Solvency ii News September 2012


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Solvency ii News September 2012

  1. 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 an interestingspeechGabriel Bernardino, Chairman of EIOPACreating a global insurance supervisory LanguageConferenceon Global InsuranceSupervisionGood evening, ladiesand gentlemen,On behalf of EIOPA I wouldlike to thank the InternationalCenter forInsuranceRegulation for thecooperation and effortsin organisingtogether withusthis Conferenceon GlobalInsuranceSupervision.I am very happy toseetoday somany colleaguesfrom thesupervisoryauthorities aswellasprominent expertsand executiveofficers of theinsuranceindustry.Our purposewith this Conferenceis tocreate aplatform of discussionand exchangeof viewsabout the international context of insurancesupervision.Your presenceand contribution tothis event is keyto itssuccessandwill certainlycontributetoa better understandingof the differentSolvency ii
  2. 2. regimesand will foster further convergenceof practicesof insurancesupervision worldwide.Insurancemarketsare increasinglyglobal.Many insurancegroupshave nowadaysa huge part of their revenuescomingfrom businessoutsidetheir home countries.This createsnew opportunitiesbut alsonew challengesfor insurers,butalsofor supervisors.Thepromotion of sound and stableinsurancemarketscallsfor moreinternationalcooperation.We firmly believe that the best waytoreinforcefinancial stabilityand consumerprotection isto develop strong globalregulatoryand supervisorystandards.This will createa level playing field forinternational players, foster a commonlanguagebetweensupervisorsand improveinternational cooperation and informationexchange.I wouldlike toshare withyou some viewsontheways of improving the efficiencyofsupervision from a global perspective.ComFrame ( Common Framework for theSupervision of InternationallyActiveInsuranceGroups(IAIGs) - ComFrameis an integrated, multilateralandmultidisciplinaryframeworkfor the group(widesupervision ofinternationallyactiveinsurancegroups.ComFrame wasinitiatedin responseto the recognition that, despite thegrowingrelevanceof IAIGs in the global insurance marketplace,noSolvency ii
  3. 3. internationallycoherent frameworkexistsfor the supervision of suchlarge, global groups.I wouldlike tostressthat EIOPAis highlycommitted to contribute tothe establishment of such standardsand, in this regard, weconsider ourparticipationin the IAIS very important. EIOPAis actively contributingtothe workof ComFrame.We consider it necessaryto enhanceregulatorycapital requirementsinorder to achieveadequateconsumer protectionon a global level.Of course,whilecallingfor thismeasure, wetake intoaccount differentperspectivesand developmentsworldwide.Seen historically, the EU had experienced comparable discussionsadecadeago.We fully support themove toenhanced group-wide supervision.Cooperation betweensupervisorsin collegesis essential for the propersupervisoryapproach to InternationallyActive InsuranceGroups.We believethat information sharingand supervisorycooperation underconditionsof professional secrecyis a key, determinativeelement ofeffectivesupervision.We needmore shared supervision.Furthermore, Comframe should comprisea capital element, establishingstrongprinciplesfor group capital calculationsconcerningtherisksincluded, the metricsused toassessthem and theoverall level ofconfidence.Without thisconsistency, thereis nolevel playing field internationally.It is not about one uniquesystem, but about a set of strong principlesthat would deliver a rangeof closerand compatiblesystems.Solvency ii
  4. 4. Comframe shouldnot be another regime on top of the alreadyexistentones.Thelocalregimesshould evolveto comply withComframe.This is my vision. I recognizethat wecannot deliver thisimmediately, but at the IAISweneed toset a timetableand concretemilestonestodevelop thisconcept in a stepby step approach.We needto be courageousand open-minded.We needto be open tochangeand evolution becausethe industry realityis alsoevolving and changing.An extra effort needsto be done by all of usbecauselike CharlesKettering(a famousAmerican inventor) said oneday: ―Peopleareveryopenmindedabout newthingsaslongastheyre exactly like theoldones.‖Systemic risk in insuranceThecrisisprompted a new look at systemic risk, includingin theinsurancesector.Theidentificationand regulation of GloballySystemically ImportantInsurersis currentlybeing discussed under theumbrella of the FinancialStabilityBoard and the IAIS.EIOPA is keen to contribute to a robust identification process of G-SIIsand to develop appropriate regulatory and supervisory tools to deal withtheir characteristics.Traditionally, systemic risk wasabankingconcept.However, the recent crisisshowedusthat certain activities developedundertheinsurancesector can alsoposesystemic risk.Solvency ii
  5. 5. Insurancecompaniesor groupsthat engagein non-traditional, or non-insurance,activities(for example:CDS, financial guaranteesorleveragingassetstoenhanceinvestment returnsthrough securitieslendingare more vulnerable tofinancial market developmentsand, importantly, more likely toamplify, or contributeto, systemic risk.Of course,this assessment may changeover time, dependingon theinnovationsand changesin insurancebusinessmodels, especiallyin lifeinsurance,aswellasin the complex interactionsbetweeninsurancegroupsand financial markets.We should be especiallyattentivetoany kind of maturity transformationand leveragingoccurring in the insurancesector.As a consequence, the identificationof a systemicallyimportant insurerassuch, should be a direct reflection of itssourceof systemicimportance.While thesizeof traditional insuranceactivityis still an importantfactor, it should not be thedominant factor in the identificationprocess.Clearly, the non-traditional and non-insuranceactivitiesand thedegreeofinterconnectednesswithother componentsof the financial system aremore relevant from a systemic point of view.Consequently, the differencesbetweeninsurersand banks in the impactof failures suggestthat requirementsfor lossabsorbencyand resolutionregimesfor insurersshould accept thesesalient differencesand proposesolutionsthat differentiateaccordingly.As a conclusion I wouldlike to underlinethat weshould havenoillusions:thecreation of global insurance supervisorystandardsis a very longprocessthat is complicatedby thedifferenceof culturesand unevendevelopment of supervisorysystems in different countries.But it is important that the regulatorsall over the world are willingtoreachmutual understandingand todevelop a common supervisorySolvency ii
  6. 6. language,whichwill help usto promote stability of the financialmarkets,to enhancetheir transparencyand to foster consumerprotection.Together wecan achievetheseobjectives.Solvency ii
  7. 7. Interesting comments for the ComFrameAcompilation of commentson a common frameworkfor thesupervision of internationallyactiveinsurancegroups,knownasComFrameby theInternationalAssociation of InsuranceSupervisors(IAIS)Bermuda, Association of Bermuda Insurersand ReinsurersABIR doesnot support the current proposal toincludecompaniesthatdobusinessin 3+ jurisdictionsasthefirst basis on which todetermineacompany may qualify asan IAIG.(Note: IAIG standsforInternationallyActive Insurance Group)(Note:ABIR standsforAssociation of BermudaInsurersandReinsurers)ABIR wouldrespectfullysubmit that one of the objectivesof ComFrameis todevelop harmonization of the applicationof group supervisionandin this regard, if for example, a group is operatingin 3 jurisdictionswithin theEEA, then under the proposed regimeharmonization inprinciplewill have been alreadystatutorilymandated, thusthepurposeofintroducinganother group supervisoryregime is not clear.We wouldproposethat an IAIG is one whichoperateswithlegal entitiesin multiplejurisdictionswhichhaveseparate and distinct regulatorysystems across3+ supervisory frameworks;for example, Canada; US;Bermuda;India, etc.ComFrame should be appliedonlyto thoseinternationallyactivegroupsthat have a global footprint and operatewith legal entitiesin jurisdictionsonmultiplecontinents.TheEU and theUnitedStateswouldeach count asa singlejurisdictionsincetheyoperatewitha common cross-stateregulatory system.Solvency ii
  8. 8. ABIR alsorecommendsthat a smallernumber of groups-saythe 20largest–betargetedwith COMFRAME; experiment first, learn from thatbeforeexpandingthenet.ABIR alsois concernedwith theproposed"constrained supervisorydiscretion" whichgrants"involved supervisors" the abilityto consideran insurancegroup an IAIG even if it doesnot meet some of theproposed criteria or toexcludeit asan IAIG.This type of discretioncreatesuncertaintyfor groupssinceit may be"deemed tobe an IAIG even if it doesnt meet the criteria.Whilst theComFrame Paper providesexamplesof when thismay beemployed, theproposal is toofar reaching.Given the proposedconstrained supervisorydiscretion on thepart of thesupervisors,doesComFrame alsopropose an appealsprocessby whichan identifiedIAIG can seek to havethat designation lifted?Canada, Office of the Superintendent of Financial InstitutionsOSFI believesthat thecurrent criteria and processmay be tooprescriptiveor mechanical.Further, OSFI discouragesdeveloping a discretelist of IAIGsthat isdetermined mainlyusing quantitativerequirements.Instead, a general definition asto thenature, size, complexity, international activityand risk profile ofinstitutionsto whichComFrame should applywouldassist thesupervisorin applying supervisorydiscretiontodetermineIAIGs.Rather than rankinginsurersquantitativelyand determininga cut-offpoint for IAIGs, thegeneral definition should be applied on acontinuum.Solvency ii
  9. 9. China, China Insurance Regulatory CommissionTheindentifying standardsof IAIG includesize, internationalactivity, and constrained discretion, whichcan reasonablyidentifyinsurancegroup companieswithinternational activityand theidentificationprocessesare comprehensiveand reasonable.In our opinion, the"constraineddiscretion" should be prudentlyusedwhile takingintoconsideration the development stageof each countrysinsurancemarket and the nature, functionand risk conditionofinsurancegroups.EU, European Insurance and Occupational PensionsAuthority(EIOPA)EIOPA stronglysupportstheworkof theIAIS todevelop a set ofinternationallyconsistent standardsfor the regulation and supervision ofIAIGs.EIOPA wouldlike tothank theIAIS for theworkconductedup tonow.Let usfirst expressthat EIOPAconsidersthe restructuringof theComFrame Paper tobe an important improvement from thepoint ofview of readability, focus, addresseeperspective, among others.In general the ComFrame criteria and processfor identifying IAIGsseem tobe appropriate.Howeverthere arenoexplicit rulestodefine the Head of theIAIG incasewherethere isnolegal entitythat controlsor exertsdominantinfluenceover the other elementsof theIAIG.Another aspect whichis not fullyexplainedrefers tocasesin whichentitiesmay beexcluded from supervision.TheComFrame only refers tothe principleof proportionalitywhereasclearerand more detailed guidancewouldbe helpful.Solvency ii
  10. 10. Moreover, EIOPAthinksthat some redundancieswithICPsnotionscould be deletedUK, Association of British InsurersThecriteria aretoowide- insurersthat are activeonlyin countries thatare part of a singleregulatory and supervisoryregime should not beclassed asbeing internationallyactive.ComFrame should bring clarityto regulation and supervisionof groupswhoseindividual legal entitiesoperate under multipleregulatoryregimes- wherea group isactivein several countries whichareall coveredby thesameregime, this need doesnot arise.It should not take three years beforea designation asan IAIG can beretracted- this wouldlead toa situationwhere, for example, an insurerthat had previouslybeen designated an IAIG but had madesignificantchangestoitsbusinessand wasno longer internationallyactive in ameaningful waywouldstill be subjecttoComFrame for twoyears to noobviousbenefit for policyholders, the company or thesupervisors.In contrast other non-internationallyactiveinsurersoperatingon anidenticalbasis but whichhad not previouslybeen an IAIG wouldnot besubjecttoComFrame.If an insurer ceasestomeet thecriteria for an IAIG then neither thecompany nor supervisorswill materiallybenefit from theapplicationofComFrame.An insurers designation asan IAIG or not should be reviewedandupdatedat least annually.USA, NAICTheprocessfor identifying IAIGsappearsto be collaborativein natureand indicativeof how ComFrame, asa workingframework, shouldoperate.Solvency ii
  11. 11. Thecriteria used to identify IAIGsshould be clearand focusedonidentifying thoseentitieswhich havea largepresenceinternationally.The criteria should be simple and allow the involved supervisors toadjust using their judgment if circumstances necessitate a differentanswer("constrained supervisorydiscretion").Thecriteria currentlyunder considerationby the IAIS attemptsto strike abalancebut should be carefullyreviewedwiththeseobjectivesin mind.As discussionon future steps(Field Testing, Implementation, etc.)progressesover thenext year, thecriteria and processfor identifyingmay need to be reassessedtoensure it isappropriate to meet theintendedobjectives.With respect to the current draft, consideration should be given as towhether the criteria for the number of jurisdictionsin which an IAIGoperatesshould includethreshold percentage of market share.This could either bepart of the criteria itselfor part of thesupervisorydiscretionprocess.Toread more:http:/ / db/ content/ 3/16037.pdfNote:ComFrame is a major project of the IAIS.While theultimateroleof ComFrame remains under discussion anddevelopment, theintent isgiven by itsname —a common framework—onethat lays out how supervisorsaround the globecan work together tosuperviseinternationallyactiveinsurancegroups(IAIGs) and closeregulatorygaps.IAIGsare the largest, most complex insuranceentities.Solvency ii
  12. 12. ComFrame hasthreemain objectiveswhichinclude:1)Developingmethodsof operatinggroup-widesupervisionof IAIGs;2)Establishinga comprehensiveframeworkfor supervisorsto addressgroup-wideactivitiesand risks,and3)Fosteringglobal convergence. ComFrame is neither intendedtobe aforum tocreate prescriptivewaystopromote a particular meansforsolvencystandards,nor tocreateadditional layers of regulation.ComFrame is expectedto evolve over time.It will be developedover a three-year period withthe DevelopmentPhasecompletedby theend of 2013.TheIAIS will issuea comprehensive report detailingtheend of theDevelopment Phase, followingwhichthere will be one or more impactassessmentsof both qualitativeand quantitativerequirementsfor IAIGs.Solvency ii
  13. 13. Solvency IIIn 2011, EIOPAfocusedon preparingthe final setof regulatory measuresforSolvencyII, the draft standardsand guidelines.One of themain achievementsof EIOPAin 2011wasthe report on theFifth QuantitativeImpact Study (QIS5) summarisingthepotentialimpact of thedetailed implementingmeasurestobe drafted for theSolvencyII regulatoryframework.QIS5 hasbeen themost ambitiousand comprehensive impact study evercarried out in the financial sector, withthedirect involvement of morethan 2500entitiesand 100supervisorsfrom member statesandEIOPA, workingtogether for almost a full year.EIOPA launched official public consultationsin 2011in twoareasinwhichearlydiscussionwith and preparation by the industryareparticularlyimportant.Theseconsultationswereon the draft standardsand guidelinesonreportingand disclosure, and on guidelineson OwnRiskand SolvencyAssessment (ORSA).At the end of 2011, EIOPAsubmittedadditional advicetothe EuropeanCommission on thecalibration of thenon-life underwritingrisk module.In the areaof catastropherisk, EIOPA madeitsfinal recommendationfor the implementingmeasureson a number of outstandingnon-life andhealth catastropheriskissues.Several task forcesconcluded their workin 2011, resultingin thepublication of the followingreports: ―Calibrationof the Premium andReserveRiskFactorsin theStandard Formulaof SolvencyII‖ and the―Report of the TaskForce on ExpectedProfitsarisingfrom FuturePremiums‖.Solvency ii
  14. 14. Finally, sincethe creation of EIOPA‘sInsuranceand ReinsuranceStakeholderGroup, EIOPAhasbenefited from their expertiseand widerangeof viewsand interests,and activelyinvolved itsmembersin majoraspectsof SolvencyII.Occupational pensionsThemain focusof EIOPA‘swork on occupational pensionsin 2011wasdeveloping EIOPA‘sresponsetotheCall forAdvice from theEuropeanCommission on thereview of Directive2003/ 41/ECon the activitiesandsupervision of institutionsfor occupational retirement provision (IORPDirective).Theworkon the Call forAdvice wasorganisedin four sub-groups,allworkingin parallel, but all reportingto the Occupational PensionsCommittee(OPC).In 2011, EIOPAalsocompleted number of survey-based reports onreportingrequirements, risksrelatedtoDC schemesand pre-enrolmentinformation.Thesesurveyswereconducted toprovidea common technical basisforrespondingtothe Call forAdvice.During 2011, EIOPAcarried out twopublic consultationson itsdraftadvice.Thefirst between8 July2011and 15August 2011on selected aspectsoftheCall forAdvice.Thesecond, between25October 2011and 2 January 2012on the entiredraft advice.EIOPA alsosubmittedduring the year 2011its input tothe ESRB on datarequirementsfor IORP and published itsrecurrent report on marketdevelopments.Solvency ii
  15. 15. Consumer protection and financial innovationEIOPA hasconsidered, from day one, consumer protection asacornerstoneof itswork and an area wherea differencehastobemade, and EIOPAhasbeen proactivein thearea of consumerprotectionand financial innovation.In the courseof 2011, theAuthority prepared ―The Proposal forGuidelineson Complaints- Handling by InsuranceUndertakings‖, theReport on Best Practicesby InsuranceUndertakingsin handlingcomplaintsand finalised a ―Report on Financial Literacyand EducationInitiativesby Competent Authorities‖.EIOPA alsocollecteddata on consumer trendsamong its memberstopreparean initial overview, analysing and reportingon thosetrends.TheAuthority alsoprovided relevant input tothe EuropeanCommission‘srevisionof the InsuranceMediationDirective(IM D) bycarrying out an extensivesurvey of sanctions(both criminal andadministrative) provided for in national lawsfor violationsof IMDprovisions.External commitment, includingbenefitingfrom the expert input ofEIOPA’stwoStakeholder Groupsand holding EIOPA‘sfirst ConsumerStrategyDay, wasalsocrucial to EIOPAachievingitsgoalsin 2011.Collegesof Supervisors and cross-border crisis managementand resolutionEIOPA‘stasksgobeyond pure regulatory work,and includeconcreteoversight responsibilities, includingan enhanced role asmembersof thedifferent collegesof supervisors.Theoverall strategictarget of EIOPA‘sCollegeworkis toconsolidatetheposition of the European EconomicArea (EEA) supervisorySolvency ii
  16. 16. communityvis-a-visinsurance groupsoperatingacrossbordersfor thebenefit of both group and solosupervision. In 2011, around 89 insurancegroupswith crossborder undertakingswereregisteredin the EEA.During the year, Collegesof Supervisorshaving at leastone actualmeetingor teleconferencewereorganised for 69groups.Atotal of 14 national supervisoryauthoritiesacted asgroup supervisorstoorganisetheevents.During the setup phasein thefirst year after its establishment, EIOPAattendedCollege meetingsand/ or teleconferencesof 55 groups.In early2011, a set of interim proceduresfor dealingwith emergencysituationswasdeveloped byEIOPAin conjunction with theother ESAs.Aseconded national expert in crisismanagement wasappointed inMarch2011, and work then commencedon thedevelopment of apermanent crisismanagement framework by EIOPA.Key to thiswasthe development of a strategicpolicy on crisismanagement.In the end of 2011a TaskForceon CrisisManagement delivered acomprehensive, decision-makingframework on crisis pre-emptionandcrisismanagement.Financial stabilityThecommon theme of EIOPA‘sfinancial stabilityinitiativesin 2011wastoidentify, at an earlystage, trends, potential risksand vulnerabilitiesstemmingfrom microand macroeconomic developments, and, wherenecessary, toinform the relevant EU institutions.Solvency ii
  17. 17. This wasachievedby specific and regular marketmonitoring, information sharing and discussionson mitigatingmeasuresin theFinancial Stability Committee(FSC).In linewiththisobjective, EIOPA‘sFSCset up itsfirst (pilot) riskdashboard in October 2011, containinga common set of quantitative andqualitativeindicatorsthat help to identify and measure systemic risk.This dashboard is tobe developed further asa joint effort of theESAsandtheESRB.In the courseof 2011EIOPAhasbeen an active member of theESRBSteeringCommitteethat wasestablishedin order toassist in thedecision-makingprocessof the ESRB.EIOPA alsowastakingpart in theESRB Advisory Technical Committee(ATC) and itstechnical subcommitteeswith themain focusonidentifying potential systemicallyimportant issuesin the sectorsofinsuranceand IORPs.Furthermore, EIOPAparticipatedin thejoint ATC andAdvisoryScientific Committee (ASC) expert group dealing withthe regulatorytreatment of sovereign exposures.In 2011, thethreeESAs and the ESRB signeda joint ―Agreement on theestablishment at the ESRB Secretariat of specific confidentialityproceduresin order tosafeguard information regardingindividualfinancial institutionsand information from whichindividual financialinstitutionscan be identified‖.EIOPA alsobegan designinga databaseof current and historical data forIORPsand insuranceand reinsuranceundertakingsin theEuropeanUnion.During 2011, EIOPAconducted harmonised, pan-European core andlow-yieldstresstestsfor the insurancesector in cooperation with theESRB, ECB and EBA.Solvency ii
  18. 18. In June and December 2011, EIOPApublished itstwosemiannualFinancial Stability Reportscontainingan assessment of the economicsoundnessof the European insurance,reinsuranceand IORPs.In December 2011, EIOPA put out for public consultation a set of datareporting templates necessary for regularly assessing sectoral risk andmonitoring financial developmentsonceSolvency II entersintoforce.EIOPA OverviewIntroductionTheEuropean Insuranceand Occupational PensionsAuthority(EIOPA) wasestablishedasa result of thereformsof the structure ofsupervision of the financial sector of theEuropean Union (EU) thatfollowedthe financial crisisof 2007, asthe crisis demonstratedthat thepre-existing3L3 Committees(CEIOPS,CEBS and CESR) had reachedtheir limit.Before and during the financial crisesof 2007and 2008, theEuropeanParliament called for a movetowardsgreater European supervisoryintegration in order toensure a true level playing field for all players atthelevel of the European Union and toreflect theincreasingintegrationof the financial marketsof the EU.In responsetothe global financial crisis, theEuropean Commissiontasked a High Level Group (Committeeof Wise Men), chairedby MrJacquesde Larosiere, toconsider how the European supervisoryarrangementscould be strengthened, both to better protect EU citizensandtorebuild trust in the financial system.Among itsmany conclusions,the Group stressedthat supervisoryarrangementsshould not only concentrateon the supervision ofindividual firms, but alsoplaceemphasison the stabilityof thefinancialsystem aswhole.Solvency ii
  19. 19. Followingtherecommendationsof the Committeeof WiseMen, theEuropean Commission initiateda reform, whichwassupportedby theEuropean Council and the European Parliament.As a result, the supervisoryframeworkwasstrengthened to mitigatetherisk and severityof future financial crises.EIOPA is part of a European System of Financial Supervision (ESFS), thepurpose of whichis toensuresupervisionof the EU financial system.TheESFS comprisesthe three European SupervisoryAuthorities(ESAs):theEuropean BankingAuthority (EBA), based in London, theEuropeanSecuritiesand MarketsAuthority (ESMA), based in Paris, andEIOPA, based in Frankfurt, aswell asthe European Systemic Risk Board(ESRB), based in Frankfurt, and the competent or supervisoryauthoritiesin theEU Member Statesasspecified in the legislationestablishingthethreeESAs.EIOPA‘smain goalsare:•Tobetter protect consumers, thusrebuildingtrust in thefinancialsystem;•Toensure a high, effectiveand consistent level of regulation andsupervision, takingaccount of thevarying interestsof all MemberStatesandthedifferent nature of thefinancial institutions;•Toachieve a greater harmonisationand coherent applicationof therules applicableto the financial institutions& marketsacrosstheEuropean Union;• Tostrengthen oversight of cross-border groups;• Topromote a coordinatedEuropean Union supervisoryresponse.Solvency ii
  20. 20. EIOPA‘score responsibilitiesare tosupport thestabilityof the financialsystem, ensure thetransparencyof marketsand financial productsandprotect policyholders, pension scheme membersand beneficiaries.EIOPA is commissioned to monitor and identify trends, potential risksandvulnerabilitiesat the micro-prudential level, acrossbordersandacrosssectors.EIOPA is an independent advisorybody to theEuropeanParliament, the Council of the European Union and theEuropeanCommission. Toaccount for thespecificconditionsin thenationalmarketsand thenature of the financial institutions,theEuropeanSystem of Financial Supervision is an integratednetwork of nationaland European supervisoryauthoritiesthat providesthenecessarylinksbetweenthemacro and microprudential levels, leavingday-to-day supervisiontothenational level.EIOPA is governed by itsBoard of Supervisors, whosemembers aretheheadsof the relevant national authoritiesin thefield of insuranceandIORPsin each Member State.TheEuropean Union’snational supervisoryauthoritiesarea sourceofexpertiseand information in the field of insuranceand IORPs.Policy Working GroupsThemajorityof PolicyWorking Groupsdealt withinsuranceandreinsurance-relatedissues,in particular SolvencyII.Twoother Working Groupsin the policy areadealt with IORPs(IORP Directive) and equivalence-relatedissues.Solvency II Working GroupsTheSolvencyII project iscompletely reshapingthe supervisoryandregulatoryframework for insuranceand reinsurancecompanies,Solvency ii
  21. 21. bringing a modern risk oriented, economicand principlebasedset ofrules.One of themain tasks for EIOPA in thecoming yearsis toprepare thenew supervisoryregime for insuranceand reinsuranceundertakingsandparticularlyto conduct all the necessaryworkfor implementationof theEU Directiveon the taking-up and pursuit of the businessof insuranceand reinsurance(SolvencyII).During 2011, the SolvencyII Working Groupsdeveloped draft standardsand guidelineswhichare likely tobe required by theOmnibusIIDirective, and whichEIOPAconsidersasessential for ensuring theexistenceof convergent supervisorypracticesfrom SolvencyII‘sfirst dayof entry intoforce.Pre-consultationswithselectedstakeholderswereheld aspart of thecontinuousinformal discussion withstakeholderswhileawaitingconfirmation of the formal legal basisfor public consultation on thestandards.Each WorkingGroup contributed to EIOPA‘strainingprogramme forsupervisorsand, whererelevant, WorkingGroupswereinvolvedin thediscussionsconductedby the European Commission on implementingmeasures.WorkingGroupscontributed to thoseareasof each other‘swork thatrequireda cross-workinggroup perspective, suchasgovernanceorreporting.Insurance GroupsSupervision Committee (IGSC)TheInsuranceGroupsSupervision Committee(IGSC) focusedondeveloping draft technical standards and guidelinesfor theconvergentimplementationof SolvencyII in the areasof group solvencycalculations,intra-grouptransactionsand risk concentration, thecooperationand exchangeof information in Colleges,and thetreatmentof third country branches.Solvency ii
  22. 22. Financial Requirements Committee (FinReq)TheFinancial RequirementsCommittee(FinReq) focused ondevelopingdraft technical standards and guidelinesfor theconvergentimplementationof Solvency II in theareasof ownfunds, technicalprovisions, and thestandard formula for capital requirements, includingtheuse of undertaking-specific parameters.FinReqcontributed to thedevelopment of calibrationfactorsfor non-lifeunderwritingrisk and catastrophe risk.Internal Governance Supervisory Review and ReportingCommittee (IGSRR)TheInternal Governance, SupervisoryReview and Reporting Committee(IGSRR) focused on developing draft technical standards and guidelinesfor the convergent implementation of SolvencyII in the areasof system ofgovernance, includingOwnRisk and SolvencyAssessment(ORSA), transparencyand accountabilityof supervisoryauthorities,public disclosureand supervisoryreporting, and valuationofassetsand liabilities(other than technical provisions).Publicconsultationon theORSAguidelinesand reportinganddisclosurerequirementswaslaunchedat the end of 2011.IGSRR alsostarted workingon guidelinesfor external audit, thesupervisoryreview process,capital add-ons,and the extension of therecoveryperiod in theexceptional fall in financial markets.IGSRR prepared EIOPA’s contribution to the International FinancialReporting Standard (IFRS) setting process and to the EU endorsementprocess.Solvency ii
  23. 23. Internal Models Committee (IntMod)TheInternal ModelsCommittee(IntMod) focused on developingdrafttechnicalstandardsand guidelinesfor the convergent implementationofSolvencyII in the areasof testsand standardsfor full and partial internalmodels,requirementsfor the approval process,and thepolicyforintroducingchangesto the model.In order toincreasesupervisoryconvergence and to prepareindustry andsupervisorsfor theuseof internal modelsunder SolvencyII, IntModimplementedinitiativesfor enhancingsupervisoryconsistencyacrossEurope in the pre-applicationprocessfor internal models, and forensuring adequatecooperation betweensupervisorswhen assessinginternalmodels.Theseinitiativesinvolvedpractical meetingsbetweenoperationalsupervisorsand training activities.Task Force on Expected Profits arising from Future Premiums(EPIFP)This taskforce wascreated todevelop a common understandingof theelement of expectedprofitsincludedin future premiums(EPIFP) soastoadvisethe Commission on thedraftingof implementingmeasuresafter the fifth quantitativeimpact study (QIS5).It wascomposedof representativesof industry, the EuropeanCommission and EIOPA membersand discussed possibleways ofharmonisingthecalculationof EPIFP under SolvencyII.EIOPA submitted a report tothe European Commission whichultimatelyonly representedtheviewsof itsown members.Solvency ii
  24. 24. Occupational Pensions Committee (OPC)Themain focusof the Occupational PensionsCommittee(OPC) workbetweenApril 2011and the end of the year wasdevelopingEIOPA‘sadvicetothe European Commission on thereview of theIORP Directiveinresponseto the Call forAdvice.Beyond this, OPC own initiativeprojectsin 2011included thepublication of a number of survey- based reportsasfollows:•‘Report on reportingrequirementstosupervisoryauthoritiesforIORPs’• ‘Report on market developments2011’•Tworeportson risksrelatingtomembersof definedcontributionpension schemes(risksfaced bymembers and mechanismsmitigatingthoserisks)•‘Report on pre-enrolment information’ aspart of a wider OPCmandateon PackagedRetail Investment Products(PRIPs) and pensionsOther inputsincludeda contribution to a report on the EuropeanSystemic Risk Board (ESRB) data requirementsin respect of IORPs.Equivalence CommitteeIn January 2011, theEquivalenceCommittee wasset up with itsmaintaskbeing to respond torequestsfrom the European Commission forfinal advice, after full consultation, on the equivalenceof third countries‘supervisorysystems.On 26 October 2011, upon request of theEuropean Commission, EIOPAdelivereditsfinal advice, after full consultation, on the SolvencyIIequivalenceassessmentsof thesupervisory systems in the followingcountries:- Switzerland,Solvency ii
  25. 25. - Bermuda and- Japan.Thesupervisorysystemsof Switzerlandand Bermuda wereassessedwithreferenceto reinsurance, inclusion of thethird country undertakinginthegroup solvencycalculation and group supervision, whilethesupervisorysystem of Japan wasassessedonly withreference toreinsurance.Theequivalenceassessment wasbased on respectivequestionnairesfilledin bythe relevant supervisoryauthorities(SwissFinancialSupervisoryAuthority – FINMA; Bermuda MonetaryAuthority – BMA;andtheJapan Financial ServicesAuthority – JFSA), followedby a desk-based analysisusingEIOPA‘smethodology, and onsitevisitsby EIOPAexpertsto each of the three countries.Regulatory Working GroupsCommittee on Consumer Protection and Financial Innovation(CCPFI)In 2011, the Committeeon Consumer Protection and FinancialInnovation(CCPFI) supported EIOPAin fulfillingthe requirement laiddownin itsRegulationof takinga leadingrole in the area of consumerprotection and financial innovation, asfollows:•preparing ―Guidelineson Complaints-Handlingby InsuranceUndertakings‖and ―Report on Best Practicesby InsuranceUndertakingsin handling complaints‖.•preparing the ―Report identifying Good Practicesfor DisclosureandSellingof VariableAnnuities‖.•finalisingthe ―Report on Financial Literacyand Education InitiativesbyCompetent Authorities‖.Solvency ii
  26. 26. •collectingdata on consumer trendsamong itsmemberssoastopreparean initial overview, analysing and reportingon thosetrends.•carrying out an extensive survey of sanctions (both criminal andadministrative) provided for in national laws for violations of IMDprovisions.Task Force on Insurance Guarantee Schemes (TF-IGS)This taskforcemet in the courseof 2011toprepare the report on thecross-border cooperation mechanismsbetweenIGSsin theEU.In accordancewithEIOPA‘smandate tocontributeto assessingtheneed for a European network of IGSsthat is adequately fundedandsufficientlyharmonised, thereport wasEIOPA‘sinput tothe EuropeanCommission‘spolicy- making on IGSs.It summarised the findingsfrom amappingexerciseof theexistingmechanismson cross-border cooperation betweenthe IGSsof MemberStates,and provided general recommendationstothe EuropeanCommission in the area of cooperationbetweenIGSsand withtheirsupervisors.Oversight Working GroupsReview PanelAt thebeginningof 2011, theReview Panel , using the experienceandlessonslearnedfrom itsfirst peer reviewexercisecompletedin2010,reviewedthe methodology for peer reviewsin linewiththeEIOPA Regulation.In the middle of the year, the Review Panel started work on three peerreview projects on supervisory practices for pre-application of internalmodels, supervision of branches of EEA insurance undertakings, andsupervision of IORPs.Solvency ii
  27. 27. Thesepeer reviewsare due to be completed in 2012.Task Force on CrisisManagementIn 2011a Task Forceon CrisisManagement wasestablishedtodevelopEIOPA‘sstructuresfor crisisprevention, management and resolution.In December 2011, this task force delivereda comprehensive, decision-makingframework that wasendorsed by theBoard of Supervisors.This frameworksetsout in detail theprocessesthat EIOPAwill followindischargingits crisispre-emption and crisismanagement responsibilitiesunder the EIOPARegulation.Financial Stability Working GroupsFinancial Stability Committee (FSC)TheFinancial StabilityCommittee(FSC) focused on monitoring andanalysingdevelopmentsin the insuranceand IORPs sectors.This includedin particular the impact of sovereign debt situation insomeEuropean countriesand alsothat of other eventssuch asnaturalcatastrophes,includingthe impact of theJapaneseearthquake in March2011and the subsequent devastatingtsunami.Furthermore, the FSC developed a 2011stresstest exercise for theEuropean insurancesector, includinga subsequent satelliteexercisefora low-yield environment.TheFSC alsodeveloped and implemented the EIOPArisk dashboardbased on quarterlyinformation collectedfrom national supervisors.TheFSC contributed to theworkof thecross-sector risk subcommitteeof the Joint Committee.Solvency ii
  28. 28. FSC alsocontributed to thetwohalf-year Financial StabilityReportsmonitoringboth sectors(IORPsand insuranceundertakings), whichwerealsosubmittedtothe EU Economic and Financial Committee(EFC) and theESRB.Corporate support Working GroupsInformation Technology and Data Committee (ITDC)In 2011, the IT and Data Committee(ITDC) focusedon developingEIOPA‘sIT and data strategy and, followingon from this, it workedonIT specificationsand implementationplans.TheIT strategy set out the IT-relatedgoalsneeded to fulfil EIOPA‘smission.TheBoard of Supervisorsadopted the IT and data strategy reportsat itsOctober 2011meetingand mandated EIOPAtoimplement the IT-relatedgoalsset out therein.TheBoard of Supervisorsrequired the ITDC toproduce high - level andoutlineIT plansand specifications,with particular focuson an EIOPAIT implementationplan.Update on Solvency II•SolvencyII is a new regulatory frameworkproviding supervisorswiththeappropriatetoolsfor assessing theoverall solvencyof insurance andreinsuranceundertakingsbyquantitativeand qualitativemeans, thusimprovingunderstandingand management of theseundertakings‘risks.•It is based on three pillars:quantitativerequirements(pillar I);governance, risk management and supervisory review (pillar II); andsupervisoryreportingand publicdisclosure(pillar III).• Theframework directivewaspublishedon 17 December 2009.Solvency ii
  29. 29. •TheOmnibusII Directive isunder discussion in theEuropeanParliament and Council of the European Union followingthelegislativeproposalfrom theEuropean Commission on 19January2011.•Implementingmeasureshave been discussedbetween theEuropeanCommission and Member Statessincethe end of 2009.•Standardsare being draftedby EIOPAtobe endorsedby theEuropeanCommission.•Guidelinesare beingdrafted byEIOPAtoensure the convergentapplication of the regulation.• Date of entry intoforce of SolvencyII: 1January2014.OmnibusII Directive and implementing measuresFollowingthecreationof EIOPA, theSolvencyII Directiverequiredrevisionto reflectthe new supervisorystructure;these revisionswill formpart of theOmnibusII Directive(OMDII).OMDII will introduceintothe SolvencyII Directivethe necessaryregulatoryand supervisorypowersfor EIOPAtodischargeitsresponsibilities.In addition, OMDII alsoincludestransitional measuresallowinggradualimplementationof SolvencyII.This extension meansthat the beginningof the regimewouldbe alignedwith the end of the financial year for most insuranceundertakings.During 2011EIOPAcontinued to providetechnical and analyticalsupport to theCommission and gave further input toclarifyitspreviousadviceon the development of the implementingmeasuresfor SolvencyII.Solvency ii
  30. 30. While deliberationsweretakingplacein theEuropean Parliament andtheCouncil of the European Union on OMDII, theCommission,MemberStatesand stakeholdersalsoexaminedthe draft implementingmeasures.Key areasunder discussion werethe sustainability of long-terminsuranceguarantees,the volatilityof elementsin undertakings’solvencybalancesheets,and reportingand disclosurerequirements.Standardsand guidelinesIn 2011, EIOPAfocusedon preparingthefinal set of regulatorymeasures,thedraft standardsand guidelines.SolvencyII will be one of the first projectstobenefit directlyfromEIOPA‘sregulatorypowersto draft standardsand subsequentlytoensure consistent implementationof legislationthrough bindingmediationand oversight of Collegesof Supervisors.Until there is agreement on the proposalsfor OMDII Directive, EIOPAwill not have completecertaintyon thescope of itspowersfor draftingthestandards for SolvencyII and the detail of the regulatory provisionswhichthe standardsand guidelinesare intendedtosupport.Consequently, it wasimportant for EIOPAtomonitor thevariousOMDII proposalsand thusidentify the standardswhich theAuthorityexpectsit will have todraft beforeSolvencyII entersintoforceon 1January2014.During 2011, EIOPAalsoidentifiedthoseareasin which it is essential tohaveguidelinesin placebeforethe entry intoforce of SolvencyII.EIOPA is committed to effectiveconsultationand communication withitsstakeholderstoimprove thequalityof the regulatory provisionsandassist theindustry in preparingfor the new regime.Solvency ii
  31. 31. Subjecttothe conclusion of thenegotiationson OMDII and theimplementingmeasures,EIOPAplanspublic consultationon thepackagesof draft standardsand guidelinesduring 2012.In 2011, EIOPA launched official public consultationsin twoareasinwhichearlydiscussionwithand preparation by the industryareparticularlyimportant.Theseconsultationswereon the draft standardsand guidelinesonreportingand disclosure, and on guidelineson OwnRisk and SolvencyAssessment (ORSA).In other areas,EIOPAcontinued itsinformal pre-consultationswithselectedstakeholders(European Insuranceand ReinsuranceFederation(CEA), Association of Mutual Insurersand InsuranceCooperativesinEurope (AMICE), Chief Risk Officers(CRO) Forum and Chief FinancialOfficers(CFO) Forum, Groupe Consultatif Actuariel Europeen), thushavingan ongoingdialoguewiththe industryahead of thepublicconsultation.Anumber of other initiativeswereset up specificallyto improve EIOPA‘scooperation and exchangeof information withitsstakeholders.Several task forcescompleted their workin 2011, whichresultedin thepublication of the ―Report on the Calibration Factorsin theStandardFormula of SolvencyII‖ and the ―Report of the TaskForceon ExpectedProfitsarisingfrom Future Premiums‖.Finally, followingthe creationof EIOPA‘sInsuranceand ReinsuranceStakeholder Group, EIOPAactively involveditsmembersin majoraspectsof SolvencyII.Solvency ii
  32. 32. Areas in which EIOPA prepared draft standardsand guidelinesduring 2011:•Solvency capital requirements for standard formula as well as forinternal model users; own funds; valuation of technical provisions;valuation of assetsand liabilities.• Group supervision.•Supervisorytransparencyand accountability, reporting anddisclosure,external audit.• Governance, ORSA.•Supervisoryreview process;capital add-ons;extension of recoveryperiod (‘Pillar 2 dampener); finitereinsurance;special purposevehicles.Quantitative Impact Study 5One of thekey achievementsof EIOPAin 2011wascompletion of thereport on theFifth QuantitativeImpact Study (QIS5) in March2011.Theresultsof theQIS5 exerciseweretaken intoaccount in discussionson theimplementingmeasuresand arebeingreflectedin thedraftingofstandardsand guidelines.The QIS5 exerciseIn March2011, EIOPAdelivered to the European Commission a reporton the resultsof the fifth pan-Europeanquantitativeimpact studyorganisedtoinform policymakerson thepotential effectsof the detailedimplementingmeasureswhicharebeingdrafted for theSolvencyIIregulatoryframework.Morethan 2 500individual undertakingsand 160groupsfrom the30Solvency ii
  33. 33. membersof theEuropean EconomicArea participatedvoluntarilyin thissimulation exercise,providing detailed quantitativeand qualitativeinputsonthe variouselementsof the future regulation.Thestudyconfirmed that overall the industry remained well capitalisedunder thedraft provisionsand optionstested.Thestudygathereduseful input on transitional provisionsfordiscounting, the grandfathering of specific elementsof own funds, andthetransitional equivalenceof third-country regimes, for example.Valuableinsight wasgainedabout the characteristicsof internal modelsunder development by undertakings,thedifficultiesin calculatingtheloss- absorbingcapacityof technical provisionsand deferred taxes, andthe potential impact of the introductionof an illiquiditypremium in thevaluation of technical provisions.Thestudyalsocovered the treatment of participations;it gatheredinformation on therelevanceof expectedprofit in future premiums, andon thegroup solvencyassessment under the consolidationanddeductionand aggregationmethods.Thestudyresultshighlightedthe areasin whichfurther work wouldbedesirable.This wasthen initiatedby EIOPAasfollows:definition of contractboundariesin thevaluation of technicalprovisions;the need to reducecomplexityin certain areas;developmentsin the calibrationofcatastropherisk; and the treatment of long-term guaranteesin thecontext of SolvencyII.Aparticular topic– therefinement of factorsused in non-lifeunderwritingand health non - similar tolife underwritingrisk modules–wasaddressed by specific data collectionin theQIS5exercise.Thedata wereanalysed using a methodology drawnup by a task force ofsupervisors,actuariesand industry representatives.Solvency ii
  34. 34. For most businesslines,the report publishedin December 2011facilitated joint recommendationsfor amendmentsof the factorsused intheQIS5 exercise.EIOPA‘scurrent and future work on thedevelopment of draft technicalstandardsand guidelinesfor SolvencyII will benefit greatly from thelessonslearnedduring the QIS5exercise, in particular byenhancingthepracticability and feasibilityof the rulesfor a singlerulebook ofstandardsand guidelinestoensureconvergent applicationof thenewsystem.Standard formula capital requirementsEIOPA prepared draft standards and guidelineson the approval processanddata qualityfor undertaking-specific parametersfor soloundertakingsand groups;methodsfor thecalculation of undertaking-specific parametersfor soloundertakings; theloss-absorbingcapacityfordeferredtaxesand technical provisions;and standard capitalrequirementsfor health underwritingrisk.Informal pre - consultationswill be launchedand further draft standardsand guidelinesdeveloped in 2012.One key area in whichEIOPAdeliveredfurther advice totheCommission wasthecalibration of thenon-life underwritingriskmodule.Theadvice wasbased on a European-widedata request totheindustrylaunched in September 2010,and on discussionswithindustryrepresentativesand theEuropean Commission toconsider themostappropriatecalibrationmethodologies.Theresultsof thiswork werepublishedin December 2011.In the areaof catastropherisk, followingdiscussionswiththeindustry, EIOPA made itsfinal recommendation on a number ofoutstanding non- life and health catastropherisk issuesfor theimplementingmeasures.Solvency ii
  35. 35. In the second half of 2011, EIOPAcontinuedworkingwith industryrepresentativeson zoning and reinsurancestandards, aswell asoncatastropherisk guidelines.Technical provisionsInformal pre-consultationswereheld on actuarial guidelinesfor thevaluation of technical provisions.EIOPA began developing the draft standard on the risk-freeinterest ratecurveand contract boundaries.For thefirst time, the European Commissiontested in QIS5 a risk-freeinterest rate term structure which includeda so-calledilliquiditypremium.Theterm structure wasbased on an adjustedswap rate, and a newextrapolationmethod wasapplied for long maturities.During 2011, discussionscontinued on adjustmentstothe risk-freeratefollowingthe QIS5resultsand on the sustainability of long - terminsuranceguarantees.EIOPA participatedin these discussionsorganisedby the EuropeanCommission withMemberState and industry representatives.Proposalsemerged from Member Statesand industry on newadjustments,theso-calledcounter-cyclical premium and thematchingpremium.Theseproposalswereanalysed by EIOPAin the context of developingastandard for therisk - freerate that EIOPAwill defineand publish.Discussionsare expectedtocontinuein 2012.Solvency ii
  36. 36. Valuation of assetsand liabilities (excluding technicalprovisions)Informal pre-consultationswereheld on draft standardsand guidelinesconcerningthevaluation of assetsand liabilities.This includedguidelineson theuseof mark-to-model techniquesandthecompatibilityof International Financial Reporting Standards(IFRS)with SolvencyII.During 2011, EIOPAalsocontributedtotheprocessof IFRSstandard-settingand subsequent EU endorsement of thosestandards.Reporting and disclosureIn 2011, EIOPAlaunched a public consultationon itsdraft guidelinesand standardsfor reporting and disclosure.This marked the end of an ongoing and fruitful processof informalconsultation withstakeholderssince2009.Due to the importanceof harmonised reportingrequirementsfor theSolvencyII project, and alsofor other areasof EIOPA‘swork, such asfinancial stabilityand thelevel of preparation that will be required fromtheindustry, one of EIOPA‘skey aimsistoarrive at stablereportingrequirementsassoon aspossible.Further discussionson specificaspectsof the reportingtemplatesandthefrequencyof reports are expected to continue in the first half of 2012.Governance and risk management requirementsInformal pre-consultationswereheld on standardsforgovernance,includingORSA(thelatterissuewasalsosubjecttopublicconsultationlater on). EIOPAbegan developing draft standardsandguidelineson transparencyand accountabilityof supervisoryauthoritiesand theSolvency ii
  37. 37. supervisoryreview process,capital add-onsand extension of the recoveryperiod in deterioratingmarket conditionsaswellasonexternal audit.Own fundsInformal pre-consultationswereheld on draft standardsand guidelinesfor ancillaryown fundsand the classificationof ownfunds.Further workwascarried out on thetreatment of participationsand ring-fenced funds.Internal modelsInformal pre-consultationswereheld on draft standardsand guidelinesfor the following:applicationprocessesfor internalmodels; policiesforchangingthemodel; partial internal models; use tests;expert judgments;probabilitydistributionforecasts(PDF); and consistencybetweenthemethodologyused for the PDF calculationand the methodologyused forvaluation of assetsand liabilities(e.g. the calculation of technicalprovisions, approximationsfor calibrations,profit and lossattributions,validationpolicyand validationtools,documentsand the useof external models).Followingthepublication in 2010of guidelinessupportingthe pre-application processfor internal models, EIOPA monitored theactivitiesof supervisorsand industry, usingthisopportunitytocheck the day-1applicabilityof internal models.This includedinformal practical meetingsof supervisorsinvolved in thepre-applicationprocess.Insurance stresstestAt the end of March2011, EIOPAlaunchedthe second Europe-widestresstest for theinsurancesector, whichwasfollowedin mid-August bySolvency ii
  38. 38. a satelliteexerciseassessingthe effectsof a prolonged period of lowinterest rates.This satelliteexerciseis often referred to asthe ―lowyield stresstest‖, and while it wasplanned in conjunctionwith the core stresstest, itslaunch waspostponed to easetheworkloadof participatingundertakings.In accordancewithitsregulation, EIOPAshall conduct stresstestexercisesfor theinsuranceand IORPssectorsat least oncea year.The2011core and low-yieldstresstest exerciseswereto assessthestrength of individual institutionsand evaluatetheoverall resilienceofthe industriesto several clearlydefined adverseeconomicand financialmarket environments.Thecore stresstest waslaunched in March2011based on data asof 31December 2010,and theaggregatedresultsof the exercisewerepublished in July2011.Of the 221 insurance and reinsurance groups and undertakingscovered, 58 groups and 71 single entities reported results toEIOPA, representing approximately 60% of the whole Europeaninsurancemarket.Theresultsof thestresstest exerciseconfirmed that the insurancemarket in Europe asrepresented bythe 129participatingentities isrobust and iswell prepared for potential future shocks.Data showedthat approximately10% (13) of the groupsandundertakingswhichrespondeddid not meet the minimum capitalrequirement (MCR) in the adversescenario.Atotal of 8% (10)failed to meet the MCR in the inflation scenario.Overall, EIOPAidentifiedthemain driversof the resultsasadversedevelopmentsin equityprices,interestratesand sovereign debt markets.Solvency ii
  39. 39. On the liabilityside, non - life risksweremore critical, triggeredbyincreasedclaimsinflationand natural disasters.Risksfrom sovereign bond exposureswere coveredseparatelyin asupplementarytest and the resultsshowedthat approximately5%(6) of the participatinggroupsand undertakingswouldnot meet theMCR.Thesatelliteexercisewaslaunched after the EIOPA2011corestresstestexercise.This wasto analyse the risksthat European insurerswouldface in ascenario whereinterest ratesremained low for a prolonged period oftime, and to understandthedevelopment of insurers‘capital positionsinadverseeconomicconditions,aswell asto evaluatethe overall stability oftheinsurancemarket.It wastargeted at thoseinsurersthat areexposed to interest-ratesensitiveproducts, sincea low-interestscenariowouldsignificantlyjeopardisethe abilityof theseundertakingsto meet theperformanceguaranteesprovidedin certain insurancecontracts.For this reason, comparedtothescope of the corestresstest, the sampleof reporting undertakingswasslightlyreducedto82in total.Otherwise,the setup of thelow-yield stresstest wasidenticaltothe coretest, i.e. valuationswerebased on SolvencyII/ QIS5 technicalspecifications,and the referencedate was31December 2010.Based on theseresults,EIOPAconcluded that, on average, theindustrywouldbe adverselyaffectedby a prolongedperiod of lowyields.Depending on the particularshapethat such a low-yield curve wouldtake and wherethe lowyieldswerelocatedalongthe curve, resultssuggest that 5%-10% of the insurersincludedin thetest wouldfacesevereproblemsin the sense that their solvencyratiowouldfall below100%.Solvency ii
  40. 40. In addition, an increasednumber of insurerswouldseetheir capitalpositiondeterioratewithsolvencyratesonly slightlyabove the100%mark, meaningtheycould becomevulnerabletoother potential externalshocks.Risk dashboardIn October 2011, the EIOPA FSC set up itsfirst (pilot) risk dashboard, inlinewiththe framework of the joint group on thecooperation betweentheESAsand the ESRB on systemic risk.As part of the new European supervisorylegislation, EIOPA, theotherESAsand theESRB are called upon to ―develop a common set ofquantitativeand qualitativeindicators(risk dashboard) toidentify andmeasure systemic risk‖.This dashboard should be constructed asa joint effort of the ESAsandtheESRB to givea structuredview of risksto the financial sector andthustofacilitate a regular assessment of theserisksand possiblemitigation policies.It is envisagedthat the risk dashboards of the variousinstitutionsbediscussed at ESRB meetings(General Board and/ orAdvisory TechnicalCommittee) toassesssystemic risk.Thetwomain outputsrequired are riskvulnerabilitiesand solvencyprofitability(meaningthe ability towithstandshocks).Afirst pilot risk dashboard hasbeen approved by EIOPA but isstill in adevelopment phaseand needstobe further refinedand finalised aftercompletion of thequalitycontrol phase.As far asthemethodologyis concerned, theEIOPAriskdashboardisbased both on publicsources(market data) and theconfidentialquarterlyfast-track reportingfrom the30largest European insurancegroupsand it containsboth quantitativeand qualitativeindicators.Solvency ii
  41. 41. Data availabilityfor dashboard purposesis expected tofurther improvewith the introduction of SolvencyII reportingfrom 2014onwards.Aset of some 50quantitativeindicatorsform thebasis of theriskassessment, and theseare mapped intoaggregatedcategoriesthat arealsoused by the other ESAs.Theseare macro risk, credit risk, market risk, funding and liquidityrisk, profitabilityand solvencyinterlinkagesand imbalances,and aspecific categoryfor insurancerisk.Therisk dashboard isthen obtainedthrough the mechanical aggregationof theseindicatorsand additional expert judgment which isimportant forfilteringout noise from thedata and producingcredibleriskassessments.Therisk dashboard will be shownin theform of a graph withcolourcoding.In addition toworkon the risk dashboard, EIOPAlaunchedseveralinitiativesduring 2011to improvemarket monitoring.For example, a daily financial market monitor waslaunched, and thisisnowproduced and circulatedamong EIOPAStaff and EIOPAFSCMembers.A more comprehensive bi-weekly briefing containing risk assessmentsand market analysis was also developed, and regular production of thisbriefing isplanned for 2012.OversightDuring 2011EIOPAundertook significant workin relation to insurancegroupsunder the current regime (SolvencyI), whilstin parallelpreparingitselffor the SolvencyII framework.Solvency ii
  42. 42. This hasincludedinitiativestoharmoniseand streamlinegroupsupervision for cross-bordergroupsand enhanceco-operationbetweensupervisorswithintheCollegesof Supervisors.EIOPA hasstarted toattend the meetingsof Collegesof Supervisorssincethe beginningof 2011, and this hasbeen a vital mechanismforhelpingsupervisorstoprepare for theentry intoforce of Solvency II, inparticular withregard to the pre-applicationsfor internal models.In MarchEIOPApublished itsreport on the functioningof colleges,andalsothetargetstobe achieved during 2011, asincluded in EIOPA‘s2011Action Plan for Collegesof Supervisors.Theoverall strategictarget of EIOPA‘sCollegeworkis toconsolidatethepositionof the EEA supervisory communityvis-a-vis thecross- borderoperatinginsurance groupsfor thebenefit of both group and solosupervision.Thefocusis on combiningand leveragingthe knowledgeand forces ofthenational supervisoryauthoritiesin theEEA toform a strong andequal supervisorycounterpart tothe mostly centrallyorganised andmanaged undertakings.In thisrespect, EIOPAasa member of theCollegesof Supervisors(―Colleges‖) promotescommunication, cooperation, consistency, qualityand efficiency in theColleges.In 2011, 89 insurancegroupswith cross-border undertakingswereregisteredin theEEA.During the year, Collegesof Supervisorswith at least one physicalmeetingor teleconferencewereorganised for 69 groups.Atotal of 14 national supervisoryauthoritiesacted asgroup supervisorstoorganisethe events.Solvency ii
  43. 43. Some6 Collegeswerechairedby theSwissFinancial Market SupervisoryAuthority (FINMA) asgroup supervisor.Duringthe setup phasein the first year after its establishment, EIOPAattendedCollege meetingsand/ or teleconferencesof 55 groups.Themain conclusionsfrom EIOPA’sobservation in the Collegesin2011are asfollows:•Substantial effortsweremade by supervisorsin preparing, organisingand contributingtothe College;•Theexchangeof theQIS5and stresstest resultsin most of theCollegesenhancedthe qualityof thediscussionsand improved thesupervisors‘common understandingof theundertakings‘risk exposure and solvencyposition;•Similarly, the discussionof financial conglomerateaspects,whererelevant, helpedtoimprove College members‘ awarenessof the financialstrength of the groupsasa whole;•Concernsor legal constraintsin some Member Statesrelatingto theexchangeof confidential information hamperedthe scope and qualityofdiscussionsin the Colleges;• Differencesobserved betweentheCollegesregarding:-Scope, content and thefrequencyof informationexchangein theColleges,-Preparation and focus of presentations and discussions with the firms‘srepresentative are areas for improvement in implementing an EEA-wideconsistent, coherent and effective supervisionfor cross-bordergroups;•Theemergencyinfrastructure test wassuccessfullycompletedby mostof the Colleges;Solvency ii
  44. 44. •TheCollegesare makinggreat effortsto prepare for theimplementationof theSolvencyII Directive, in particular thepre-application processfor useof an approved internal model.Participation in Collegesby EIOPAstaffDuring 2011, five full-timeequivalent staff wererecruited to constituteEIOPA‘sCollege team.Acoordinatorhad been appointed at thebeginningof 2011to prepareastrategyfor EIOPAand tokick off EIOPA‘sparticipation in theColleges.EIOPA staff‘scommitment tothe Collegesfocusedprimarily on thefollowingissues:• Toexplain EIOPA‘srolein the Colleges;•Togain experiencefrom participatingin College meetingsfor the firstyear;•Tomonitor the collaboration of College membersregardingtheappropriateinformation exchangeand the discussionof relevant topicsin theCollege;•Toprovide input intotheagenda and stimulateinformation exchangewithin Collegeson stresstest resultsand thedialogueon risk exposure,financial strength and resiliencetoadverseeconomicand financialmarket developments;•Toprovide regular updateson the workingassumptionsin light of thestill pending decisionson the SolvencyII timelines;•Toact asa link betweenthe Collegesand SolvencyII WorkingGroupsandprovidepractical input intoSolvencyII policy work.Solvency ii
  45. 45. During 2011, EIOPAstaff observed overall significant differencesin thelevel of information exchange.Areas for improvement include in particular a continuous and effectiveinformation exchange, as well as discussion and assessment of risks bytakinga more prospectiveview.EIOPA‘sAction Plan 2012for Collegeswasestablishedtaking intoaccount the experienceand conclusionsfrom Collegeworkin 2011.Crisis ManagementIn early2011, a set of interim proceduresfor dealingwith emergencysituationswasdrawnup by EIOPAin conjunction with theother ESAs.Aseconded national expert in crisismanagement wasappointed inMarch2011, and work then commencedon the development of apermanent framework for crisismanagement for EIOPA.Key to thiswasthe development of a strategic policy on crisismanagement that waspresented to theBoard of Supervisorsin June2011.The Board of Supervisors recognised the need to put a robust frameworkin place at an early stage, and an ad hoc Board of Supervisor‘s task forcewascreated to develop this framework.In December 2011, the taskforce delivereda comprehensive, decision-makingframeworkwhich wasendorsedby the Board of Supervisors.This frameworksetsout in detail the processesthat EIOPAwill followindischargingits crisispre-emption and management responsibilitiesundertheEIOPARegulation.A small standing group was created, comprising EIOPA members andstaff, that will consider on a regular basis whether EIOPA needs to actunder theRegulationand what actionsit may take.Solvency ii
  46. 46. This approachisseen asthemost efficient wayof carrying out regularmonitoring and preparing Board of Supervisors‘decisionson crisismanagement issues.EIOPA Work Programme 2012In 2012EIOPAwill already operateasa fully-fledged Europeanagency, howevermany of theprocessesand procedureshave toberefinedor adapted to the growingorganisationand new responsibilities.TheWork Programme setsout thegoalsand deliverablesfor the secondyear of operations.Regulatory tasksIn 2012,EIOPAwill deliver draft implementingand regulatory technicalstandardsaswell asguidelinesin thedifferent workstreams, accordingtospecificneedsto complement theprinciplesand regulationsissuedbytheEuropean Commission.Theconcretescope and timingof these deliverablesdepend on thefinaldecision on theOmnibusII Directive(OMDII) aswell ason theapproval of the final DelegatedActsimplementingSolvencyII.In 2012,EIOPAwill prepare itsfinal advicetotheEuropeanCommission on thereview of the Directiveon the activitiesandsupervision of institutionsfor occupational retirement provision (IORPDirective).EIOPA will then develop specifications and carry out a targetedquantitative impact study (QIS) exercise in order to support theCommission‘sproposal for a revised IORP Directive.Solvency ii
  47. 47. EIOPA will contributetothe revision of the InsuranceMediationDirective(IM D), by providing a respectiveadvice to theEuropeanCommission.Supervisory tasksEIOPA will continue to participatein theworkof Collegesof Supervisorsand will specificallypromote frequent information exchangeanddiscussionon risks.Topromotetheexchangeof information in a safeand sound mannerwithin Collegesof Supervisors, EIOPAwill give priority toitsworkon theimplementationof a common IT solution for the secureexchangeofinformation withinColleges, alsoin crisis times,withthe aim tohavethetool readyin 2012.In the courseof 2012EIOPAwill launchingthreepeer reviewson thefollowingtopics: supervision of branchesof EEA insuranceentities,supervisory aspectsof thepre-applicationof internal modelsand supervisorypowerstoobtain information and interventionregardingIORPs.Consumer Protection and Financial InnovationEIOPA will further develop and pursue itsleadingrole in promotingtransparency, simplicityand fairnessin themarket for consumerfinancial productsand servicesacrossthe internal market.This will be done by developing more standardisedand comparableinformation about therisksand costsof products, relevant regulatoryrequirementsand complaintshandling procedures.TheCCPFI will continue itsmonitoringand assessment of new orinnovativefinancial activities, releasegood practicesreportsand, wheredeemed appropriate, make proposalsfor the adoption of guidelinesandSolvency ii
  48. 48. recommendationswitha view topromoting the safety and soundnessofmarketsand convergenceof regulatory practice.Financial StabilityEIOPA will carry out a harmonised, pan-European stresstest for theinsurancesector in cooperation withthe ESRB, the ECB and EBA.In autumn 2012EIOPAwill deliver an annual assessment of sectordevelopments, highlightingimplicationsfor financial stability, withaprovisional report in thespring of 2012,outliningmain market trendssincethe end of 2011.TheAuthority will alsofurther develop and monitor a risk dashboard incooperationwiththeESRB and other ESAs.Crisis managementEIOPA will continue to develop its crisis management framework withthe focus on the pre-emption element and analytical tools to be used indecision- making.Later in 2012a simulation exercisetotest theoperation of thenewframeworkwill be carried out.EIOPA will alsocontributeto theworkof the European Commission indeveloping crisismanagement proposalsfor insurance, alongwiththeworkof the IAIS on resolution tools for systemically important insuranceundertakings.External RelationsEIOPA‘sview is elaboratedwiththe Members‘support and set forth intherelevant committeesof IAIS. Particular focus will be given to raiseEIOPA‘svoice in theIAIS Executive Committeeand topromote theCommon Framework for theSupervision of InternationallyActiveInsuranceGroups(ComFrame).Solvency ii
  49. 49. At the same time, EIOPA will continuetodevelop itsinternationalrelationsby holdingregulatory dialoguesand maintaininga closecontact withthird countries includingtheUS, China, Japan and LatinAmerica.EIOPA will alsocontinuetoassist the European Commission inpreparingequivalencedecisionspertainingto supervisoryregimesinthird countriesby wayof producingfinal, fullyconsultedupon advice.Joint CommitteeIn 2012theJoint Committeewill further developitsworkin the sub- committeeson financialconglomerates,on crosssectordevelopments, risksand vulnerabilitieson anti-moneylaunderingand on consumer protectionand financial innovation.Theexchangeof information with the ESRBwill alsobe further developed.Solvency ii
  50. 50. List of the Members and Observersof the EIOPA Board ofSupervisorsSolvency ii
  51. 51. Solvency ii
  52. 52. Agathe Côté: Modelling risks to the financialsystemRemarksbyMsAgathe Côté, DeputyGovernor oftheBank of Canada, to the CanadianAssociationfor BusinessEconomics,Kingston, Ontario, 21August 2012.* * *IntroductionIt hasbecome a summer tradition for theBank of Canada to addresstheCanadianAssociation for BusinessEconomics.This year it is my pleasureand I thank you for the kind invitation.An audienceof colleaguesand felloweconomists offersme anopportunitytodelveintoa complex subject, and onethat is particularlytimely: financial system risk.We continueto seetodaytheenormouscoststo the global economy ofthefinancial crisisthat started five years ago.Of the many lessonswehave learned from the crisis, a keyone is this:weneed to paymore attention tothe stabilityof the financial system asawhole.This meansunderstandingbetter how risksget transmittedacrossfinancial institutionsand markets, and understandingbetter thefeedbackloop betweenthe financial system and the real economy.From a policyperspective, this meanstakinga system-wideapproachtofinancial regulationand supervision.Majorreforms of theglobal financial system now under wayaddressthisneed.Solvency ii
  53. 53. System-widerisk hasbeen a focusof attention at the Bank ofCanada,and at other central banks,for sometime.Ten yearsago, theBank issued the first editionof itssemi-annualFinancial System Review in whichit identifieskeysourcesof risksto theCanadian financial system and highlightsthe policies needed to addressthem.Ayear later, in 2003,weorganized our annual conferenceon the themeof financial stability.In the wakeof theglobal financial crisis, the Bank hasintensified itsresearch effortsin this area.In particular, a priorityis toimprove thetheoretical and empiricalmodelsweusetoanalyze elementsof thefinancial system that can leadtothe emergenceof risks and vulnerabilities.With more finely tunedquantitativemodels and tools, theBank will bebetter ableto identifyriskson a timelybasissothat the private sectorandpolicy-makerscan take correctiveaction to support financialstability.Let me acknowledgeupfront that this task is complex.While macroeconomic models havelong been usedtoguidemonetarypolicy decisionsby central banks, modelsof financial stability andsystemic risk aremuch lessadvanced.In my remarkstoday, I want to talk about the progressthat wehavemadeat the Bank in modellingriskstothefinancial system.I will start by brieflydescribingthe notion of systemic riskand variousapproachesused to identify and measure it.Solvency ii
  54. 54. I will then discuss two state-of-the-art quantitative models that we havedeveloped to improve our assessment of risks to the Canadian financialsystem.The multiple dimensions of systemic riskSystemic, or system-wide, risk goesbeyond individual institutionsandmarkets.It is the risk that the financial system as a whole becomes impaired andthat the provision of key financial services breaks down, with potentiallyseriousconsequencesfor the real economy.Systemic risk manifestsitself in different ways.There is a time dimension, whichreferstothe accumulationofimbalancesover time, and a cross-sectional dimension, whichrefers tohow risk isdistributedthroughout the financial system at a givenpointin time.Procyclicality isthekey issuein thetimedimension.It reflectsthetendencytotake on excessiverisk during economicupswings– toomuch punch from thepunchbowl, if you will – and tobecome overly risk averseduring the downturns.Procyclicalitymakes the financial system and the economy morevulnerable toshocks, and increasesthe likelihoodof financial distress.Riskconcentrationsand interconnectionsare thekey issuesin the cross-sectional dimension.Financial institutionscan have similar exposurestoshocksor be linkedthrough balancesheets.As a result, lossesin one institution can lead tofearsof contagion thatSolvency ii
  55. 55. amplify the adverseeffectsof the initial shock.For instance, uncertaintyabout the viabilityof counterpartiescan lead tohoardingof liquidity, whichmay seem like an appropriate action for theindividual institutionbut can havedisastrousconsequencesfor thefinancial system asa whole.System-widesurveillancerequires that weregularly assesstheimportanceof varioustypes of systemic risk.How wejudgea particular risk will be basedon theprobabilitythat itwill lead to financialsystem distress, and on theextent of itsimpactshould that distressmaterialize.Early-warning indicatorsAfundamental challengeis todetect the risksarisingfrom both globaland domestic sourcesin an environment witha vast number of potentialindicators.Therefore, one directionof research at the Bank hasbeen toisolatethekey signalsfrom this broad information set by identifying a smallergroupof variablesthat can serve asearly-warningindicatorsof emergingimbalances.Sincefinancial crisesin Canadahave been rare, international data areused to help establishnumerical thresholdsfor each domesticindicator.For example, if international evidencesuggeststhat credit growthabovea certain rate tendstobe associatedwithincreasedrisk, thena periodwith credit growth above thethreshold wouldsuggest an elevatedprobabilityof financial stress.Selectingthe level of thresholdsinvolvesa difficult trade-off betweenfalsealarms and failure to signal an event, soin practice theearly-Solvency ii
  56. 56. warningindicatorsare used mainlytoidentify areaswheremore detailedinvestigationmay bewarranted.Theyprovide an objective, practical startingpoint todetect the buildupof imbalancesin thefinancial system.One early-warningindicatorthat weregularlytrack is the deviation oftheaggregateprivatesector credit-to-GDP ratiofrom itstrend (thecredit-to-GDPgap), whichservesasa rough measure of excessiveleverageacrossthe financial system (Chart 1).This indicatorhasbeen shown toprovidesome leadinginformationasapredictorof bankingcrises,and hasbeenproposed by theBaselCommitteeon BankingSupervision (BCBS) asa useful guide fordecisionsabout when to activatethecountercyclical capital buffer – animportant macroprudential policy instrument in the Basel III agreement.Given the complexityof systemic risk, it is unrealistic toexpect a singlemeasure or indicatortoserve all purposes.Solvency ii
  57. 57. Combining indicatorscan producebetter signals withfewerfalsealarmsandundetected crises.For example, research shows that combining the Credit - to - GDP gapwith a measure of real estate prices producesan indicator that performsbetterthan either variable on itsown.Our own workat theBank reinforcesfindingselsewherethat aggregateprivate sectorcredit and real estatepricesare among the most reliableindicatorsof financial stress.Identifying sourcesof risk is essential, but sois determiningthelikelihoodthat theserisks will materialize.Therefore, another important aspect of ongoingresearch is thedevelopment of statistical models to help usforecast theprobabilitythata crisiswill occur basedon a group of indicators.Macro stresstestsEarly-warningindicatorsareuseful to gaugethe probabilityof financialstress, but a thorough assessment alsorequiresan analysis of what couldhappen if the risk materializes.This is thegoal of macro stresstesting.Agood part of theBank‘seffortsin recent years hasbeendevotedtodeveloping and refiningstress-testingmodels.This class of models takes a large but plausible macroeconomic shock asa starting point and analyzesitsimpact on the balance sheets of banksorother sectorsof theeconomy.TheBank now hastwomain stress-testingmodels to help monitor riskstothe financial system.Solvency ii
  58. 58. Thesemodels can alsobeused toassessthepotential impact of policytoolsor regulatoryactionsin mitigatingfinancial system risks.Assessing risks from elevated household debtThefirst, the Household RiskAssessment Model, or HRAM, is amicrosimulationmodel that assesseshow the debt burden of Canadianhouseholdscan affect financial stability.Using microdata from household balance sheets, the model allows us toestimate how various shocks would affect the distribution of debt withinthehousehold sector.Thesimulationstake intoaccount changesover time in individual debtlevels,aswell aschangesin household wealth from savingsandfluctuationsin thevalue of financial assets.Tracking theasset sideof household balancesheetsgivesusa moreaccuratepicture of systemic risk sincechangesin wealth affecthouseholds‘abilitytopay their debt.Household vulnerabilitiesdepend not onlyon the averagelevel ofdebt, but alsoon howdebt is distributedacrossindividuals.One strength of themodel is precisely itsabilityto account for thisdistribution.For instance, while record-lowinterestratesin recent years havecontributedtoa relatively lowaggregate household debt-serviceratio, theshare of Canadian householdsthat are consideredmostvulnerable– thosewithadebt-serviceratio equal toor higher than 40percent – hasclimbedtoabove-averagelevels,ashasthe proportion of debtheldbythesevulnerable households(Chart 2).Solvency ii
  59. 59. Using HRAM, weestimatethat if interest rateswereto riseto 4.25percent by mid-2015,theshare of highly indebtedhouseholdswouldrisefrom slightlyabove6 per cent in 2011toroughly 10 per cent by2016,while theproportionof debt heldby thesehouseholdswouldrisefrom11.5per cent to about 20 per cent over thesame period.Sowhile theaggregate household debt-serviceratiopaintsa somewhatrosypicture, takingintoaccount distributionsgivesusa clearer andmore cautionaryindicationof how vulnerable our financial systemactuallyis to household debt.Another strength of themodel is that it providesa flexibletool forsimulatingtheimpact on household solvencyof a widerangeofpotential shocks, such asan increasein unemployment.HRAM indicatesthat household loansin arrearswouldmore thandoubleunder a severelabour market shock similartothat observed inthe recession of theearly1990s.Solvency ii
  60. 60. Despitethe model‘sstrengths, wecontinue to enhanceour analysisbyimprovingHRAM.Expandingthe behavioural aspectsof the model is one waytodo this.For instance, the model currently allowsdistressed householdstopaytheir debtsbysellingtheir liquidassets,but not their homes.Work is alsounder waytoimprovethe design of the shock scenarios.Resultsof stresstestsusing HRAM are regularly reported in the Bank‘sFinancial System Review and constitutean important element of ouroverall assessment of the risksassociated withhousehold finances.Assessing contagion effects in the banking systemHRAM providesinvaluableinformation on vulnerabilitiesin thehousehold sector, but the Bank is alsointerestedin assessingrisks morebroadly withinthe Canadian financial system.Tothisend, wehavebeen workingfor several years on developingaMacroFinancial Risk Assessment Framework(or MFRAF).Drawingon detaileddata from bank balancesheets,MFRAF is aquantitativemodel that tracksthe contribution of individual bankstosystemic risk.Traditional stress-testingmodels focusexclusivelyon solvencyrisk, andestimatetheoverall risk to thefinancial system by simplyaggregatingcredit (or other asset) lossesthat wouldmaterialize at individual banksintheevent of a severe shock.MFRAF goesbeyond this traditional approach by taking intoaccountlinkagesamongbanks arisingfrom counterpartyexposures– or networkspillovereffects– aswell asfunding liquidityrisk, that is, therisk ofmarket-basedrunson banks.Solvency ii
  61. 61. Thefinancial crisisillustratedthesignificant risks associatedwithadeteriorationof fundingliquidity.Thecollectivereactionsof market participantsled to mutuallyreinforcingsolvencyand liquidityproblemsat banks around theworld.As funding liquidityevaporated, many well-capitalizedinstitutionshadtotakewritedownson illiquidassets,or sell them at a loss, creatinguncertaintyin the market about their solvencyand adding to thedownward pressure on asset prices.MFRAF hasbeenbuilt tointegratefundingliquidityrisk asanendogenousoutcome of the interactionsbetweensolvencyconcernsandtheliquidityprofilesof banks.This strong microeconomicfoundationconstitutesa major innovation inmacro stress-testingmodels.MFRAF alsoincorporatesnetworkexternalitiescaused by thedefaultsofcounterparties, withthesizeof a counterparty‘sinterbank exposuresincreasingthe likelihoodof spillover effects.Akey lesson from the model is that failureto account for either fundingliquidityrisk or interbank exposurescould lead tosignificantunderestimationof therisksto the financial system asa wholeif thebankingsystem isundercapitalizedand relies extensively on theshort-term fundingmarket.Importantly, thelossdistributionsgeneratedby themodel exhibitfat tails, a key featureof the actual distribution of financial system risks(Chart 3).Solvency ii
  62. 62. Thefact that the model is ableto replicatethisimportant stylized factdemonstratesthat it hassignificant potential asa tool for assessingsystemic risk.Nevertheless, while MFRAF is alreadysomewhat complex, the layers ofinteraction will need to be further augmented.For instance, the model missesany negativefeedback that could occurbetweenheightenedrisks to the banking system and the real economy.Themodel could alsobe expandedover timetoincludeother types offinancial institutionsand markets.Compared withother approachesthat use market-based data, such astheasset-pricingapproach, the transmissionchannel in models likeMFRAF is transparent, and this improvesour interpretationof results.Becauseof this ―story-telling‖ ability, many central bankshave begun tousethistype of framework in their financial stability analysis.Solvency ii
  63. 63. In addition toassessingrisks, MFRAF can be used toexaminethemeritsof policyor regulatory initiativessuch ascapital and liquidityrules.As the model becomesmore refined, theobjectiveis touse it more tocomplement other existingmacro stress-testingexercisesand to sharpenour analysis and communication of risksin the Bank‘sFinancial SystemReview.ConclusionLet me conclude.TheBank of Canada is conductingextensiveresearchintofindingmethodologiesand toolstoidentify and measure systemic risk.While work in thisarea is extremelycomplex, the Bank hasmadesubstantial progressin recent years.We now have twostate-of-theart models.And with HRAM, the Bank ofCanada isone of thefew central banksat theleadingedge of usingmicrosimulationmodels toassessvulnerabilitiesin the household sector.Our effortsto build these models haveprovideduswithimportantlessons.First, distributionsmatter – wecannot rely solely on aggregate data:distributional featuresand complex interactionsare very important forassessingrisks.This meansdevelopingmodels that capture theseeffects.Our household simulationmodel is aimed directlyat understandinghowthedistribution of debts,assetsand income affectsfinancialstability.Solvency ii
  64. 64. MFRAF uses information about the interconnections of individualfinancial institutions because these can lead to non-linear networkeffectsthat are alsoimportant for assessing systemic risks.Second, predictingbehaviour under stressconditionsis very difficult.Modelsneed to be ableto handlea variety of ―what-if‖ scenarioscorresponding to different assumptionsabout behavioursunder stress.Finally, weneed to consider themany different sourcesof risk tothefinancial sector and take intoaccount their cumulativeeffectsandinteractions;otherwisewemay underestimaterisks.Obviously, quantitativemeasuresalonewill never be enough to get acompletepicture, especiallysincethe financial system evolvesrapidly.Intelligencegathered from discussionswith the financial sector, aswellasinformationshared withother policy-makers and supervisorshere inCanada and in the international community, will always be criticaltotheoverall assessment of the risks.While weare makingprogress,it isimportant to remember that financialsystem modellingis still in itsinfancy.Thegoal – understanding, preventing, and reducingsystemic | risk –deservesour attention, diligent research and hard work. It hasbeen mypleasuretosharesome of the Bank‘seffortswithyou today. Thank youvery much.Solvency ii
  65. 65. EBA, EIOPAand ESMAJoint ConsultationPaper on Draft Regulatory Technical Standardsontheuniform conditionsof application of the calculation methodsunderArticle 6.2of the Financial ConglomeratesDirective (JC/ CP/2012/02)I. Responding to thisConsultationEBA, EIOPAand ESMA(theESAs) invitecommentson all mattersinthispaper and in particular on thespecificquestionsstatedin theattacheddocument ―Overview of questionsfor Consultation‖ at the endof this paper.Commentsare most helpful if they:- respond to thequestion stated;- indicatethespecific question towhichthecomment relates;- contain a clear rationale;- provideevidencetosupport the viewsexpressed/ rationaleproposed;and- describeany alternativeregulatory choicesEBA should consider.II. Executive SummaryTheCRR /CRD IV proposals(the so-calledCapital RequirementsRegulation - henceforth ‗CRR‘- and theso-calledCapital RequirementsDirective– henceforth ‗CRD‘) set out prudential requirementsfor banksSolvency ii
  66. 66. and other financial institutionswhich are expected to applyfrom 1January2013.In anticipationof thefinalisationof the legislativetextsfor theCRR/ CRD IV, theEBA, EIOPAand ESMA(hereaftertheESAs)through the Joint Committee,have developed the draft RTSinaccordancewiththemandatecontained inArticle 46(4) of theCRR andArticle 139of CRDIV (amendingArticle 21a (2a) of the Directive2002/ 87/ EC) on thebasisof the European Commission‘sproposals.ThisArticle providesthe ESAs through the Joint Committee,to developdraft Regulatory TechnicalStandards (RTS) withregard to theconditionsof theapplication of theArticle6(2) of the Directive2002/ 87/ EC (hereafter the Directive).Further the ESAshave developed the draft RTShaving regard toArticle230in connection withArticles220and 228of the Directive2009/ 138/ EC2.Tothe extent that thetextsmay changebeforetheir adoption, theESAsshall adapt itsdraft RTS accordinglyto reflect anydevelopments.TheRTS included in this consultation have tobe submittedtothe EUCommissionby 1January2013.Pleasenotethat theESAshave developed thepresent draft RTSbasedon theEuropean Commission‘slegislativeproposalsfor the CRR/ CRDIV.Theyhave alsotaken intoaccount major changessubsequentlyproposedbytherevisedtextsproduced by theCouncil of the EU and the EuropeanParliament, during the ordinarylegislativeprocedure (co- decisionprocess).Followingtheend of theconsultation period, and to the extent that thefinal text of the CRR/CRD IV changesbeforethe adoption of the RTS,Solvency ii
  67. 67. theESAswill adapt the draft RTS accordinglytoreflect anydevelopments.Main features of the RTSThis consultation paper putsforwarddraft RTSin order toensure thatinstitutionsthat are part of a financial conglomerateapplytheappropriatecalculationmethodsfor thedetermination of requiredcapital at the level of the conglomerate.Theyare based in particularon thefollowingelements:General PrinciplesoEliminationof multiplegearing;oEliminationof intra-group creationof ownfunds;oTransferability and availability of ownfunds;andoCoverageof deficit at financial conglomeratelevel having regard todefinitionof cross-sectorcapital.Technical calculation methods1. Method 1:―Accounting consolidation method‖:TheFICOD providesin relationtoMethod1that the own fundsarecalculatedon thebasis of the consolidatedposition of the group.Accordingtothis general provision, thecalculationof own fundsshouldbebased on the relevant accountingframework for the consolidatedaccountsof theconglomerateapplicabletothescope of the Directive.Theuse of ―consolidatedaccounts‖ eliminatesall ownfunds‘intra-group items,in order toavoid doublecounting of capital instruments.Solvency ii
  68. 68. Accordingtothe Directiveprovisions, theeligibilityrulesare thoseincludedin sectoral provisions.2. Method 2: ―Deduction and aggregation method‖.This method calculatesthesupplementary capital adequacyrequirementsof a conglomeratebased on the accountsof soloentities.It aggregatestheown funds, deductsthebook valueof the participationsin other entitiesof the group and specifiestreatment of the proportionalshareapplicabletoown fundsand solvencyrequirements.All intra-groupcreation of own fundsshall be eliminated.3. Method 3: ―Combination of methods1and 2‖.Theuse of combination of accounting consolidationmethod 1anddeductionand aggregationmethod 2 islimitedtothe caseswheretheuseof either method 1or method 2 wouldnot be appropriateand issubjecttothepermission by the competent authorities.III. Background and rationaleThesupplementarysupervision of financial entitiesin a financialconglomerate iscovered by the Financial ConglomeratesDirective2002/ 87/ EC, hereafter knownasthe Directive.This Directiveprovidesfor competent authoritiestobe able toassessat agroup-widelevel the financial situationof credit institutions,insuranceundertakingsand investment firms whicharepart of a financialconglomerate,in particular asregards solvency(includingtheelimination of multiplegearingof own fundsinstruments).The nature of RTSunder EU lawSolvency ii
  69. 69. Draft RTSare produced in accordancewithArticle 10 of the ESAsregulation.AccordingtoArticle 10(4) of the ESAs regulation, they shall be adoptedbymeansof Regulationsor Decisions.AccordingtoEU law, EU regulationsare bindingin their entiretyanddirectlyapplicablein all Member States.This meansthat, on thedateof their entry intoforce, theybecomepartof the national law of the Member Statesand that their implementationintonational law is not onlyunnecessarybut alsoprohibitedby EU law,except in sofar asthis is expresslyrequiredby them.Shapingtheserulesin the form of a Regulation wouldensure a level-playing field and wouldfacilitatethe cross-borderprovisionof services.Background and regulatory approach followed in the draft RTSThesedraft RTSareproduced in accordancewithCRD IV/ CRRproposals,which providethat the EBA, ESMA and EIOPA(hereafter theESAs), through the Joint Committee, shall develop draft regulatorytechnicalstandardswithregard tothe conditionsof the applicationof thecalculation methodswithregard toArticle 6(2) of the Directiveand shallsubmit thosedraft regulatory technical standardstotheCommissionby 1January2013.Theproposeddraft RTS coverstheuniform conditionsfor the useof themethodsfor thedetermination of capital adequacyof a financialconglomerateunder the Directive.Theyelaborate on Technical principlesapplying to all of thethreemethodsprovided for by Directive; and alsocontain anAnnex providingfurther detail for Method2.Solvency ii
  70. 70. Therequirementscontained in thedraft RTSare mainlydirected atinstitutions,although some of them are directedat competentauthorities.IV. Draft Regulatory Technical Standardson the uniformconditionsof application of the calculation methods underArticle 6.2 of the Financial Conglomerates DirectiveCommissionDelegatedRegulation (EU) No XX/ 2012supplementingDirectivexx/ XX/ EU [CRD] of the European Parliamentand of the Council of [date], Regulation (..) No xx/XXXX [CRR] of theEuropean Parliament and of the Council of [date] and Directive2002/ 87/ EC [Financial ConglomeratesDirective] of the EuropeanParliament and of theCouncil of [date] with regard toregulatorytechnicalstandardsfor theuniform conditionsof application of thecalculationmethodsunderArticle 6.2of theFinancial ConglomeratesDirectiveof XX Month2012THE EUROPEAN COMMISSION,Havingregard to the Treaty on the Functioningof theEuropeanUnion, Having regard to the[proposal for a] Regulation (...) No xx/ xxxxof theEuropean Parliament and of the Council of dd mm yyyy on prudentialrequirementsfor credit institutionsand investment firmsRegulationxx/ xxxx [CRR] and in particularArticle 46 (4) thereof.Havingregard to the [proposal for a] Directive(...) No xx/ xxxx of theEuropean Parliament and of the Council of dd mm yyyy on the accesstotheactivityof credit institutionsand theprudential supervisionof creditinstitutionsand investment firms[CRDIV] and in particularArticle 139thereof.Havingregard to the Directive2002/ 87/ EC, asamended, of theEuropean Parliament and of the Council on the supplementarysupervision of credit institutions,insuranceundertakingsand investmentSolvency ii
  71. 71. firmsin a financial conglomerate(hereinafter―theDirective‖) and inparticular toArticle 6(2) andAnnex 1thereof.Whereas:(1)Directive2002/ 87/EC providesin Chapter II, Section 2, rules oncapital adequacyof financial conglomerates, such that the elementsofownfundsare available at the level of a Financial Conglomeratesarealwaysat least equal to the capital adequacyrequirementsascalculatedin accordancewithAnnex I of theDirective.(2)Regulation (...) No xx/ xxx (‗CRR‘) providesin Article 46, within PartII, Chapter 2, Section 3, Sub-Section 2 and in thecontext of commonequityTier I rules, requirementsfor deductionwhereconsolidationorsupplementarysupervisionare applied.This section of theCRR providesempowermentsto the EuropeanCommissiontoadopt delegatedacts(regulatory technical standards) inaccordancewitharticles10-14of the Regulation(EU) No 1093/2010establishingthe European BankingAuthority (‗EBA‘), Articles10-14of theRegulation (EU) No 1094/ 2010establishingthe European InsuranceandOccupational PensionsAuthority (‗EIOPA), andArticles10-14of theRegulation (EU) No 1095/ 2010(‗ESMA), establishingtheEuropeanSecuritiesand MarketsAuthority.Theseactswill completetheEU singlerulebook for institutionsin thearea of ownfunds.(3)Directive(...) No xx/xxx (‗CRDIV‘) providesin Article 139that theDirective2002/ 87/ EC shall be amended, such that the EBA, EIOPAand ESMAthrough the Joint Committee, to develop draft RegulatoryTechnicalStandards(RTS) with regard totheconditionsof theapplication of theArticle 6(2) of the Directive.Solvency ii