$9.6 billion.Although the vast majority of Cayman-domiciled captivesciteNorthAmerica astheir primary risk location, thejurisdiction alsosupportscaptivesfrom Europe,Africa, Asia, theMiddleEast and thePacific Rim.Solvency ii
  18. 18. The Joint ForumReport on intra-group support measures, February 2012A. ExecutivesummaryTheobjectiveof this report prepared by the Joint Forum is toassistnational supervisorsin gaininga better understandingof theuseof intra-group support measures in timesof stressor unexpected lossby financialgroupsacrossthebanking, insuranceand securitiessectors.Thereport providesan important overview of theuseof intra-groupsupport at a time whenauthorities areincreasinglyfocusedon waystoensure banksand other financial entitiescan bewound downin anorderly manner during periodsof distress.Thereport may alsoassist thethematic workcontemplated by theFinancial Stability Board (FSB) on deposit insuranceschemesand feedintothe ongoing policy development in relationto recovery andresolution plans.Thereport is basedon the findingsof a high-level stock-takewhichexaminedtheuse of intra-groupsupport measuresavailabletobanks,insurersand securitiesfirms.Thestocktakewasconducted through a surveyby the Joint ForumWorkingGroup on RiskAssessment and Capital (JFRAC) that wascompleted by 31financial institutionsheadquarteredin tenjurisdictionson three continents:Europe, NorthAmerica andAsia.Participantsweredrawnfrom thebanking, insurance and securitiessectorsand from many of thejurisdictionsrepresented by Joint Forummembers.Many participatingfirms werelarge global financial institutions.Solvency ii
  19. 19. Thereport providesan overview and analysisof thetypesand frequencyof intra-group support measuresusedin practice.It is based only on information providedby participantsin thesurvey.Responseswereverified by supervisorsonlyin certain instances.The survey’s main findingsare asfollows:1.Intra-groupsupport measurescan vary from institutionto institution,driven by the regulatory, legal and tax environment; themanagementstyle of theparticular institution;and thecross-border nature of thebusiness.Authoritiesshould be mindful of the complicatingeffect of thesemeasureson resolution regimesand the recovery processin theevent offailure.2.Themajorityof respondentssurveyed indicatedcentralisedcapitaland liquiditymanagement systems werein place.Accordingtoproponents,this approachpromotestheefficientmanagement of a group’soverall capital level and helpsmaximiseliquiditywhile reducingthe cost of funds.However, the respondentsthat favoureda “self-sufficiency” approachpointed out that centralisedmanagement potentiallyhastheeffect ofincreasingcontagion risk within a group in theevent of distressat anysubsidiaries.Theuse of these systemsimpactsthe nature and design of intra-groupsupport measureswithsome firms indicatingthat the waythey managedcapital and liquiditywithin the group wasa keydriver in their decisionsabout the intra-group transactionsand support measurestheyused.Solvency ii
  20. 20. 3.Committed facilities, subordinated loans and guarantees were themost widely used measures. This was evident across all sectors andparticipatingjurisdictions.4.Internal support measuresgenerallywereprovidedon aone-waybasis(egdownstreamfrom a parent to a subsidiary).Loansand borrowings,however, wereprovided in some groupson areciprocalbasis.As groupssurveyed generallyoperated acrossborders,most indicatedsupport measureswereprovidedboth domesticallyand internationally.Support measureswerealsoin placebetweenboth regulated andunregulated entitiesand between entitiesin different sectors.5.Thestudyfound noevidenceof intra-groupsupport measureseither- a) Being implemented on anything other than an arm’s lengthbasis,or- b) Resulting in the inappropriate transfer of capital, income or assetsfrom regulated entities or in a way which generated capital resourceswithin a group.However, thisdoesnot necessarilymean that supervisoryscrutinyofintra-groupsupport measuresis unwarranted.As this report is basedonindustry responses,further in-depth analysisbynational supervisorsmay provide a more completepicture of the riskspotentiallyposedbyintra-groupsupport measures.6.While the existingregulatory frameworksfor intra-group supportmeasuresare somewhat limited, firmsdohave certaininternal policiesandprocedurestomanageand restrict internal transactions.Solvency ii
  21. 21. Respondentspointedout that theregulatory and legal frameworkcanmake it difficult for some forms of intra-groupsupport to come intoforcewhilesupervisorsaim toensurethat both regulated entitiesandstakeholdersareprotected from risksarisingfrom the use of supportmeasures.For instance, upstream transfers of liquidity and capital are monitoredand large exposure rules can limit the extent of intra-group interactionfor risk control purposes.Jurisdictional differencesin regulatorysettingscan alsoposea challengefor firms operatingacrossborders.7. Based on the survey and independent of remainingconcernsandinformation gaps, singlesector supervisorsshouldbe awareof the risksthat intra-group support measuresmay poseand should fullyunderstandthemeasuresusedbyan institution, includingitsmotivationsfor usingcertainmeasuresover others.In order toobtain further insight intotheintra-groupsupport measuresput in placeby financial institutionswithin their jurisdiction, nationalsupervisorsshould, where appropriate, conduct further analysis in thisarea.ScopeFinancial groupswhich encountered problemsor whichfailed between2007and 2009during the financial crisistypically had to consider thequestion of whethertosupport a subsidiaryor relatedentity.Although thesedecisionslargely hingeon the potential damage tofranchiseand reputation, thestartingpoint for making such decisionsisbased on intra-group contractual and legal obligations.Solvency ii
  22. 22. Thelevel of intra-group support and interconnectednessof legal entitieswithin thegroup affectsthe extent to which thefailureof one entityposescontagion riskfor other entitieswithin thegroup.It is alsothesecontractual obligationswhichdeterminethe lossesultimatelysuffered by creditorsof each entityin the group.Definition of “intra-group support measures”Intra-group support consistsof varioustypesof support measures,inparticular capital and liquiditysupport measures,extended betweenentitieswithin a group in timesof stressor unexpected loss.For thepurposeof this study, intra-groupsupport measuresare- Legallyenforceablecommitmentsfor financial assistanceorassurancemade byone group entity (usuallya parent) upon whichanother group entity(usuallya subsidiary) can call in timesof stressor unexpected loss;or- Commitmentswhichregulatorswouldregard asreliablemeansofsupport.Thesemeasurestypically increasethe risk of lossto theprovider whencalledupon by a beneficiary that subsequentlyfails.Support measurescan vary betweenjurisdictionsdue to differingregulatory, legal or tax regimes.Support measurescan stem either from contractual agreementsor asamatter of law or regulation.Theycan taketheform of ongoing or contingent support, secured orunsecured, within national boundariesor cross-border.Solvency ii
  23. 23. Theseintra-group support measuresmay existbetween regulated entitiesor between regulated and unregulated entitiesand can take placeon across-sectoralbasis.Thedirectionof support may alsovary in relationto the hierarchyof thegroup’slegal control structure.Support providedby a subsidiarytoitsparent isreferred to as“upstream” support whereassupport providedbya parent to itssubsidiary isreferred to as“downstream” support.Differingregulationsrelated to intra-group support measuresand thevarying types of contractual agreementsdetermined by specific marketpracticesand/ or businessmodelshave resultedin a broad range ofintra-groupsupport measuresacrossfinancial groups.Concernsrelating to intra-group supportTheimportanceand variety of intra-group support measureswithinfinancial groupshasincreasedthe supervisorychallengesof ensuringthat regulatedentitiesand their stakeholdersareprotectedfrom risksarisingfrom theuseof such support measures.In general, supervisoryconcernsarise whenintra-group supportmeasures:- Result in capital, income or assets being inappropriately transferredfrom the regulated entity, or result in intra-group creation of capitalresources(ie doubleor multiplegearing);- Are used asa substitutefor financial resources(egusing a guaranteeor loanrather than capital held at the subsidiary);- Are implemented on termsor under circumstanceswhichthirdpartieswouldnot accept;Solvency ii
  24. 24. - Adversely affect thesolvency, liquidityand profitabilityof individualentitieswithin a group;- Result in contagion risk, therebyprecipitatingknock-on effectsonfinanciallysound entitieswhenone entitywithinthe groupexperiencesstress;- Complicate group structuresand therefore obscure thesupervisor’sview of the group and/ or legal entitiesthat operate withintheirjurisdictions,thusaffectingboth the abilitytosuperviseon anongoing basis, and resolution and recoverability; and- Are used asa meansof regulatory arbitrageto evade capital or otherregulatoryrequirementsaltogether.There may however be positive aspects to intra-group support measuresas they can provide financial resilience and create a stabilising effect onthewider group.Intra-group exposures/ transactionsIntra-group exposures/transactionstake theform of an often complexnettingof direct and indirectclaims whichentitieswithinfinancialgroupstypicallyhold on eachother.Themost transparent form of intra-groupexposure isa credit or a lineofcredit which either the parent grantsto a subsidiary or one subsidiarymakes availabletoanother subsidiary.Intra-groupexposures,however, can originatein a varietyof other ways:for examplethrough- (a) intragroup crossshareholdings;- (b) trading operationswherebyone group entitydealswithor onbehalf of another group entity;Solvency ii
  25. 25. - (c) central management of short term liquiditywithinthe group and- (d) guaranteesand commitmentsprovided to or received from othercompanies in thegroup.For thepurposesof this report, intra-group support measuresshouldbeconsidereda subset of intra-group exposures/ transactions.Wider intra-groupexposures/ transactionsrelatingto “businessasusual” activities arenot consideredtobeintra-groupsupport measures.Instead thispaper focuseson intra-groupsupport measuresthat areputin placein timesof stressor unexpected losses.Wider intra-groupexposures/ transactionsnot captured by this narrowerdefinitionof intragroup support may be put in placefor the followingreasons:- Topromotethedevelopment of group businessactivities(egfacilitate acquisitions,integrationof acquired business,distributionarrangements,internal restructurings,salesor other disposalsofassetsor businessesor similar transactions);- Toenablethe group to operate on an integratedbasisacrossdifferent legal entities,some of whichmay not be in the samejurisdictions;- Tosupport entitycredit ratingsin a group (egparental support of anentityin order toobtain the same credit rating asthe parent entity)andthereforeensuring competitivefinancingtermsfor entitiesof thegroup;- Topromoteefficient use and fungibility of the group’s capitalresourcesacrossthedifferent legal entities;andSolvency ii
  26. 26. - Tomanage and provide liquidityand capital resourcesacrossthegroup.Notwithstandingtheir economic and commercial benefits, both intra-group exposures/ transactionsand support measureshavethe potentialtoadversely affect thesolvency, liquidityand profitabilityof individualentitieswithin a group.Theycan impede effectivesupervision and resolution efforts, andincreasecontagion risk acrossthe group.Gatheringinformation on existing“businessasusual” intra-groupexposures/ transactionswasnot an objectiveof this study.However, it should be noted that makinga clear separation betweenintra-groupexposures/transactionsand intra-groupsupport measureswasnot alwayspossiblein practice.For this reason, “businessasusual” intra-group exposures/ transactionswereconsideredtothe extent that theymight changemateriallyor beextended in timesof stressor unexpectedloss(thusbecoming forms of“intra-groupsupport” asdefined for thisstudy).Table of participating firmsThefollowingtableshowsthe sector and continent (Europe, NorthAmerica and/ orAsia) of origin of the 31financial groupsfrom tencountrieswhichparticipatedin thesurvey.Both for confidentialityreasonsand becausemanyresponsesprovidedbyfirms werehigh-level rather than detailed, firm namesand firm-specific responsesto thequestionnaire havenot been included.Anonymous and summaryextractsand themeshave insteadbeenprovided.Solvency ii
  27. 27. Key findings1. General overviewResponsesillustrated a varying understanding of the term “intra-groupsupport” ascertain firmsprovided informationon “intra-groupexposures”more generallyrather than on intragroup support-measures.Information on intra-group exposures can provideinsight intotheinterconnectednessof financial groups,sheddinglight on avenuesforcontagion and onthe group’sabilityto stand asan integratedsingleentityagainst adverse conditions.However, thiscan complicate thedistinctionbetweenwhat is“businessasusual” and what isextraordinarysupport in timesof stress.Ameasure can be part of normal businesspractices, but can alsobecome a support measurein a financial crisis(egthe extension of acredit line).As such, intra-groupexposuresthat are likelyto become a supportmeasure in timesof stressweregiven consideration.Thesurvey found that the measuresused varied from institutiontoinstitution. Threeinstitutionsstatedthat intra-groupsupport measuresrepresent a very small portionof total intra-group exposures.Another group expresslystated that theydonot have any prearrangedsupport mechanismsin place, but decideon a case-by-casebasisif andhowtheycan support a group entityin timesof stress.Solvency ii
  28. 28. Theypointed out that this isa crucial part of themanagement functionandthey choose mainlybetweenguarantees, loansand equity injections.Akey factor toconsider whenassessingthe interconnectednessof groupentitiesis whetherthe groupsmanagecapital and liquidityon acentralisedbasisor whethereach entitymanagesin a self-sufficient orself-containedmanner.Themodel chosen impactsthe nature and design of intra-groupsupportmeasures.Certainfirms statedthat the management of group-wide capital andliquiditywasa keydriver of intra-group transactionsand supportmeasures.Themost common support measuresused by groupswerecommittedfacilities(senior loans), subordinatedloansand guarantees.Insurancegroupsand conglomeratesuseinternal groupreinsurance, however, due tothenature of reinsurance, it wasnotconsidered a support measure for thepurposesof this study asit isgenerallycalledupon onlywhencertain eventsspecified in thecontractmaterialiseand generallynot whenother stressful eventsoccur.Internal support measuresgenerallywerefound to be providedon a one-waybasis(egdownstreamfrom a parent toa subsidiary).Loansand borrowings,however, werefound in some groupson areciprocalbasis.Thegroupsincluded withinthesurveygenerallyoperate acrossbordersand, assuch, statedthat their support measureswereprovideddomesticallyaswell asinternationally.Support measuresalsotake placebetweenregulatedand unregulatedentities.Solvency ii
  29. 29. Of the groupswhichhad activitiesboth in the banking and insurancesectors, three out of five respondentsindicatedthat intra-groupsupportoccurred on a cross-sectoralbasis.Thefollowingsectionsset out- Adescription of, includingadvantagesand disadvantagesof, centralised and decentralisedcapital and liquiditymanagementasexplainedby firms - an important driver for engagingin intra-group support in timesof stress;- Thenature and frequencyof thespecific types of intra-groupsupportmeasurescommonly used by respondent firmsincludingtherationalethat firmsput forwardin relationto theadvantages/ disadvantagesofdifferent types of intra-groupsupport measures;- Respondents’viewson the restrictionsand regulatory requirementswhichapplytointra-group support measures.2. Centralised and decentralised capital and liquiditymanagement(a) Centralised capital managementSeventeen of 25respondentsaddressingthisissuestated that theycentralisetheir capital management.Respondentscommentedon the centralisedcapital managementarrangementstheyusedand their advantages:- Respondentsconfirmed that activecentralisedcapital managementincreasesthe efficiencyof a group’s overall capital management.Agroup’savailablefinancial resourcescan be managedtocover thecapital requirementsdetermined both bythe internal risk model andSolvency ii
  30. 30. bythe requirementsof supervisoryauthoritiesand rating agenciesona consolidatedbasis.- One respondent statedthat it used centralised capital managementat a regional level.That is, centralisedcapital management is takingplace not at theparent level but on regional level coveringall thegroup entities(branchesand subsidiaries)that are locatedin that region.- One respondent statedthat it operatesin such a waythat itsvariousbusinessesoperateon a standalonebasisand thereforeneed fewerintra-groupsupport measuresthan wouldbe expected for a similargroup.Notwithstandingthis, itsgroup aimstomaintain excesscapitalcentrallyin order toallowmaximum flexibilityand to deliver on itslongterm strategy.- One respondent advised that theymanage capital on a group basiswherebycapital is raised at theparent holdingcompany and theninjectedasrequired intosubsidiaryentities.Thefirm statedthat anyexcesscapital generated by a subsidiary isrepatriated by theparent holding companyunlesslocaltax orregulatorycapital requirementsjustify retainingit.Capital re-allocationfrom the group parent tosubsidiariesisthengovernedby a “group application” processwith a goal of optimisingtheuse of capital acrossthegroup.- One respondent noted that it managesitsmaterial subsidiarieson an“arm’slength basis” wherebyeachsubsidiary is required to manageitsown capital (and liquidity) resourceswithout relianceon othergroup entitiesexcept wheresupport isexplicitlyapproved.Solvency ii
  31. 31. Thefirm statedthat the group’score capital is allocatedtosubsidiariesin linewith their localregulatory capital requirementsand subsidiariesare then required togenerate an appropriate returnon theseresources.- One respondent statedthat it managescapital centrallyat itscorporatetreasury under a framework of internal governancerules.Thefirm noted that their treasury department setsdomestic andinternational legal entityrisk-basedcapital and solvencytargetsinlinewithregulatoryand competitivebusinessrequirements.Capital plansare alignedtotargetsand monitoredand updatedthroughout the year.Excesscapital is directed tothe holdingcompany and managedcentrally.- One respondent noted that the objectivesof their capitalmanagement processensure that thegroup optimisescapital whilstminimisingtax through governance and control of external andinternalcapital movements(eg betweensubsidiaries).Somerespondentsnoted disadvantagestocentralisedcapitalmanagement includingthe potential for a deterioration of thecapital/ fundingposition of a subsidiary tohave contagion effectsacrossthe group.(b) Centralised liquidity management (cash pooling)In general, many of therespondentsthat had centralised capitalmanagement in placealsoused centralisedliquiditymanagement.- Tworespondentswhousedcentralisedcapital management alsostatedthat thegroup’s liquiditywasmanagedcountry by country.Solvency ii
  32. 32. - One of thesefirmsexplained that itsgroup treasury functiondeterminesthe policies, processes,controls, systemsand reportingrequirementsfor each country treasurywhichthen isresponsibleforapplying thosecontrolsacrossthe activitiesof all businessunitsintheir respectivecountry.- Another respondent statedthat itsgroup pooling activitiestake placeonlyin certain legal entities.One group stated each currencyis managedin one geographiccompetencycentre for the entire group (eg thedollar is managedfrom NewYork, Sterlingand theEuro from Brussels, etc) withconsolidatedmonitoring of all currenciesby the treasury at grouplevel.Thesefirmsdid not however provide further information astowhytheir capital and liquiditywasnot managed onthe same basis.- One respondent statedthat it runsa centralisedliquiditystressmodellingprocessaswellasa separatelegal entitystressmodellingprocesswhen required by host country regulators.This group maintainsa combination of substantial pools of liquidityheld in variousareas(in variousentities,eg broker dealers).Thesespoolsare held on an as-neededbasis(entityby entity) or asrequiredby locallaw/ regulation.This group stated that it is unable to allocate liquidity across sectorsfrom a bank to a non-bank affiliate as regulatory guidelines generallyprohibit support acrosssectors.- Another respondent noted that it maintainsanexcesspool ofliquiditysufficient tomeet requirementsin both a normalenvironment and amodelled stressenvironment.Solvency ii
  33. 33. Potential outflowsin a stressed environment are determinedthroughan internal stressanalysis.The group’s excess liquidity is held at the group level as well as atthe level of major operating entities which also maintain their ownpools.CorporateTreasurymanagesthefundscentrally.For subsidiaries with no legal, regulatory, tax or other restrictions, thegroup employs a central cash management framework it receiving anddistributingcashtoentitiesasrequired.With certain exceptions,most loanstoaffiliateshave open/ overnightmaturities in order toallowfor maximum flexibility.Respondentsusingcentralisedliquiditymanagement outlined their cashmanagement objectivesasmaximisingliquiditywhile minimisingthecost of funds.One respondent noted that the objectiveof its liquiditymanagement istomeet the group’scommitmentsastheyfall due whilst maintainingmarket confidencein the firm.Respondentsstatedthat central liquiditymanagement enabledtheirgroupstopreparefor and mitigatevariousrisksto the group’sliquidityposition.Theynoted that this ensured sufficientlyhigh liquid assetsat all timesintheevent of potential liquidityoutflowsunder both normal and stressconditions,includingacutestressconditions(eg in the caseof a potentialdowngradeof the credit ratingat theparent or locallevel).Certainrespondentsalsoexplained that cash pooling isimportantbecauseit can reduceconsolidatedleverage.Solvency ii
  34. 34. It can alsoreducetheneed for third-partyplacementsat the subsidiarylevel (and thecredit risk attached) becausethehighest ratedentityin thegroup, the parent company, is best positioned to accessthemost cost-effectivefunding, providea singleface tothemarket and effectivelymanagethe relationshipswithratingagenciesand institutional investors.Unlike manyof thesubsidiaries, theparent alsohasfewerrestrictionsonboth lendingand recoupingfunding to and from subsidiaries.One respondent stated that centralised liquidity management had beenparticularly beneficial to them during the 2007-2009 financial crisis, as itlimitedtheir potential exposure to banksthat ultimately failed.Another respondent pointed out that in many casesthere isan economictrade-off betweenintra-groupsupport measures(eg guarantees) andintra-groupfundingin the normal courseof business.Adecisiontoreducecentralisedfunding requires higher amountsoffundingto be obtained by subsidiariesin their localmarkets.In order todo soeconomically, subsidiarieshave a greater incentivetousethe stronger name of the parent through a parental guarantee.(c) Decentralised capital and liquidity management(“subsidiary self-sufficiency”)In contrast, ten of 25respondentsthat addressedthis issuestated theydid not operateon a centralisedbasis, but rather relied on decentralisedmanagement - an operatingmode premisedon the self-sufficiencyofsubsidiarieswithina group.Tworespondentsexplainedthat they demand that individualsubsidiariestry toobtain resources(eg capital and funding) themselvesfrom their own markets, rather than usingcentralisedresources.Solvency ii
  35. 35. Even though this strategyimpliesan increasein cost, accordingto thesegroups,it providesbetter diversification and clearliabilitypricing(ie costpricing).One respondent noted that although their group corecapital (ie equity) isallocatedto subsidiaries,thiscould besupplemented by locallyissuedTier 2 capital (ie debt).Respondentssuggestedthat soundnessof capital and liability pricingatthesubsidiary level iscritical and that groupsoperatingwithout it cannottruly understandtheir cost of resources, making them susceptibletolessrational group capital allocationdecisionsover time.Furthermore, centralisationcan result in subsidiariesbecoming toodependent on their group parentsfor other functions(eg riskmanagement and strategic decisions).Domestic riskmodelstranslatethe group’srisk expertiseintoa localimplementationof riskassessment strategies.Akey advantagenotedby respondentsoperatingself-sufficientsubsidiarieswasthat theyallowfor easier separationfrom therest of thegroup - for example, in termsof thesaleof anyparticular unit forcommercial gain or in situationswhenit is necessarytoisolateanentityduring a crisis to limit contagion totherest of the group.One respondent from the insurancesector explainedthat theydo notmanageliquiditycentrally.Various insurance subsidiaries in the group write different product mixesin different jurisdictions, resulting in claim patterns that can vary locally.Liquidityneedscan thereforevary with localconditions.However, there is central control over what investmentsa subsidiaryispermittedtomake, and localsubsidiarieshave accessto crisiscapitalfrom theparent.Solvency ii
  36. 36. GlossaryCommitted facilities(senior loans):Are an extensionof credit wherebythe lender contractstolend up toaspecific sum under pre-definedtermsand conditions.Subordinated loans:Atype of loan that is junior toother debtsshould a company be woundup.Typical providers of subordinated loansare major shareholdersor aparent company.Athird-partyprovidingfundsthrough a subordinated loanwouldseekhigher compensation (eg higher interest) relative toa senior loandue totheloans subordinatedstatus.(Aloans status,whethersubordinated, secured or unsecured, is spelledout in the contract betweenborrowerand lender.)Letter of credit:Alegal commitment issued by a bank or other entitystatingthat, uponreceipt of certain documents,thebank will pay against draftsmeetingthetermsof theletter of credit.Lettersof credit arefrequentlyused for risk financingpurposestocollateralisemoniesowedby an insuredunder variouscash flowprogramssuch as:incurredbut not paid lossesin paid lossretrospectiveratingprograms, a meansof meeting thecapitalisation requirementsofcaptives,and to satisfy the securityrequirementsof theexcessinsurer in"fronted" deductibleor retention programs.For captives, lettersof credit serve twopossiblepurposes: theymay beused in lieu of or in addition tocash or other securities ascapital, and/ ortosecuritisethe fronting insurers reinsurancereceivablecreated by anon-admittedreinsurer.Solvency ii
  37. 37. Letter of comfort:Aletter issued to a lendinginstitutionby a parent companyacknowledgingthe approval of a subsidiary companys attempt forfinancing.Theletter of comfort in nowayguaranteestheloan of the subsidiarycompany.It merelygivesreassuranceto thelender that theparent company isawareand approvesof the situation.Declarationof backing:Unrestricted letter of comfort. With a declaration of backing theissuer ensures(withonlycertain specific exception, eg in thecaseofpoliticalrisk) that selectedgroup entitiesare able to meet theircontractual liabilities.If this should not bethe case, the receiver of this declaration(typically alendertoone of theselectedgroup entities)can suetheissuer fordamages.Profit transfer agreement:In a profit transfer agreement, one company agreesto transfer itsprofitstoanother company.This type of contract is used in Germany.Theprofit transferagreement isusedtoconsolidateprofits betweencompanies.Thecontrollingcompany in thisarrangement is the one that receivestheprofitsof thecontrolledcompany.Under the rulesof theagreement, thecontrolledcompany must act andoperatein the best interestsof the controllingcompany.Thearrangement isessentiallythat of a parent company and subsidiary.Solvency ii
  38. 38. However, if the controlledcompany suffers losses,the controllingcompany is obliged toprovide it compensation for itslosses.Guarantee:Non-cancellableindemnitybond that guaranteestimely payment ofinterest and repayment of principal tothebuyers (holders) of a debtsecurity.Equityinjections:Theprovision of cash by one entitytoa secondentity in the form ofequitycapital (ie permanent capital withnolegal obligationof capitalreturn or fixed payment) of thesecond entity.Bond swaps:Astrategy in whichan investor sellsa bond and simultaneouslypurchasesa different bond withthe proceedsof sale.There areseveral reasonswhyentitiesuse a bond swap:for tax benefits,toalter investment exposures(eg to upgradea portfolioscredit qualityor speculateon the performanceof a particular bond).Bond/securitylendingagreements:An agreement betweenentities(eg parent and subsidiary) accordingtowhichtheparent can borrow securitieson the balancesheet of thesubsidiary in order toimprovetheliquiditypositionof the parent.Solvency ii
  39. 39. Solvency II SpeakersBureauTheSolvencyII Association hasestablishedthe SolvencyII SpeakersBureau for firmsand organizationsthat want to accesstheexpertiseofCertified Solvencyii Professionals(CSiiPs) and Certified SolvencyiiEquivalenceProfessionals(CSiiEPs).TheSolvencyII Association will be the liaison betweenour certifiedprofessionalsand theseorganizations,at no cost. We stronglybelievethat this can be a great opportunity for both, our certified Solvency_II_Speakers_Bureau.htmlCourse 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 compliancewiththe SolvencyiiDirectiveof 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 Holding Companies(MFHC), InsuranceHolding Companies(IH C) - providing insuranceand/ orreinsuranceservicesin theEEA, whoseparent islocatedin acountry of theEEA.Solvency ii
  40. 40. 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 decisionmakers, managers, professionalsand consultantsof insurance and/ orreinsurancefirmsinvolved in risk and compliancemanagement.About the CourseINTRODUCTIONTheEuropean Union’sLegislativeProcessDirectivesand 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 theApplicationSolvency ii
  41. 41. Important DefinitionsValue-at-Riskin SolvencyIIAuthorisationCorporateGovernanceGovernanceFunctionsRiskManagementCorporateGovernanceand Risk Management - Level 2Fit and proper requirementsfor personswhoeffectivelyrun theundertakingor haveother key functionsInternal ControlsInternalAuditActuarial FunctionOutsourcingBoard of Directors:Role and Solvencyii Responsibilities12Principles– System of Governance (Level 2)PILLAR 2SupervisoryReview Process(SRP)Focuson Risk Management and Operational RiskOwn Risk and SolvencyAssessment (ORSA)ORSA- TheInternal Assessment ProcessORSA- TheSupervisoryToolORSA- Not a Third Solvency Capital RequirementCapital add-onPILLAR 3DisclosureRequirementsTheSolvencyand Financial Condition Report (SFC)PILLAR IValuationOf AssetsAnd LiabilitiesTechnicalProvisionsTheSolvencyCapital Requirement (SCR)Solvency ii
  42. 42. TheValue-at-RiskMeasureCalibratedtoa 99.5% ConfidenceLevel over a 1-year Time HorizonTheStandardApproachTheInternal ModelsTheCollectionofAdditional HistoricalDataExternal DataThe Minimum Capital Requirement (MCR)Non-CompliancewiththeMinimum Capital RequirementNon-CompliancewiththeSolvencyCapital RequirementOwn FundsInvestment RulesINTERNAL MODEL APPROVALCEIOPSLevel 2 - Testsand Standardsfor Internal ModelApprovalCEIOPSLevel 2 - The procedure tobe followedfor theapproval 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 aggregationmethodSolvency ii
  43. 43. Parent 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:The ProportionalityPrincipleCaptivesand SolvencyIIEQUIVALENCE WITH SOLVENCY II AROUND THE WORLDSolvencyii and Countriesoutsidethe European EconomicAreaTheInternationalAssociation 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 ClientSolvency ii
  44. 44. Competing withBanksLearningfrom theBasel ii FrameworkRegulatoryArbitrage:AMajorRisk for Countriesthat seeComplianceasan Obligation, not anOpportunityBasel II, Basel III, SolvencyII and RegulatoryArbitrageChallengesand Opportunities:What is nextRegulatoryShopping after SolvencyIITolearnmore about theonlineexam you may CSiiP_CSiiEP_Certification_Steps.pdfTolearnmore about Certified_Solvency_ii_Training.htmSolvency ii
  45. 45. Solvency ii