Monday September 10 2012 - Top 10 Risk Management News

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Monday September 10 2012 - Top 10 Risk Management News

  1. 1. Page |1 International Association of Risk and Compliance Professionals (IARCP) 1200 G Street NW Suite 800 Washington, DC 20005-6705 USA Tel: 202-449-9750 www.risk-compliance-association.com Top 10 risk and compliance management related news storiesand world events that (for better or for worse) shaped the weeks agenda, and what is next George Lekatis President of the IARCPDear Member,According to Mr Kiyohiko G Nishimura, Deputy Governor ofthe Bank of Japan (to the 6th Irving Fisher Committee Conference, Bankfor International Settlements, Basel, 29 August 2012), “the Bank monitorsshadow banking entities and activities through various channels”.Wow! Look at that. Even secret services should become very jealous,especially the ones that don’t monitor such activity. What a plan! _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  2. 2. Page |2He continues:“Amongst these channels, direct monitoring of major shadow bankingentities is of course the most significant.Thus, the bank has increased the number of staff directly monitoringmajor securities companies.However, it is practically impossible to conduct dialogues with allfinancial institutions of a shadow banking nature, and moreover, shadowbanking activities tend to change rapidly with developments in financialmarkets.”It is a very interesting speech.Read more at Number 7B, just after the very interesting speech of MrYoshihisa Morimoto, Member of the Policy Board of the Bank of Japan.Welcome to the Top 10 list. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  3. 3. Page |3Some Thoughts on Global Risks and Monetary PolicyCharles L. Evans, President and Chief Executive OfficerFederal Reserve Bank of ChicagoEBA, EIOPA andESMAJoint ConsultationPaper on Draft Regulatory Technical Standards on the uniformconditions of application of the calculation methods under Article 6.2 ofthe Financial Conglomerates Directive (JC/CP/2012/02)Cryptographic Key Management Workshop 2012Purpose: NIST is conducting a two-day Key Management Workshop onSeptember 10-11.The subject of the workshop is the technical and administrative aspects ofCryptographic Key Management Systems (CKMSs) that currently existand may be required for U.S. Federal use in the future. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  4. 4. Page |4Short Selling Regulation UpdateMarket Maker & Primary DealerExemption Notification ProcedureThe European Securities andMarkets Authority (ESMA) ispublishing this notice to alert financial market participants to itsupcoming consultation on the market making and authorised primarydealer exemption under the EU’s Short Selling Regulation (SSR) and theprocedure to be followed by firms and regulators in dealing withnotifications of intention to use the exemption.Preliminary AnnualReport on U.S.Holdings of ForeignSecuritiesPreliminary datafrom an annualsurvey of U.S.portfolio holdings offoreign securities atyear-end 2011 were released.Dr Andreas Dombret, Member of the ExecutiveBoard of the Deutsche BundesbankForeign banks between financial crisis andfinancial stability _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  5. 5. Page |5Economic activity and prices in Japan and monetarypolicySpeech by Mr Yoshihisa Morimoto, Member of thePolicy Board of the Bank of Japan, at a meeting withbusiness leaders, Ishikawa, 2 August 2012.Market intelligence, market information and statisticsin central bankingKeynote Speech by Mr Kiyohiko G Nishimura, DeputyGovernor of the Bank of Japan, to the 6th Irving FisherCommittee Conference, Bank for InternationalSettlements, Basel, 29 August 2012.News Release - The dog andthe frisbee – paper by AndrewHaldaneIn a paper given at the FederalReserve Bank of Kansas City’s36th economic policysymposium in Jackson Hole, Wyoming, Andrew Haldane – ExecutiveDirector for Financial Stability and member of the Financial PolicyCommittee – explores why the type of complex financial regulationdeveloped over recent decades may be sub-optimal for crisis control _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  6. 6. Page |6VII Annual Seminar on Risk, FinancialStability and BankingSão PauloA very interesting presentationWhat caused the Global Financial Crisis?Central Bank of Ireland Publishes July2012 Money and Banking StatisticsThe Central Bank of Ireland publishedthe July 2012 Money and BankingStatisticsLoans and other credit _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  7. 7. Page |7NUMBER 1Some Thoughts on Global Risks and MonetaryPolicyCharles L. Evans, President and Chief Executive OfficerFederal Reserve Bank of ChicagoIntroductionThank you for the invitation to speak to you today. I amvery happy for the opportunity to participate in Market NewsInternational seminar and to offer my thoughts on the U.S. and worldeconomies.We live in an amazingly interconnected world — a world in whichfinancial markets are linked by the instantaneous transmission ofinformation and business activity is intertwined among nations.For a long time, U.S. consumers and firms have been an important sourceof demand for Asian economies.This comes with pluses and minuses: Without the robust growth in theU.S. in 1997–98, the Asian financial crisis may well have been much worsethan it actually was; in contrast, the recession and sluggish growth in theU.S. over the past five years have weighed heavily on the demand forproducts from Asia.My comments today will focus primarily on the outlook for the U.S., butwith an eye on its potential impact on Asian economies.Of course, here I have to cover the substantial downside risks to theforecast stemming from both the European debt situation and the U.S.fiscal cliff.I will also discuss how this outlook and other economic analyses shapemy views for the appropriate stance of monetary policy. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  8. 8. Page |8Before I turn to the focus of today’s discussion, I would like to remind youthat the views expressed are my own and do not necessarily representthose of the Federal Open Market Committee (FOMC) or the FederalReserve System.OutlookLet’s start with the economic outlook.We are all too familiar with the fact that the financial crisis that unfoldedin 2007 and 2008 precipitated a global recession that was unusually deepand lengthy in the U.S. and other advanced economies.Perhaps this shouldn’t have been surprising.The detailed analysis by Carmen Reinhart and Kenneth Rogoff (2009)concludes that recessions caused by financial crises generally are severeand are followed by anemic recoveries.By any yardstick, this certainly describes the U.S. recovery to date:Output growth has averaged only 2-1/4 percent annually, and resourcegaps remain huge.In particular, the unemployment rate remains over 8 percent — wellabove the 5-1/4 to 6 percent rate most FOMC participants view as beingconsistent with a fully employed labor force over the longer run.Both public and private sector forecasts see relatively modest rates ofgrowth over the next few years.For example, most recent forecasts by the private sector have 2012 grossdomestic product (GDP) growth at less than 2 percent; a pace that maynot even be enough to keep up with potential.Growth in 2013 is expected to be only moderately higher.Moreover, both the European debt situation and the looming U.S. fiscalcliff impart substantial downside risks to the forecast.Even absent any negative shocks, such tepid growth rates would close thelarge existing resource gaps only very gradually. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  9. 9. Page |9Indeed, I expect that we will face unemployment well above sustainablelevels for some time to come.Implications for AsiaIn the aftermath of the Great Recession, most Asian economies enjoyed areturn to solid levels of growth.Today, however, growth in Asia faces some new challenges.One of these challenges is that Asian economies will not be immune tothe tepid growth prospects facing the world’s advanced economies.Forecasts for growth in Asia have been marked down over the past year,reflecting in part the impact of the downgrade in the outlook for Asianexports for the U.S. and the euro area.For example, the U.S. and the euro area account for about one-third ofChina’s merchandise exports.The recession and weak recoveries in those economies were big factors inthe Chinese current account surplus falling from about 10 percent of GDPin 2007 to less than 3 percent in 2011.This weakness remains a consideration as we look forward; indeed, it isan important reason why the International Monetary Fund (IMF) isprojecting that the Chinese current account surplus will fall even more by2013.International trade is an excellent thing: Exploiting comparativeadvantages raises living standards for all nations.However, all countries can’t simultaneously export their way out of theirproblems. For the world as a whole, the current account has to balance.Thus, countries with large external surpluses face risks to their economiesposed by slowdowns in their trading partners.Aggregate world growth must reflect aggregated domestic demands. So ifdemand is going to be sluggish in a large share of the world economy,other nations must take up the slack, or world growth will fall. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  10. 10. P a g e | 10InflationWith regard to inflation, as you know, the FOMC’s long-run inflationobjective is 2 percent as measured by the price index for personalconsumption expenditures (PCE).For a number of reasons, I don’t foresee much risk that inflation will riseabove reasonable tolerance levels relative to this objective.First, we see evidence of low expectations for inflation and growth in thetoday’s historically low Treasury yields.If there were warning signs of dangerous inflationary pressures, theten-year rate wouldn’t be in the neighborhood of 1-3/4 percent!Second, even with the latest increase in oil prices, energy and commodityprices remain well off their recent peaks as the global outlook dims.Third, as I just noted, the output gap remains large and is likely to closeonly slowly.In this economic environment, wage pressures are practicallynonexistent.And it is hard to envision how major persistent inflation pressures willemerge without a parallel increase in wage costs. Such parallel price andwage increases were a big part of the 1970s inflation, a scenario some fearrepeating today.Fourth, inflationary dynamics depend in large part on the momentumgenerated by people’s expectations of future inflation; currently, inflationexpectations are well anchored, which will tend to keep inflation frommoving either up or down.Putting all of these factors together along with the fact that core inflationaveraged 1.8 percent over the past year, I conclude that inflation will likelyremain near or below our 2 percent target over the medium term.Sources of Risk and Their ImplicationsI would now like to turn to two important downside risks to the outlookfor growth. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  11. 11. P a g e | 11This will be a bit of a U.S.-centric view, but clearly these risks also haveimportant implications for growth here in Asia and the rest of the world.EuropeLet me begin with the European debt situation.Obviously, the developments in Europe pose a significant downside riskto the U.S. economy and world economic growth more broadly.The direct effects of slower European growth on the U.S. economy wouldbe relatively small.The eurozone nations account for less than 15 percent of U.S.merchandise exports.Thus, according to standard elasticity estimates, even a moderateeurozone recession would reduce U.S. exports by only a couple of tenthsof GDP.The indirect effects of eurozone developments could, however, be moresevere, both in the U.S. and Asia. One possible channel would be throughfinancial contagion.If losses on euro-centric assets put a large enough dent in the balancesheets of financial institutions that lend to U.S. households andbusinesses, the increases in the cost and availability of credit wouldreduce growth in the U.S. with possible spillover effects into Asia as well.Clearly, this is a risk worth monitoring.Fortunately, though, U.S. financial institutions are in much better shapeto handle such potential losses than they were in 2008.Recognizing the risks posed by the European debt situation, U.S.institutions have reduced their direct exposure to European assets andtightened lending standards to European banks.On the regulatory front, the most recent stress tests made large U.S.banks demonstrate that they would have adequate capital even in theevent of a sharp European recession with contagion to global financialmarkets. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  12. 12. P a g e | 12A second possible channel would be through the effects of uncertainty oncurrent demand.Throughout the recovery, U.S. business and household sentiment hasbeen very fragile.Every hint of bad news seems to generate a wave of increased caution andan associated pullback in spending as firms and families seek to protecttheir individual balance sheets.After what the U.S. economy went through in the Great Recession, thisskittishness is understandable — particularly if one can envision a verylarge downside to the news event.And, as I just noted, given developments in Europe, there certainly aresome serious downside scenarios one can envision, even if they are notthe most likely outcomes.So it would be no surprise if yet another wave of uncertainty put a furtherdent in consumption and investment.U.S. fiscal cliffAnother risk to the U.S. economy comes from the so-called fiscal cliff.Under current U.S. law, numerous tax and spending provisions enacted invarious stimulus packages dating as far back as 2001 are scheduled toexpire on January 1, 2013.In addition, if no budget agreement is reached by Congress, there will besignificant automatic spending sequestration and other spending cuts inJanuary.According to projections made by the Congressional Budget Office(CBO), if all these things took place, real GDP growth would be reducedby about 4 percentage points in 2013.I’m not saying that a pullback of this magnitude should be the base-casescenario.The orders of magnitude are just too big to be a base case. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  13. 13. P a g e | 13But when you go through the various items and make guesses at whichmay stay and which may go, it is easy to envision scenarios that include amarked increase in fiscal restraint in 2013.In addition, given the political process, it seems unlikely that we willknow much about the size or composition of the cuts until late in theprocess.It’s also easy to see how the rhetoric of public negotiating stances couldproduce an atmosphere that causes already jittery households andbusinesses to put some spending plans on hold.In sum, a messy resolution to the fiscal cliff problems presents animportant downside risk to U.S. growth prospects and, by extension, toworld economic growth.And even the possibility of such an outcome could be a drag in the secondhalf of the year.Policy ChoicesLet me now switch gears and talk about my views regarding the choicesfacing monetary policymakers in the U.S.Yes, we have substantial liquidity already in place in our financial system.On the surface, this looks like substantial monetary accommodation.But as a large body of economic theory tells us, for this liquidity to besufficiently accommodative, the public needs to expect that we will keepit in place for as long as is necessary to restore the economy to a soundfooting.This is why I believe we should clarify the Fed’s forward guidance withregard to the future course of policy. Let me now go into the detailsbehind these thoughts.An explicit economic state-contingent policyIn weighing alternative policy approaches, I think the best way to provideforward guidance is by tying our policy actions to explicit measures ofeconomic performance. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  14. 14. P a g e | 14There are many ways of doing this, including setting a target for the levelof nominal GDP.But recognizing the difficult nature of that policy approach, I have a moremodest proposal: I think the Fed should make it clear that the federalfunds rate will not be increased until the unemployment rate falls below 7percent.Knowing that rates would stay low until significant progress is made inreducing unemployment would reassure markets and the public that theFed would not prematurely reduce its accommodation.Based on the work I have seen, I do not expect that such policy wouldlead to a major problem with inflation.But I recognize that there is a chance that the models and other analysissupporting this approach could be wrong.Accordingly, I believe that the commitment to low rates should bedropped if the outlook for inflation over the medium term rises above 3percent.The economic conditionality in this 7/3 threshold policy would clarify ourforward policy intentions greatly and provide a more meaningful guide onhow long the federal funds rate will remain low.In addition, I would indicate that clear and steady progress towardstronger growth is essential.Because we are not seeing that now, I support further use of our balancesheet to provide even more monetary accommodation.In June we decided to continue our Maturity Extension Program, whichputs downward pressure on long-term interest rates by extending theaverage maturity of the Federal Reserve’s securities portfolio.I thought that was a useful step.However, I believe it is time to take even stronger steps, such as thepurchase of more mortgage-backed securities, to increase the degree ofmonetary support for the recovery. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  15. 15. P a g e | 15As suggested recently by my colleagues Eric Rosengren and JohnWilliams, these could be open-ended purchases, meaning that they wouldcontinue at a certain rate until there was clear evidence of improvement ineconomic conditions.To me, one example of clear evidence would be a resumption of relativelysteady monthly declines in unemployment for two or three quarters.Once this momentum was confidently established, the Fed could stopadding to our balance sheet but keep the funds rate at zero.The funds rate would remain unchanged in my thinking, until theunemployment rate hit at least 7 percent or the medium-term inflationoutlook deteriorated dramatically and rose above 3 percent.Later, reductions in the Fed’s balance sheet assets would occur sometimeafter the first increase in the funds rate.This corresponds to the general exit principles the FOMC agreed uponlast year.Presumably, the pace of asset reductions would be measured andconsistent with a continued, robust recovery in the context of pricestability.Accommodation in the Context of a Symmetric Inflation Targetand Balanced PolicyI can’t tell you how often people look at me in horror when I say that weshould adopt a conditional policy that tolerates the risk of inflationexceeding our target by as much as 1 percentage point.How can I accept inflation rising above our stated target? Isn’t thisblasphemy for a central banker?In January, in the same framework document that announced our 2percent inflation target, we also stated a number of principles for theconduct of monetary policy.One was that policy would take a balanced approach in achieving the twolegs of the Federal Reserve’s dual mandate — maximum employmentand price stability. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  16. 16. P a g e | 16An explicit real-side mandate makes the Federal Reserve different thanmost central banks.While just about all central banks follow a flexible inflation targetingapproach, in which they seek to minimize real-side fluctuations in pursuitof their inflation objective, most are explicitly charged only with aninflation objective.But for the Fed, maximum employment is an explicit part of our policymandate.I strongly support the policy principles document we released in January.But we’re still hearing questions about whether our inflation goal issymmetric and about the specifics of how policy will be implementedunder the balanced approach articulated in this framework.As Chairman Bernanke (2012) stated at his April press conference, the 2percent inflation goal is a symmetric objective and not a ceiling oninflation.Symmetry means that inflation below 2 percent should be viewed as thesame policy miss as if inflation overran 2 percent by equal amount.We need to take symmetry seriously.If we disproportionately recoil at inflation a little above 2 percent versus alittle below, then we are not symmetrically weighing policy misses.And we will not average 2 percent inflation, which is our goal.There is some risk of this misperception taking hold. Consider theFOMC’s latest Summary of Economic Projections (SEP), which includesthe projections of all FOMC participants, voters and non-voters alike.In it, several forecasts have the funds rate rising before 2014, even thoughthroughout the projection period most see inflation at or below 2 percentand unemployment well above the sustainable rate indicated by thelong-run projections.Without further explanation, it’s difficult to see how this is consistent witha symmetric inflation goal and a balanced approach to achieving the twolegs in our dual mandate. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  17. 17. P a g e | 17I believe the FOMC can do better at describing our thinking with respectto tolerance bands around our long-run inflation and unemploymentgoals.Clarification would increase both transparency and accountability.Importantly, it would reassure economic agents that Fed policy would nottighten prematurely.To me, a symmetric inflation goal and a balanced approach to policymean that if we are missing our employment mandate by a large amount,but are close to our inflation target, then we should be willing toundertake policies that could substantially reduce the employment gapeven if they run the risk of a modest, transitory rise in inflation thatremains within a reasonable tolerance range of our target.I believe such actions, such as the 7/3 threshold policy I have beenadvocating, would produce smaller net losses relative to our dual mandategoals than would current policy.Conclusion: The Need for a Vibrant Economy to Cushion RisksFinding a way to deliver more accommodation — whether it is monetaryor fiscal — is particularly important now because delays in reducingunemployment are costly.An unusually large percentage of the unemployed have been withoutwork for quite an extended period of time; their skills can become lesscurrent or even deteriorate, leaving affected workers with permanent scarson their lifetime earnings.And any resulting lower aggregate productivity also weighs on potentialoutput, wages and profits for the economy as a whole.The damage intensifies the longer that unemployment remains high.Failure to act aggressively now could lower the capacity of the economyfor many years to come.Such potential costs would come with the continuation of a subpar paceof economic recovery. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  18. 18. P a g e | 18The significant risks I discussed earlier – financial disruption from aworsening of the situation in Europe or a messy resolution of U.S. fiscalpolicy – raise the specter of an even more worrisome outcome.At the moment economic growth is not much above stall speed.Another negative shock could send the economy into recession.And if a recessionary dynamic takes hold, it would be especially difficultto regain momentum.I have outlined some policy actions that I think can take us in thedirection of a more vibrant and resilient economy.Given the risks we face, I think it is vital that we make such moves today.I don’t think we should be in a mode where we are waiting to see what thenext few data releases bring.We are well past the threshold for additional action; we should take thataction now.Thank you.NoteCharles L. Evans is the ninth president and chief executive officer of theFederal Reserve Bank of Chicago. In that capacity, he serves on theFederal Open Market Committee (FOMC), the Federal Reserve Systemsmonetary policy-making body.The Federal Reserve Bank of Chicago is one of 12 regional Reserve Banksacross the country. These 12 banks — along with the Board of Governorsin Washington, D.C. — make up our nations central bank.As head of the Chicago Fed, Evans oversees the work of roughly 1400employees in Chicago and Detroit who conduct economic research,supervise financial institutions, and provide payment services tocommercial banks and the U.S. government.Before becoming president in September of 2007, Evans served asdirector of research and senior vice president, supervising the Banksresearch on monetary policy, banking, financial markets and regional _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  19. 19. P a g e | 19economic conditions. Prior to that, Evans was a vice president and senioreconomist with responsibility for the macroeconomics research group.His personal research has focused on measuring the effects of monetarypolicy on U.S. economic activity, inflation and financial market prices. Ithas been published in the Journal of Political Economy, AmericanEconomic Review, Journal of Monetary Economics, Quarterly Journal ofEconomics, and the Handbook of Macroeconomics.Evans is active in the civic community. He is a board member at ChicagoMetropolis 2020 and the Metro Chicago Information Center, and a trusteeat Rush University Medical Center.Evans has taught at the University of Chicago, the University of Michiganand the University of South Carolina. He received a bachelors degree ineconomics from the University of Virginia and a doctorate in economicsfrom Carnegie-Mellon University in Pittsburgh. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  20. 20. P a g e | 20NUMBER 2EBA, EIOPA and ESMAJoint Consultation Paper on Draft Regulatory Technical Standards on theuniform conditions of application of the calculation methods underArticle 6.2 of the Financial Conglomerates Directive (JC/CP/2012/02)I. Responding to this ConsultationEBA, EIOPA and ESMA (the ESAs) invite comments on all matters inthis paper and in particular on the specific questions stated in theattached document “Overview of questions for Consultation” at the endof this paper.Comments are most helpful if they:- respond to the question stated;- indicate the specific question to which the comment relates;- contain a clear rationale;- provide evidence to support the views expressed/ rationale proposed; and- describe any alternative regulatory choices EBA should consider.II. Executive SummaryThe CRR/CRD IV proposals (the so-called Capital RequirementsRegulation - henceforth ‘CRR’- and the so-called Capital Requirements _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  21. 21. P a g e | 21Directive – henceforth ‘CRD’) set out prudential requirements for banksand other financial institutions which are expected to apply from 1January 2013.In anticipation of the finalisation of the legislative texts for theCRR/CRD IV, the EBA, EIOPA and ESMA (hereafter the ESAs) throughthe Joint Committee, have developed the draft RTS in accordance withthe mandate contained in Article 46(4) of the CRR and Article 139 ofCRDIV (amending Article 21 a (2a) of the Directive 2002/87/EC) on thebasis of the European Commission’s proposals.This Article provides the ESAs through the Joint Committee, to developdraft Regulatory Technical Standards (RTS) with regard to the conditionsof the application of the Article 6(2) of the Directive 2002/87/EC(hereafter the Directive).Further the ESAs have developed the draft RTS having regard to Article230 in connection with Articles 220 and 228 of the Directive2009/138/EC2.To the extent that the texts may change before their adoption, the ESAsshall adapt its draft RTS accordingly to reflect any developments.The RTS included in this consultation have to be submitted to the EUCommission by 1 January 2013.Please note that the ESAs have developed the present draft RTS based onthe European Commission’s legislative proposals for the CRR/CRD IV.They have also taken into account major changes subsequently proposedby the revised texts produced by the Council of the EU and the EuropeanParliament, during the ordinary legislative procedure (co-decisionprocess).Following the end of the consultation period, and to the extent that thefinal text of the CRR/CRD IV changes before the adoption of the RTS,the ESAs will adapt the draft RTS accordingly to reflect anydevelopments. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  22. 22. P a g e | 22Main features of the RTSThis consultation paper puts forward draft RTS in order to ensure thatinstitutions that are part of a financial conglomerate apply the appropriatecalculation methods for the determination of required capital at the levelof the conglomerate.They are based in particular on the following elements:General Principleso Elimination of multiple gearing;o Elimination of intra-group creation of own funds;o Transferability and availability of own funds; ando Coverage of deficit at financial conglomerate level having regard todefinition of cross-sector capital.Technical calculation methods1. Method 1: “Accounting consolidation method”:The FICOD provides in relation to Method 1 that the own funds arecalculated on the basis of the consolidated position of the group.According to this general provision, the calculation of own funds shouldbe based on the relevant accounting framework for the consolidatedaccounts of the conglomerate applicable to the scope of the Directive.The use of “consolidated accounts” eliminates all own funds’ intra-groupitems, in order to avoid double counting of capital instruments.According to the Directive provisions, the eligibility rules are thoseincluded in sectoral provisions. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  23. 23. P a g e | 232. Method 2: “Deduction and aggregation method”.This method calculates the supplementary capital adequacyrequirements of a conglomerate based on the accounts of solo entities.It aggregates the own funds, deducts the book value of the participationsin other entities of the group and specifies treatment of the proportionalshare applicable to own funds and solvency requirements.All intra-group creation of own funds shall be eliminated.3. Method 3: “Combination of methods 1 and 2”.The use of combination of accounting consolidation method 1 anddeduction and aggregation method 2 is limited to the cases where the useof either method 1 or method 2 would not be appropriate and is subject tothe permission by the competent authorities.III. Background and rationaleThe supplementary supervision of financial entities in a financialconglomerate is covered by the Financial Conglomerates Directive2002/87/EC, hereafter known as the Directive.This Directive provides for competent authorities to be able to assess at agroup-wide level the financial situation of credit institutions, insuranceundertakings and investment firms which are part of a financialconglomerate, in particular as regards solvency (including the eliminationof multiple gearing of own funds instruments).The nature of RTS under EU lawDraft RTS are produced in accordance with Article 10 of the ESAsregulation.According to Article 10(4) of the ESAs regulation, they shall be adoptedby means of Regulations or Decisions. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  24. 24. P a g e | 24According to EU law, EU regulations are binding in their entirety anddirectly applicable in all Member States.This means that, on the date of their entry into force, they become part ofthe national law of the Member States and that their implementation intonational law is not only unnecessary but also prohibited by EU law,except in so far as this is expressly required by them.Shaping these rules in the form of a Regulation would ensure alevel-playing field and would facilitate the cross-border provision ofservices.Background and regulatory approach followed in the draft RTSThese draft RTS are produced in accordance with CRD IV/CRRproposals, which provide that the EBA, ESMA and EIOPA (hereafter theESAs), through the Joint Committee, shall develop draft regulatorytechnical standards with regard to the conditions of the application of thecalculation methods with regard to Article 6(2) of the Directive and shallsubmit those draft regulatory technical standards to the Commission by 1January 2013.The proposed draft RTS covers the uniform conditions for the use of themethods for the determination of capital adequacy of a financialconglomerate under the Directive.They elaborate on Technical principles applying to all of the threemethods provided for by Directive; and also contain an Annex providingfurther detail for Method 2.The requirements contained in the draft RTS are mainly directed atinstitutions, although some of them are directed at competent authorities. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  25. 25. P a g e | 25IV. Draft Regulatory Technical Standards on the uniformconditions of application of the calculation methods underArticle 6.2 of the Financial Conglomerates DirectiveCommission Delegated Regulation (EU) No XX/2012supplementing Directive xx/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 Conglomerates Directive] of the EuropeanParliament and of the Council of [date] with regard to regulatorytechnical standards for the uniform conditions of application of thecalculation methods under Article 6.2 of the Financial ConglomeratesDirective of XX Month 2012THE EUROPEAN COMMISSION,Having regard to the Treaty on the Functioning of the European Union,Having regard to the [proposal for a] Regulation (...) No xx/xxxx of theEuropean Parliament and of the Council of dd mm yyyy on prudentialrequirements for credit institutions and investment firms Regulationxx/xxxx [CRR] and in particular Article 46 (4) thereof.Having regard to the [proposal for a] Directive (...) No xx/xxxx of theEuropean Parliament and of the Council of dd mm yyyy on the access tothe activity of credit institutions and the prudential supervision of creditinstitutions and investment firms [CRDIV] and in particular Article 139thereof.Having regard to the Directive 2002/87/EC, as amended, of theEuropean Parliament and of the Council on the supplementarysupervision of credit institutions, insurance undertakings and investmentfirms in a financial conglomerate (hereinafter “the Directive”) and inparticular to Article 6(2) and Annex 1 thereof.Whereas: _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  26. 26. P a g e | 26(1) Directive 2002/87/EC provides in Chapter II, Section 2, rules oncapital adequacy of financial conglomerates, such that the elements ofown funds are available at the level of a Financial Conglomerates arealways at least equal to the capital adequacy requirements as calculated inaccordance with Annex I of the Directive.(2) Regulation (...) No xx/xxx (‘CRR’) provides in Article 46, within PartII, Chapter 2, Section 3, Sub-Section 2 and in the context of commonequityTier I rules, requirements for deduction where consolidation orsupplementary supervision are applied.This section of the CRR provides empowerments to the EuropeanCommission to adopt delegated acts (regulatory technical standards) inaccordance with articles 10-14 of the Regulation (EU) No 1093/2010establishing the European Banking Authority (‘EBA’), Articles 10-14 ofthe Regulation (EU) No 1094/2010 establishing the European Insuranceand Occupational Pensions Authority (‘EIOPA), and Articles 10-14 of theRegulation (EU) No 1095/2010 (‘ESMA), establishing the EuropeanSecurities and Markets Authority.These acts will complete the EU single rulebook for institutions in thearea of own funds.(3) Directive (...) No xx/xxx (‘CRDIV’) provides in Article 139 that theDirective 2002/87/EC shall be amended, such that the EBA, EIOPA andESMA through the Joint Committee, to develop draft RegulatoryTechnical Standards (RTS) with regard to the conditions of theapplication of the Article 6(2) of the Directive.(4) For effective supervision of Financial Conglomerates, supplementarysupervision should be applied to all such conglomerates, thecross-sectoral financial activities of which are significant, which is thecase when certain thresholds are reached, no matter how they arestructured. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  27. 27. P a g e | 27Supplementary supervision should cover all financial activities identifiedby the sectoral financial legislation and all entities principally engaged insuch activities should be included in the scope of the supplementarysupervision, including asset management companies and alternativeinvestment fund management companies.(5) Without prejudice to sectoral rules, supplementary supervision of thecapital adequacy rules is necessary to bring more convergence in theapplication of the calculation methods listed in Annex 1 of the Directive.(6) For financial conglomerates which include significant banking orinvestment business and insurance business, multiple use of elementseligible for the calculation of own funds at the level of the financialconglomerate (multiple gearing) as well as any inappropriate intra-groupcreation of own funds must be eliminated.(7) The financial conglomerate should seek an acceptable timeframe forthe transferability of funds across entities within the financialconglomerate, which shall depend on whether the specific entity issubject to the Directive 2009/138/EC or the CRDIV/CRR.Moreover for an entity subject to the CRD IV/CRR this timeframe shouldbe expediated based on the fact that due to the nature of their activities,they are more vulnerable to a rapid deterioration in confidence and/orsudden resolution situation.(8) In addition any non-sector-specific own funds, in excess of sectoralrequirements, need to originate from entities which are not subject totransferability/availability impediments.(9) It is important to ensure that own funds are only included atconglomerate level if there are no impediments to the transfer of assets orrepayment of liabilities across different conglomerate entities, includingacross sectors.(10) If there is a deficit of own funds at the level of the financialconglomerate, the financial conglomerate should inform the coordinatoron the measures taken to cover this deficit. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  28. 28. P a g e | 28(11) Further convergence in the way that financial conglomerates applythese rules shall ensure the robust and consistent application of themethods of calculation.(12) For bank-led conglomerates it is necessary to apply the most prudentmethod of calculation for the treatment of insurance holdings to avoidregulatory arbitrage.(13) It is important that sector-specific own funds cannot cover risksabove sectoral requirements.The financial conglomerate should first count sector-specific own fundsagainst their requirements (while respecting sectoral rules and limits) foreach relevant entity or group of entities. If there is an excess ofsector-specific own funds, this should not be recognised at conglomeratelevel.(14) When calculating supplementary capital adequacy of a financialconglomerate, in respect to non-regulated financial entities within thefinancial conglomerate, both a notional capital requirement and anotional level of own funds shoud be calculated.(15) Under Solvency II, method 1 is applied on the basis of consolidateddata which are set out at Level 2 and not on the basis of consolidatedaccounts.(16) Further changes to the capital adequacy rules may be addressed inthe European Commission’s review of Directive 2002/87/EC.(17) It is necessary that the new regime for treatment of methods ofconsolidation enters into force the soonest possible following the entryinto force of the CRR/CRD IV and Solvency II.(18) This Regulation is based on the draft regulatory technical standardssubmitted jointly by the EBA, EIOPA and ESMA to the Commission.(19) The EBA, EIOPA and ESMA have conducted open publicconsultations on the draft regulatory technical standards on which this _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  29. 29. P a g e | 29Regulation is based, analysed the potential related costs and benefits, inaccordance with Article 10 of Regulation (EU) No 1093/2010, Article 10 ofRegulation (EU) No 1094/2010, Article 10 of Regulation (EU) No1095/2010,and requested the opinion of the Banking Stakeholder Groupestablished in accordance with Article 37 of Regulation (EU) No1093/2010, Insurance Stakeholder Group and the OccupationalStakeholder Group established in accordance with Article 37 ofRegulation (EU) No 1094/2010, and the European Securities and MarketsStakeholder Group established in accordance with Article 37 ofRegulation (EU) No 1095/2010.HAS ADOPTED THIS REGULATION:TITLE ISubject matter and definitionsArticle 1Subject matterThis Regulation lays down rules of the uniform conditions of applicationof the calculation methods under Article 6.2 of the Directive.Article 2Definitions1. Definitions of the CRD IV/CRR, Directive 2002/87/EC and Directive2009/138/EC shall apply to this Regulation.2. Capital instruments are those capital instruments eligible under CRR(Regulation 2012/…./EC) and those capital instruments referred to as“own funds” in Directive 2009/138/EC.3. Ultimate responsible entity is the entity within the financialconglomerate that is responsible for determining the capital for thefinancial conglomerate having regard to the following minimum criteria:control, the dominant entity from the market’s perspective (market listed _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  30. 30. P a g e | 30entity) and the ability to fulfill specific duties towards its subsidiaries andits supervisor.4. ‘indirect holding’ as defined under definition 17 of Article 22 of CRR [tobe added if not in final CRR text].5. Insurance-led financial conglomerate is a financial conglomeratewhose most important sector is insurance as defined under Article 3(2) ofthe Directive.6. Bank-led financial conglomerate is a financial conglomerate whosemost important sector is banking as defined under Article 3(2) of theDirective.7. Investment firm-led financial conglomerate is a financial conglomeratewhose most important sector is investment services as defined underArticle 3(2) of the Directive.TITLE IITechnical PrinciplesArticle 3Elimination of multiple gearing and the intra-group creation ofown fundsThe ultimate responsible entity shall ensure that own funds, which havebeen created by intra-group transactions, be it direct or indirect, shall beeliminated for the purpose of determining the required capital on aconsolidated basis.Article 4Transferability and availability of own funds1. For all entities of a financial conglomerate, own funds, in excess ofsectoral solvency requirements, shall be considered available to absorblosses elsewhere in the financial conglomerate provided that all of thefollowing conditions are fulfilled: _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  31. 31. P a g e | 31(a) There are no practical, legal, regulatory, contractual or statutoryimpediments to the transfer of funds or repayment of liabilities acrossconglomerate entities in due course.This is the case when the transfer of own funds from one conglomerateentity to another is not barred by a restriction of any kind and there are noclaims of any kind from third parties on these assets.The ultimate responsible entity of the financial conglomerate shallconfirm to the satisfaction of the coordinator that the conditions set out inthis point are met.(b) For the purpose of assessing the transferability of funds to entitiessubject to 2009/138/EC, “in due course” shall mean no later than 9months;for the purpose of assessing the transferability of funds to entitiessubjected to CRR, “in due course” shall mean no later than, threecalendar days with no impediments on the coordinator requiring a fastertransfer if necessary.2. Own funds, in excess of sectoral solvency requirements, which do notmeet the criteria under point 1 shall be excluded from the conglomerate’sown funds.3. The financial conglomerate shall demonstrate that measures have beentaken to mitigate the risk that transfer of funds would have a materialeffect on the transferor’s solvency.EXPLANATORY TEXT for consultation purposesThis text is consistent with Annex 1 of the Directive which states “whencalculating own funds at the level of the financial conglomerate,competent authorities shall also take into account the effectiveness of thetransferability and availability of the own funds across the different legalentities in the group, given the objectives of the capital adequacy rules”. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  32. 32. P a g e | 32Point 1(a) aims to ensure that own funds are only included atconglomerate level if there are not impediments to the transfer of assets orrepayment of liabilities across different conglomerate entities, includingacross sectors.If the conglomerate cannot confirm to the satisfaction of the coordinatorthat there are no inherent impediments in relation to a given entity, thatentity’s own funds in excess of its sectoral requirements cannot beincluded at conglomerate level.The impediments to be considered include practical, regulatory,contractual or statutory ones.Point 1(b) establishes an acceptable timeframe for the transferability offunds across conglomerate entities.There is a differentiation based on the fact that entities subject to CRR,due to the nature of their activities, are more vulnerable to a rapiddeterioration in confidence and/or sudden resolution situation.Article 5Deficit of own funds at the financial conglomerate level1. When the difference calculated according to method 1, 2 or 3 as detailedin Annex 1 of the Directive is negative, the financial conglomerate shallensure that the deficit is remedied with cross-sector own funds elementsas defined in point 2 below.2. When calculating own funds at the level of the financial conglomerate,cross sector own funds are elements eligible for:(a) Common Equity Tier 1 in accordance with Regulation …/2012/EC[or Tier 1 Unrestricted Basic Own Funds in accordance with Directive2009/138/EC], or(b) Elements that meet both sets of rules for Additional Tier 1 inaccordance with Regulation …/2012/EC and Tier 1 [Restricted BasicOwn Funds in accordance with Directive 2009/138/EC], or _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  33. 33. P a g e | 33(c) elements that meet both sets of rules for Tier 2 in accordance withRegulation …/2012/EC and for Tier 2 in accordance with Directive2009/138/EC.3. Cross-sector own funds elements mentioned in point 2 shall only betaken into account if their transferability and availability across thedifferent legal entities in the financial conglomerate meet the conditionsset out in Article 4.EXPLANATORY TEXT for consultation purposesThe text is based on the Technical principles in Annex 1 of the Directive“Whichever method is used, when the entity is a subsidiary undertakingand has a solvency deficit, or, in the case of a non-regulated financialsector entity, a notional solvency deficit, the total solvency deficit of thesubsidiary has to be taken into account.Where in this case, in the opinion of the coordinator, the responsibility ofthe parent undertaking owning a share of the capital is limited strictly andunambiguously to that share of the capital, the coordinator may givepermission for the solvency deficit of the subsidiary undertaking to betaken into account on a proportional basis.”In line with the Directive only cross-sector own funds are allowed as aremedy to a conglomerate deficit.That is, from the point at which a conglomerate deficit is observed, thatshortfall amount shall be covered by the issuance of cross-sector ownfunds, regardless of the cause of the conglomerate deficit.The financial conglomerate shall inform the coordinator about the deficitand the measures to cover this deficit without delay.Article 6Consistency1. The Method of Calculation selected from those methods defined inAnnex 1 of the Directive shall be applied in a consistent manner over time. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  34. 34. P a g e | 342. For the purpose of Article 6(2) and Annex 1 of the Directive, for abanking led conglomerate, where Article 46 (1) of the CRR is applied, thecoordinator, after consulting with other competent authorities concerned,shall decide the most prudent method to be applied by the financialconglomerate.Article 7ConsolidationFor the purpose of Art 6(2) and Annex 1 of the Directive, Method 1 of theDirective 2009/138/EC shall be considered as equivalent to theconsolidation as defined under Method 1 of the Directive, forinsurance-led financial conglomerate.The equivalence assessment is valid provided that the scope of the groupunder Solvency II is the same under the Directive or the difference in thescope is not material.EXPLANATORY TEXT for consultation purposesThis text is based on the Directive 2009/138/EC, Article 230 inconnection with Articles 220 ss.The Solvency II Implementation measures will need to be consideredonce they have been published.According to Directive 2009/138/EC, for the calculation of group ownfunds all the multiple use of eligible own funds and intra-group creationof capital should be eliminated.Moreover, own funds of other financial sectors should be calculatedaccording to the relevant sector rules.As a result, both Method 1 of the Directive 2009/138/EC and Method 1 ofthe Directive are consistent with the main objectives of thesupplementary supervision since they ensure that: all double-counting is _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  35. 35. P a g e | 35removed; own funds are calculated in accordance with the definitions andlimits established in the relevant sectoral rules.The equivalence assessment is valid provided that the scope of the groupunder Solvency II is the same under the Directive or the difference in thescope is not material.Article 8Solvency requirement1. For the purpose of the calculation of the supplementary capitaladequacy requirements of the regulated entities in a financialconglomerate, a solvency requirement shall satisfy either of the pointslaid down in (a) and (b):(a) Where the rules for the insurance sector are to be applied, solvencyrequirement means the Solvency Capital Requirement as defined byArticle 100 or 218 of Directive 2009/138/EC as applicable, including anycapital add-on applied in accordance with Articles 37, 231(7) or 232 of thesame directive as applicable, and any other capital or own fundsrequirement applicable under Union legislation.(b) Where the rules for the banking or investment services sector are to beapplied, solvency requirement means the sum of own funds requirementsas defined by Articles 87 to 93 of CRR, combined buffer requirements asdefined by Article 122 of CRD IV, and specific own funds requirements asdefined by Article 100 of [CRDIV], and any other requirement applicableunder European Union law.Article 9The financial conglomerates own funds and capitalrequirements1. Except where expressly stated in this Regulatory Technical Standard,the financial conglomerates own funds and capital requirements shall becalculated in accordance with the definitions and limits established in therelevant sectoral rules. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  36. 36. P a g e | 362. The own funds of asset management companies shall be calculatedaccording to Article 2 (l) of Directive 2009/65/EC; the capitalrequirements are calculated according to Article 7(1) (a) of Directive2009/65/EC.3. The own funds of alternative investment fund managers shall becalculated according to Article 9 of Directive 2011/61/EU.Article 10Sector specific own funds1. Sector specific own funds, are recognised for the coverage of risks at thesectoral level only and cannot be used to cover risks of another sector andshall not be included (above or) beyond the sectoral level.Sector specific own funds are own funds recognised under sectoral rulesthat do not fall within one of the following categories:(a) Common Equity Tier 1, Additional Tier 1 and Tier 2 own funds under[CRR]; or(b) Tier 1 unrestricted basic own funds, Tier 1 restricted basic own funds,and Tier 2 basic own funds under Directive 2009/138/EC.2. Risks originating from the other sector shall not be covered by sectorspecific own funds.EXPLANATORY TEXT for consultation purposesArticle 10 sets out that sector-specific own funds cannot cover risks abovesectoral requirements.In practice, this means that, for each relevant entity or group of entities,conglomerates need to first count sector-specific own funds against theirrequirements (while respecting sectoral rules and limits).If there is an excess of sector-specific own funds, this shall not be _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  37. 37. P a g e | 37recognised at conglomerate level.In addition, as stated in Article 4, any non-sector-specific own funds inexcess of sectoral requirements need to originate from entities which arenot subject to transferability/availability impediments.Article 11Treatment of cross sector holdings for the calculation of capitalrequirementsWhere an insurance holding of a bank-led financial conglomerate or aninvestment firm-led financial conglomerate is eliminated pursuant toArticles 14.3 and 14.4 or Article 15.2 or the application of these Articles aspart of Method 3, no capital charge for that holding shall be applied at thefinancial conglomerate level for the purpose of supplementarysupervision, even if a capital charge is applied at sectoral level.EXPLANATORY TEXT for consultation purposesAt sectoral level, holdings may receive a risk weight or capital charge.At the financial conglomerate level, the same holding may be deducted oreliminated from own funds through consolidation, making the riskweight or capital charge superfluous.This capital charge shall thus not be applied for the purposes of thecalculation of the conglomerates solvency requirements.Article 12Non-regulated financial entities1. For a non-regulated mixed financial holding company and for anon-regulated entity held by a mixed financial holding company, the ownfunds and the capital requirements attributable to the non-regulatedfinancial sector entities shall be calculated according to the mostimportant sector in the financial conglomerate in accordance with Article3(2) of the Directive. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  38. 38. P a g e | 382. The own funds and the solvency requirements attributable to othernon-regulated financial entities shall be calculated according to thesectoral rules of the sector (insurance or banking) to which the nonregulated entity is designated.EXPLANATORY TEXT for consultation purposesA “mixed financial holding company” is defined under Article 2(15) of theDirective.Whichever method is used, for the purpose of the calculation of thesupplementary capital adequacy of a financial conglomerate, both anotional capital requirement and notional level of own funds should becalculated for non-regulated financial entities.These should be calculated according to the rules of the sector to whichthe non regulated entity belongs, or according to the most importantsector in the conglomerate, having regard to Annex 1 of the Directive “Inthe case of a non-regulated financial sector entity, a notional solvencyrequirement is calculated in accordance with section II of this Annex,notional solvency requirement means the capital requirement with whichsuch an entity would have to comply under the relevant sectoral rules as ifit were a regulated entity of that particular financial sector; the notionalsolvency requirement of a mixed financial holding company shall becalculated according to the sectoral rules of the most important financialsector in the financial conglomerate”.Article 13Transitional and grandfathering arrangementsThe sectoral rules applied in the calculation of conglomerate own fundsand solvency requirements shall take into account any transitional orgrandfathering arrangements in force at sectoral level. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  39. 39. P a g e | 39TITLE IIITechnical calculation methodsArticle 14Method 1 Calculation criteria1. The own funds of a financial conglomerate shall be calculated on thebasis of the consolidated accounts (according to the relevant accountingframework) applied to the scope of supplementary supervision of theDirective.2. The calculation of own funds shall take into account the removal ofintra group balances, transactions and income and expenses related tothe process of accounting consolidation.3. For bank-led and investment firm-led conglomerates, unconsolidatedsignificant investments in a financial sector entity pursuant to Article 40of the CRR shall be fully deducted, if the entity belongs to the insurancesector as defined in Article 2(8) of the Directive.4. Unconsolidated non significant investments are deducted inaccordance with the treatment described in Article 43 of CRR.5. For bank-led and investment firm-led conglomerates, the sectoraltreatment in Part 2, Title II of the CRR shall apply to all unconsolidatedinvestments, participations and holdings of a conglomerate entity,provided that:(a) The conglomerate entity is a credit institution or an investment firm;and(b) The investment, participation or holding is in a credit institution or inan investment firm.6. Without prejudice to points 3 and 4, any other own funds issued by oneconglomerate entity and held by another, if not already eliminated in theaccounting consolidation process, shall be deducted. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  40. 40. P a g e | 407. Joint controlled entities shall be treated in accordance with sectoralrules.8. The valuation of assets and liabilities calculated for the purposes ofDirective 2009/138/EC shall be used at the level of the financialconglomerate.9. Where asset or liability values are subject to the calculation ofprudential filters and deductions in accordance with those required underCRR, the asset or liability values used shall be those attributable to therelevant entities under CRR, excluding assets and liabilities attributableto other entities of the financial conglomerate.Where calculation of a threshold or limit is required in order to respectsectoral rules, the threshold or limit shall be calculated on the basis of theconsolidated data of the financial conglomerate and after the removal ofholdings called for by these standards.10. Where credit institutions/investment firms and related entities areconsolidated under CRR, the same entities shall be considered together.11. Where insurance and related entities are consolidated under Directive2009/138/EC, the same entities shall be considered together.12. Conglomerate entities that are not consolidated under CRR orDirective 2009/138/EC shall be treated separately.13. For the purpose of the calculation of solvency requirements, eachsector shall respect the requirements as calculated under the relevantsectoral rules.When summing the relevant sectoral solvency requirements there shall beno adjustment other than as foreseen by Article 11 of Title II or as causedby adjustments to sectoral thresholds and limits pursuant to point 9 ofthis Article 14. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  41. 41. P a g e | 41EXPLANATORY TEXT for consultation purposesACCOUNTING CONSOLIDATION AND JOINTCONTROLLED ENTITIES (Points 1, 2 and 7)Under Method 1, the Directive requires the calculation of the own fundsof the conglomerate on the basis of the consolidated position of thegroup.In addition, any inappropriate intra-group creation of own funds must beeliminated.In order to ensure these provisions are respected, points 1 and 2 of Article14 requires the conglomerate to use consolidated accounts (applied to thescope of the conglomerate) as the starting point for the calculation of theown funds.In doing so, the conglomerate must allow all eliminations of own fundsarising from the process of accounting consolidation to take place.Joint-controlled entities are to be proportionally consolidated in line withpoint 6.OTHER INTRA-GROUP CREATION OF OWN FUNDS(Point 6)In line with the Directive’s principles, Article 3 of this Regulation calls forthe elimination of all own funds that have been created by intra-grouptransactions, be it direct or indirect.For the avoidance of doubt in the context of Method 1, point 5 furtherspecifies that all intra-group creation of own funds should be eliminatedon top of accounting consolidation, if not already eliminated as part of theaccounting consolidation process.Such additional elimination may be required in particular where thetreatment of the participation called for by the Directive is different fromthat provided for by accounting rules, considered that accounting rules _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  42. 42. P a g e | 42doesn’t consider the multiple gearing issue.CROSS SECTOR HOLDINGS AND OTHER HOLDINGS(Points 3, 4 and 5)For bank-led and investment firm-led conglomerates, the calculation ofown funds at the level of the conglomerate should also take into accountthat the sectoral rules allow institutions to risk weight and not deductsome cross-sector holdings.For this reason, in order to ensure the elimination of multiple gearing atthe level of conglomerate, point 3 of Article 14 requires the deduction ofholdings that are neither consolidated nor eliminated (by deduction) atsectoral level, where those holdings are in entities belonging to theinsurance sector.Point 4 describes the treatment of unconsolidated non-significantinvestment holdings where those holdings are in entities belonging toinsurance entities.Point 5 describes the treatment of other holdings, specifying that otherholdings are treated according to sectoral rules (see the table in AnnexII).SOLVENCY 2 VALUATION CRITERIA (Points 8)For insurance parts of the conglomerate, given that Article 75 of Directive2009/138/EU sets out specific valuation rules for assets and liabilities,point 8 of Article 14 specifies that assets and liabilities for those entitieswithin the conglomerate should follow the valuations calculated for thepurpose of Directive 2009/138/EU.This point is aimed at ensuring that the calculation of the elements ofown funds at the level of conglomerate is consistent with sectoral rules. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  43. 43. P a g e | 43RECALCULATION OF LIMITS AND THRESHOLDS,TAKING INTO ACCOUNT REMOVAL OF HOLDINGS(Points 9)Once the accounting consolidation has been carried out, as well as theother provisions already mentioned, amounts of CET1 attributable toconglomerate entities that are subject to CRR at sectoral level, as well asamounts of holdings belonging to such entities that are neither deductednor consolidated, will change.So the calculations based on CET1 in Article 45 of CRR, which measurethe threshold for the deduction of deferred tax assets and significantinvestments, should be recalculated.The recalculation should take into account the effect on CET1 of theconglomerate accounting consolidation process, proportionalconsolidation in accordance with point 7, the removal of holdings in point3, and any other factors stemming from the conglomerate calculation thathave led to a change in CET1 .In the calculation according to Article 45 of CRR for an entity or group ofentities, the deferred tax assets and significant investments to be takeninto account are only those belonging to that entity or group of entitieswithin the conglomerate.These rules are provided for in point 9.MULTI-LAYER CONGLOMERATES (Points 10, 11 and 12)This Regulation recognises that financial conglomerate structures maybe very complex and involve different layers (see graph example below). _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  44. 44. P a g e | 44In cases like this, where a banking group controls an insurance group,which – in turn – controls a bank, in order to calculate the limits orthresholds provided at sectoral level, the data of the banking group at thetop of the group shall not be calculated jointly with the data belonging tothe bank (B) controlled by the insurance group.In this case, bank (B) calculates a threshold on its Deferred Tax Assets.Bearing in mind that the Directive states the elements eligible for thecalculation of the own funds are those that qualify in accordance with therelevant sectoral rules, point 10 calls for the relevant groupings at sectorallevel to be maintained also at the conglomerate level for the purposes ofcalculating limits and thresholds.SOLVENCY REQUIREMENTS (Point 13)Finally, point 13 specifies that the calculation of solvency requirements isbased on the sum of sectoral and notional requirements, except for theprovision included in Article 11 (no capital charge for holdings that areconsolidated or deducted at the conglomerate level). _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  45. 45. P a g e | 45See also the Annex - Summary of the treatment of holdings andparticipations for the purpose of the calculation of the own funds of theconglomerate.Article 15Method 2 Calculation criteria1. For the purpose of calculating Method 2 as set out in Annex I part II ofthe Directive:(a) The proportional share applicable to own funds and solvencyrequirements shall relate to the proportion of the subscribed capital whichis directly or indirectly held by the parent undertaking or undertakingwhich holds a participation in another entity of the group;(b) The book value of participations in other entities of the group shall bethe book accounting value for the parent undertaking or for theundertaking that holds a participation in another entity of the group;(c) Where the own funds of a holding is subject to a prudential filter, thefiltered amounts shall be:i) Added to the book value mentioned in b), if the filtered amountincreases regulatory capital; orii) Deducted from the book value mentioned in b), if filtered amountdecreases regulatory capital.(d) For the purpose of point (c), the filtered amounts pertains to the netamount affecting own funds of the holding.2. For bank-led and investment firm-led conglomerates, significantinvestments in a financial sector entity pursuant to Article 40 of the CRR,if the entity belongs to the insurance sector as defined in Article 2(8) ofthe Directive, shall be:(a) Fully deducted, where the holding is not a participation as defined inArticle 2(11) of the Directive, and _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  46. 46. P a g e | 46(b) Treated according to Method 2, where the holding is a participation asdefined in Article 2(11).3. For insurance-led conglomerates, participation as defined in Article2(11) of the Directive shall be considered for the application of point 1.4. For the purpose of the first point, to eliminate the intra-group creationof own funds, the eligible amount of intra-group investments in anycapital instruments that are eligible as regulatory capital, respectingrelevant sectoral limits, shall be eliminated.EXPLANATORY TEXT for consultation purposesPoint 1(c) addresses cases where prudential filters affect the own funds ofa participation for prudential purposes by adding back unrealised lossesor subtracting unrealised gains, for example in the case of a holding heldin the Available For Sale category.If this is the case, the effect of the prudential filter should be reversed [byadjusting the book value of the participation to be deducted].Without this reversal the filtering of unrealised gains would undulyreduce own funds after deduction of accounting book value, while thefiltering of unrealised losses would unduly flatter own funds after thededuction of accounting book value.Referring to the formula in the Annex: if, because of the application of aprudential filter the Own Funds term xi(OFi-REQi) changes, then itseffect should be neutralized by an offsetting adjustment in the book valueterm: BVi.See also the Annex - Summary of the treatment of holdings andparticipations for the purpose of the calculation of the own funds of theconglomerate. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  47. 47. P a g e | 47Article 16Method 3 Calculation criteria1. The competent authorities may permit the financial conglomerate touse a combination of methods 1 and 2, only where the financialconglomerate can demonstrate to the competent authorities that itsrequest has been made:(a) Further to its best effort to apply either, Methods 1 or 2; and(b) Having regard to the cases in Article 6 (5) of the Directive.2. If several entities are collectively of non neglible interest, the competentauthorities shall take this into account in assessing the request to useMethod 3.3. The application of the specific combination of Methods 1 and 2 toentities within the financial conglomerate that was permitted bycompetent authorities shall be applied in a consistent manner over time.4. The coordinator shall consult the other relevant competent authoritiesbefore taking a decision on whether to permit the use of the combinationof methods 1 and 2.EXPLANATORY TEXT for consultation purposesArticle 6 (5) (a) (b) and (c) of the Directive states:“(a) If the entity is situated in a third country where there are legalimpediments to the transfer of the necessary information, withoutprejudice to the sectoral rules regarding the obligation of competentauthorities to refuse authorisation where the effective exercise of theirsupervisory functions is prevented;(b) If the entity is of negligible interest with respect to the objectives ofthe supplementary supervision of regulated entities in a financialconglomerate; _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  48. 48. P a g e | 48(c) If the inclusion of the entity would be inappropriate or misleadingwith respect to the objectives of supplementary supervision.However, if several entities are to be excluded pursuant to (b) of the firstsubparagraph, they must nevertheless be included when collectively theyare of non-negligible interest.”TITLE IVFinal provisionsArticle 17This Regulation shall enter into force on the twentieth day following thatof its publication in the Official Journal of the European Union.This Regulation shall be binding in its entirety and directly applicable inall Member States.Done at Brussels,For the CommissionThe President[For the CommissionOn behalf of the President[Position] _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  49. 49. P a g e | 49ANNEX ICalculation methodology for Method 2 – Deduction andaggregation method1. General principlesThe calculation of method 2 shall be carried out on the basis of theregulatory reporting required under the applicable accounting frameworkof each of the entities in the group following the formulaic expressionbelow:where own funds (OFi) exclude intra-group capital instruments.The supplementary capital adequacy requirements (scar) shall thus becalculated as the difference between:(1) The sum of the own funds (OFi) of each regulated and non-regulatedfinancial sector entity (i) in the financial conglomerate; the elementseligible are those which qualify in accordance with the relevant sectoralrules; and(2) The sum of the solvency requirements (REQi) for each regulated andnon-regulated financial sector entity (i) in the group (G); the solvencyrequirements shall be calculated in accordance with the relevant sectoralrules; and the book value (BVi) of the participations in other entities (i) ofthe group.In the case of non-regulated financial sector entities, a notional solvencyrequirement shall be calculated according to Article 11. Own funds andsolvency requirements shall be taken into account for their proportionalshare (x) as provided for in Article 6(4) and in accordance with Annex I. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  50. 50. P a g e | 50The difference shall not be negative.ANNEX II- Summary of the treatment of holdings andparticipations for the purpose of the calculation of the own fundsof the conglomerate _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  51. 51. P a g e | 51V. Accompanying documentsa. Draft Cost- Benefit Analysis / Impact Assessment1. IntroductionAccording to CRDIV/CRR proposals, the EBA, EIOPA and ESMA(hereafter the ESAs) through the Joint Committee, shall develop draftregulatory technical standards with regard to the conditions of theapplication of the Article 6(2) of the Directive, and shall submit thosedraft regulatory technical standards to the Commission by 1 January 2013.The Technical Standard describes how institutions following theconsolidation methods set out in this Directive shall calculate own fundsin the parent institution in a financial conglomerate.The standard introduces restrictions on which elements of own funds insubsidiaries and other participated entities of a financial conglomeratecan be used in the calculation of own funds.The main rationale underpinning this Technical Standard is to avoid an“inflated” calculation of own funds of cross-sector financialconglomerates.This Technical Standard focuses on harmonising the calculation offinancial conglomerates’ own funds.2. Problem definitionA lesson learned from recent financial crises is that the regulation ofsupplementary supervision, in particular the current set of rules ondetermining own funds at the conglomerate level, deserves a thoroughrethink.For example, in the recent past it became clear that parent institutionscould report strong levels of own funds, giving an impression of a robustsolvency. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  52. 52. P a g e | 52In some cases that impression turned out to be misleading as significantamounts of own funds were, in practice, locked-in in the subsidiaries.This consequently rendered the Directive’s assumption of availability offunds at the conglomerate level rather uncertain - because of a lack ofharmonisation of rules on conglomerate own funds.This affects the ability of conglomerates’ own funds to absorb losses,which makes financial conglomerates more fragile than figures on ownfunds would suggest.Multiple gearingUncertainties in the application of the methods for determining ownfunds at the conglomerate level may have led to undesirable levels ofmultiple gearing.This Technical Standard therefore builds upon the Directive andcontributes to achieving its objective to eliminate the multiple use ofelements eligible for the calculation of own funds at the level of thefinancial conglomerate (see for example Recital 7, Article 31 point 2, andAnnex I, section I of the Directive).Methods to determine Own funds at the FinancialConglomerate Level.Uncertainties in the guidance about the choice of methods fordetermining own funds at the conglomerate level may have led to anarbitrary combination of the methods that are offered under Annex I ofthe Directive.This Technical Standard therefore provides additional clarity on thecalculation methods for conglomerate own funds.3. Objectives of the Technical StandardThe objective of this Technical Standard is to achieve a more consistent _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  53. 53. P a g e | 53harmonisation of the calculation methods of Own Funds listed in Annex Iof Directive.This should translate in increased efficiency and effectiveness ofconglomerate supervision by competent authorities, more clarity on theavailability and transferability of own funds for the conglomerate, as wellas tightly controlled levels of multiple gearing.4. OptionsAnnex I of the Directive, describes three methods to calculate aconglomerate’s own funds.This Technical Standard concentrates on the application of thesemethods.There is not a wide selection of options available for this TechnicalStandard. Any choice made with respect to this Technical Standardderives from the text of relevant Directives, predominantly the sectoraldirectives, CRR/CRD4 and Solvency II.The guiding principles used by this Technical Standard to achieve moreconsistent harmonisation of calculation methods mentioned in Annex I ofthe Directive are:1. To offer clarity in rules regarding transferability and availability ofconglomerate own funds,2. To eliminate the multiple use of elements eligible for the calculation ofown funds at the level of the financial conglomerate,3. To avoid double deduction of items and amounts from own funds, and4. To respect sectoral rules. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  54. 54. P a g e | 54Method 1Method 1 is based on consolidated position of the conglomerate in orderto avoid multiple gearing.For this purpose, the RTS requires the elimination of all intra-groupcreation of own funds; the scope of the group is defined according toarticle 2, point 12 of the Directive.Adjustments are required to sectoral rules in the treatment of bankingcross holdings and some instructions not included in the Directive areprovided for unregulated entities.According to the Directive provisions, the capital requirements arecalculated as sum of sectoral requirements without the elimination ofintra-group transactions.Method 2The description of this method in its current form is already quiteprescriptive and unambiguous.However, this Technical Standard elaborates on two issues that may leadto disharmonised interpretations:i. The proportional share applicable to own funds and solvencyrequirements;ii. The interpretation of the book value of participations in other entitiesof the group.With respect to the latter issue, this Technical Standard uses the bookvalue from the accounts of the parent as a starting point, but appliesadjustments to any book values subjected to prudential filters in order tosafeguard consistency in the calculation of this method’s deduction ofbook value. _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  55. 55. P a g e | 55The method requires, according to the general principle of avoidinginappropriate creation of intra-group own funds, the deductions of all theintra-group investments in capital instruments eligible according tosectoral rules.This provision ensure also an equivalence between this method ofcalculation of the own funds and the others allowed according to theDirective.Method 3The use of combination of methods 1 and 2 is limited only to the caseswhere the use of either method 1 or method 2 solely would not beappropriate due, for example, to the lack of information on specificentities within the group.The use of method 3 shall need the permission of the competentauthorities or the coordinator after consultation of the relevant othercompetent authorities.The combination method 3 shall be applied in a consistent manner overtime.The supervisory consent is needed in order to prevent regulatoryarbitrage.5. ImpactsThis technical standard’s objective is to achieve a more consistentharmonization of the methods mentioned in Annex I of the Directive.This may limit the degree of freedom with respect to the ways ofcalculating own funds of conglomerates.The expected impact compared to the sectoral rules for insurance-ledconglomerate that apply method 1 of the Directive, where the scope of theinsurance group under Solvency II is not the same as the financialconglomerate under the Directive (see Article 7), is due mainly to the lineby line consolidation of the items of the banking subsidiaries and _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  56. 56. P a g e | 56banking joint controlled entities instead of the consolidation proceduresprovided under the Solvency 2 framework.In the case the scope is the same or difference is not material,insurance-led conglomerate applies Solvency 2 rules as they will bedefined in the implementing measures Solvency 2.For banking-led and investment firm-led conglomerate the mainexpected impact compared to the sectoral rules is due to theconsolidation of the insurance subsidiaries and joint controlled insuranceentities that are risk weighted or deducted according to CRR.Both insurance and banking group shall also adjust, where applicable, theamount of the threshold and parameters used for their eligibility limits(for example, thresholds on Deferred Tax Assets and on deduction ofholdings under Article 45 of CRR), considering the effect of theconsolidation of cross sector holdings at conglomerate level.Insurance, bank and investment firm-led conglomerates shall take intoaccount of limits to transferability and availability of own funds asforeseen in the Technical Standard.A cost factor relates to the alignment of the entities to the requirements ofthis Technical Standard.Such costs may arise if current national regulations need to be amendedto comply with the Technical Standard.Another cost factor may arise in the cases where competent authoritiesare called upon to approve the use of Method 3.Lastly, this Technical Standard may also affect the business model for agroup to organize itself as a financial conglomerate.There are a number of expected benefits related to this TechnicalStandard. They are:i. More consistency in the selection and application of the methods of _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com
  57. 57. P a g e | 57Annex I of the Directive;ii. Increased efficiency and effectiveness of conglomerate supervision;iii. More clarity on the amount, availability, and transferability of ownfunds within a financial conglomerate;iv. More effective loss absorption of the capital held by conglomerates;v. An increased standardization of the use of the methods, leading tolower costs of their application; andvi. A contribution to greater financial stability.b. Overview of questions for Consultation1. What are the cost implications of a requirement for conglomerates tofollow the clarifications for calculating own funds and solvencyrequirements described in this paper?If possible, please provide estimates of incremental compliance cost thatmay arise from the requirements, relative to following the Directive in theabsence of the Regulatory Technical Standards.2. How, in your opinion would the proposed clarifications impact onconglomerates’ business models?3. How far would the suggested clarifications change current marketpractices?4. Are the Technical Principles in Title II sufficiently clear? If not, whatareas require further clarification?5. Are there any areas of ambiguity in the way that the TechnicalPrinciples in Title II apply to the three consolidation methods?6. Are there any areas of ambiguity in the way that Method 1 needs to becarried out? _____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com

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