Solvency ii News May 2013


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Solvency ii News May 2013

  1. 1. P a g e | 1Solvency ii Association1200 G Street NW Suite 800 Washington, DC 20005-6705 USATel: 202-449-9750 www.solvency-ii-association.comDear member,Lifeis becoming more complex for riskmanagers.We must have a “forward-lookingperspective”, remember?We have all thesenew lawsand regulations…… but wealsohave rules, proposalsand reportstoconsider.Have you ever discovered the common elementsof thevariousinitiatives,includingthe Volcker rule in the United States, theproposalsoftheVickersCommission for theUnitedKingdom, the Liikanen Report totheEuropean Commission?LeonardoGambacorta andAdrian van Rixtel from theMonetaryandEconomicDepartment of the BISwill help ustoday to seethe commonelementsand the differences!This is a great analysis! We read:TheVolcker rule isnarrow in scope but otherwisequitestrict.It is narrow in that it seekstocarveout onlyproprietary trading whileallowingmarket-makingactivitieson behalf of customers.Moreover, it hasseveral exemptions, includingfor transactionsinspecific instruments, such asUS Treasuryand agencysecurities.It is strict in that it forbids the coexistenceof suchtrading activitiesandother banking activitiesin different subsidiarieswithinthesame group.Solvency ii
  2. 2. P a g e | 2It similarlypreventsinvestmentsin, and sponsorship of, entitiesthatcould expose institutionsto equivalent risks,suchashedge fundsandprivateequityfunds.That said, it imposesvery few additionalrestrictionson the transactionsof banking organisationswith other financial firmsmore generally(egsuch asthrough constraintson lendingor funding among them).However, it is worthrememberingthat the current US legislationdoesconstrain theactivitiesof depositoryinstitutions.TheLiikanenReport proposalsare somewhat broader in scope but lessstrict.Theyare broader because theyseek tocarve out both proprietarytradingand market-making, without drawinga distinctionbetweenthe two.Theyare lessstrict becausetheyallowtheseactivitiestocoexist withother bankingbusinesswithin the samegroup aslong asthesearecarried out in separatesubsidiaries.Theproposalslimit contagion withinthegroup by requiring, inparticular, that thesubsidiariesbe self-sufficient in termsof capital andliquidityand that transactionsbetweenthe legal entitiestake place onmarket terms.Just like theVolcker rule, theproposalsdo not envisagesignificantrestrictionsbetweentheprotectedbanking unit and other financialfirms, except that theyrequire theseparation of exposurestoentitiessuch ashedge fundsand special investment vehicles (SIVs) in thetradingentity.TheVickersCommission proposalsare evenbroader in scope but have amore articulatedapproachtostrictness.Solvency ii
  3. 3. P a g e | 3Solvency II: whereare we now?Although there is nocertaintyon the SolvencyIIimplementationdate, EU policymakersare continuing to finalisekeyaspectsof the framework.Recent developmentsincludeEIOPA‟s consultationon interimmeasures,the impact assessment of the long-term guaranteepackageand a debate on whethernew legislationis needed formally todelaySolvencyII‟sapplication.Solvency II implementation dateThelegal positionis that Member Statesmust transposetheSolvencyII Directiveintonational lawsby30 June 2013andapplyit to firmsfrom 1January 2014.It is clear, however,that this SolvencyIItimetableis not feasible.EU Member Statescannot implement theSolvencyII framework by the set dates, for thesimplereasonthat it isnot finalised.AMember State‟sfailure to meet thelegal implementation deadlinesforSolvencyII wouldmean that it wasnot complying with EU law andcould have legal implications.As a result, MemberStatesare keen to ensurethat further legislationamendsthe SolvencyII Directive to postpone deadlinesfor SolvencyIIimplementationon a formal basis.This can bedone bymeansof another “quick-fix Directive”, similar totheone adopted last summer, whichestablished current transpositionand implementationdates.Solvency ii
  4. 4. P a g e | 4Many peopleexpect implementation to beput back to January2016.TheEuropean Commission, however, is resistingpressure tointroduceanotherquick-fix, soasto encourage othersin theEU‟s legislativeprocesstoagree theOmnibusII Directiveasa priority.Instead, the Commission proposestoproducea letter of comfort toMemberStatesconfirmingthat it will not commenceproceedingsagainst them for failure to implement SolvencyII.Thediscussion isongoingand wearemonitoring it.EIOPA‟s consultation on Solvency II interim measuresAlthough the SolvencyII legislativeprocessisdelayed, EIOPAbelievesthat the insuranceindustryshould build on preparatory work alreadyundertaken.In addition the IMF‟sFinancial SectorAssessment Programme (FSAP)review of the EU concluded that earlyharmonised implementation ofSolvencyII wouldreduce risksarisingfrom thecurrent regime.EIOPA hasthereforepublisheda set of consultationdocumentsproposingto introducesome core SolvencyII provisionsin advanceoftheformal deadline(still to be confirmed).EIOPA‟sguidelinesare addressedtonational supervisorsand cover thefollowingareas:- System of governance- Aforward lookingassessment of theundertaking‟sown risks(basedon theORSA)- Submissionof informationto national supervisors(reportingrequirements)Solvency ii
  5. 5. P a g e | 5- Pre-applicationfor internal modelsLloyd‟s is reviewingthe guidelinesand contributing to thedebateat UKand EU levels.Many insurersare most concerned about EIOPA‟sproposedreportingrequirements,whichlook very onerous.In arelated development, theEuropeanCentral Bank (ECB) plans topassaRegulation enablingit tocollect information from insurersforfinancial stabilityand statistical purposes.TheECB is workingwithEIOPA and, sofar aspossible, will rely ondata collectedthrough the SolvencyII reporting templates.In the interim period, before Solvency II is implemented, it probablywillnot require insurerstoreport any additional data.Longer-term, however, its requirementsmay become more extensive.Legally, this Regulation will applyto EurozoneMember Statesonly,although central banks in other MemberStatesmay decidetoimposesimilar reporting requirements.It is unclear what positionthe Bank of England will take.Impact assessment of the long-termguarantee packageLast year‟sdebateson the long-termguaranteepackageprovedinconclusiveandthe Commission decided to conductan impact assessment toinform OmnibusII‟sdevelopment.EIOPA launched theassessment inJanuary2013:insurershad until the end ofSolvency ii
  6. 6. P a g e | 6March2013tosubmit information.Lloyd‟s did not participatedueto the issue‟slimitedrelevanceto most ofLloyd‟s business.EIOPA is expectedtopublish a report withitsfindingsin Junethisyear, followedby a communication from the Commission.Parliament hasscheduled a vote on theOmnibusII Directivefor 22October 2013.This is indicativeonly, but suggeststhedeadlineby whichagreement onthelong-term guarantee packageshould be reached.Compromisesover the long-term guaranteepackageand subsequentadoptionof the OmnibusII Directive are important totheSolvencyIIimplementationtimeline.If agreement is not reachedand the Directiveis not finalisedin 2013,thisis likelyto delaySolvencyII implementationbeyond the expecteddeadlineof January2016.Solvency ii
  7. 7. P a g e | 7Theimportance of culture in drivingbehavioursof firms and how the FCA willassessthisSpeechby CliveAdamson, Director of Supervisionat the CFA Society- UK ProfessionalismConference19April2013,London.IntroductionGood afternoon and my thanksto CFA Society for invitingme to speaktoday.Thesubject of my speech todayis theimportanceof culturein drivingkey behavioursin firmsand how the FCAwill assessthis.But beforeI take you through that, I wouldlike to provide some context.As many of you will know, the FinancialConduct Authority (FCA) cameintoofficial beingearlier this month, takingover theconduct supervisionof 25,000firmsin theUK.This is a significant moment in UK financial regulation, withthecreationof a focused conduct regulator seekingtoprotectconsumers, enhancemarket integrity and promote effectivecompetition.I think it is fair tosaythat weare all awareof theerosion of trust infinancial services.This hasbeen caused partlyby the financial collapsein the bankingsector, but alsoby a seriesof large-scaleconduct failingsstretchingbackover many years, from pensionsmis-selling, endowment mis-selling, splitcapsto more recently, PPI and the sale of interestrate hedgingproductstoSMEs.In the wholesalespacetoowehave seen the LIBOR scandal.Solvency ii
  8. 8. P a g e | 8Theseevents, and associatedlack of trust, have imposed substantialcostson consumers, firmsand the economy.Sowhat hasgone wrong?We accept that the FSAhasnot been aseffectivea conduct regulator asit could havebeen.But thereare other reasonstoo.Firms have designed, manufactured and sold productsnot alwayswiththeneedsand interestsof their customersin mind but instead, seeingthecustomer assomebody tomaximise profit from.This hasbeen accentuatedby a view, and it hastobe said encouraged bytheFSA, that disclosureat the point of saleabsolvesthe sellerfrom a realresponsiblyof ensuring that theproduct or servicerepresentsa goodoutcome for the customer.This, in turn, has led in many casesto a tick-box and overlylegalisticcomplianceculture within firms, encouraged by what hasbeenseen asatick-box regulatory approach.Underpinningall of thisis the issueof culture.In many cases, where things have gone wrong, whether it ismis-sellingof PPI or in attempting to manipulate LIBOR, a cultural issue is at theheart of theproblem.It is fair to saythat tomany in the outsideworld, the cultural approachofdoing the right thinghas been lost for financial services.It is cleartous, therefore,particularlyasa conduct regulator, that thecultural characteristicsof a firm area key driver of potentiallypoorbehaviour and I wouldlike to explorethisfurther withyou today.Solvency ii
  9. 9. P a g e | 9What doI mean by culture?Culture is like DNA.It shapesjudgements,ethicsand behavioursdisplayed at thosekeymoments,big or small, that matter totheperformanceand reputation offirmsand theservicethat it providesto customersand clients.For us, weview culture through thelensof what mattersto usasaconduct regulator.This meansan effectiveculture isone that supportsa businessmodelandbusinesspracticesthat have at their core, the fair treatment ofcustomersand behavioursthat do not harm market integrity.This is very different from what wehavetodaywhere, asI said earlier, thefocushasbeen on ensuringcompliancewitha set of rulesrather thandoing the right thingfor customers.Looked at this way, the responsibilityfor ensuring the right outcomesforcustomersresideswitheveryone at thefirm, led by seniormanagement, and not something delegated to complianceor controlfunctions.Thechallengefor manyfirmsis that culture is hard tochangeandrequiresdedicatedand persistent focusover a number of yearsin ordertoembeddeddifferent approachesand waysof behaving.As the Saltz Review recentlyconcluded, if cultureis left toitsowndevices,it shapesitself, withthe inherent risk that behaviourswill not bethosedesired.Driversof culture at a firmIt seemsto me that wecan identify keydriversof culture at a firm. Theseinclude:Solvency ii
  10. 10. P a g e | 10- settingthe tone from thetop;- translatingthisintoeasilyunderstood businesspractices;and- supportingtheright behavioursthrough performancemanagement, employee development, and reinforcing throughrewardprogrammes.Let me saya few wordsabout each of these.Setting the tone from the topSettingthe tone isall about creatinga culture whereeveryone hasownership and responsibilityfor doing the right thing, becauseit is theright thing to do.It is about setting valuesand translatingthem intobehaviours.This can only be establishedby theCEO and other membersof theseniormanagement team, whoneed to not only set out the keycompanyvalues,but alsopersonallydemonstratetheymean them through theiractions.Theseclearlygowiderthan thosethat directlyimpact what we, astheconduct regulator, are lookingfor but should clearlyincludethese.We have been encouraged to seethat a number of firmsare re-articulatingtheir keyvaluesand principles,ledby their respectiveCEO– and wesupport thismove.For us, though, wewill want tosee this new tone translatedintobehavioursthrough the organisation.Businesspracticesand waysof behavingSolvency ii
  11. 11. P a g e | 11Thetask then isto translatethis tone intobusinesspracticesthat drivehowbusinessdecisionsare made, howthe firm respondsto events,howindividualsshould behaveand how issuesare elevated in an open way.For me, therefore,translatingcultureintobusinesspracticesis a waytomake cultureintosomethingmore hard edged.I heard one CEO sayearlier this year that one of their keyvalueswasto„treat our clientslike you woulda member of your family.If you see a product featureyou wouldn‟t feel comfortablesellingto arelative, then weshouldn‟t be sellingit toour customerseither‟.Let me giveyou an examplethat waspassedon to me last week.Thosewhocommutearound London will be awareof the problemssomeweeksagoon the M25,which meant hundredsof passengersranlate for flightsout of Heathrow and Gatwick.One airline, whichspotted this, and in light of somany of its passengersfacingdisappointment at theprospect of missingtheir flights,chosetohold back certain planessothat passengershad a chanceto make theirflights.Of coursethis meant it faced complaintsat the other end from thedominoeffect of thedelayed flights, not tomention theadditional costsduetoinactiveplanessat on therunway.I am told though, that once the announcement made it totheotherend, there werenocustomer complaintsmade.Theykey point from thisexampleis that the airlinetook a judgementcall and did what it thought wastheright thingfor itscustomers,eventhough it came at a cost.This is thekind of consumer-focusedbehaviour that customerswouldreasonablyexpect to be shown by the financial servicesindustry.Solvency ii
  12. 12. P a g e | 12But wehave alsoseen caseswhen this hasnot beenthe case.Take our useof mystery shopping asa supervisory tool, asan example.When weassessedthe qualityof investment adviceat themajor retailbanksand building societies,wefound that the messagescommunicated from thetop of a firm werenot fullyembedded intotheday-to-day operationson the shop floor.Thistranslatedintopoor advicebeing giventoconsumers - in fact wefound that in one quarter of cases, consumersweregiven unsuitableadviceor theadviserhadn‟t gathered enough information to ensure theiradvicewassuitable.Thepoint here isthat, although senior management may havethoughtthat good advice wasbeinggiven, this wasn‟t happening on the ground.Performancemanagement, employee development and rewardprogrammesPerformancemanagement, employee development and rewardprogrammesareclearlya powerful lever toinfluencethe culture of anyorganisation.We have seen in financial serviceshow themisalignment betweenincentivesstructuresand corporatevalueshasled to significant damage.Our own workon financial incentivesnoted that high-riskincentiveschemeswiththe potential for salesstaff toearn big bonuseswerecommon acrossauthorised firms.Sadly, wealsouncovereda catalogueof serious failings, includingfirmsstrugglingtounderstand their own incentiveschemesbecausethey weresocomplex.Soit isnot surprising that wesee more eventssuch asthe „shareholderspring‟last year, whichsent a strong messagetotheexecutivesof thoseSolvency ii
  13. 13. P a g e | 13firmsthat financial incentivisationisstill a critical factorthat needstobecarefullybalanced to reinforcepositivecorporate expectations.I am pleased though that many firmshave either alreadychanged or arecurrentlychangingtheir salesincentivesplans.Thequestion is then, how can a firm incentiviseand reward itsemployeesin a responsiblewayto encourage theright outcomes?I mentioned remuneration asbeingan important lever, but sotoo areeffectiverecruitment and promotion policies,development andperformancemanagement of employees – so, if by advancingsomeoneyou areessentiallytellingthem that their behaviour within theworkplaceis appropriate, or even outstanding, then you need toensure, and be abletodemonstrate, that they are reinforcingtheright valuesbefore makingthat decision and embeddingthat behaviour.How will the FCA assessculture?I‟d like now toturn my attentiontohow theFCA will be assessingculture.Our approachtoday is todraw conclusionsabout culture from what weobserveabout a firm – in other words,joiningthedotsrather thanassessingculturedirectly.This can be through a range of different measuressuch ashow a firmrespondsto, and dealswith, regulatory issues;what customersareactuallyexperiencingwhentheybuy a product or servicefrom front-linestaff; how a firm runsitsproduct approval processand theconsiderationsaround these;the manner in whichdecisionsare madeor escalated;thebehaviour of that firm on certain markets;and even theremunerationstructures.We alsolook at how a board engagesin thoseissues,includingwhetherit probeshigh return productsor businesslines,and whetheritunderstandsstrategiesfor cross-sellingproducts,how fast growthisSolvency ii
  14. 14. P a g e | 14obtainedand whetherproductsarebeingsold to marketstheyaredesignedfor.We are able, from all of this, todraw conclusionsabout the cultureof afirm.This includesassessingif the perceivedcustomer-focusedcultureissupported by, for example, regular discussionson conduct at board leveland appropriatesalesincentivesplans.How will the FCA encouragepositive culture change in firms?We don‟t have direct rulesabout culture,although our high-levelprinciplesfor businesscome closeto thisin some respects.As I have set out here, wedon‟t directlysupervise „culture‟.However, asculture and businesspracticesare soimportant in drivingbehaviours,wedo want toencourage positiveculture changein firms.We will therefore increasingly, as I have indicated, draw conclusionsabout a firm‟s culture and reflect that back to firmsas part of the riskassessment process.Wherewebelieve cultural measuresexposure the firm to a high level ofrisk in thecontext of our objectives,wewill expect thefirm totakeaccount of it.Of course,there areother waysto improve standards.With the Retail DistributionReview (RDR), wehave set new professionalstandardsand I am pleasedwith the progressindustrymadetomeet thesebythedeadlineof last year.In addition, aspart of our new supervisory approach, wewill be placinggreater emphasison individual accountability aswell ascorporateSolvency ii
  15. 15. P a g e | 15accountabilityfor meetingour standardsand wewill be more preparedtohold these to account whenthingsgowrong.SummaryI hopethishasgiven you a better ideaof whyweat theFCA areinterestedin the culture of firmsand how weare goingabout assessingit.There is no doubt that this isa complex subject and one whereourthinkingwill continue to evolve asthe FCAestablishesitself, whichiswhywewouldlike toencourage widerdebateabout it and how wecanpositivelyinfluenceit.Soto summarise,culture is important tousasa conduct regulatorbecauseof its role in drivingbehavioursin firms and direct impact onour intended outcome of ensuring that customersget the rightoutcomes.We certainlysupport the roleof the CFASocietyin raisingprofessionalstandardsand look forwardtodiscussingthisissueover the years ahead.Thank you.Solvency ii
  16. 16. P a g e | 16Letters…… betweenAndrew Tyrie MP, and the ExecutiveDirector of thePrudential RegulationAuthority, Andrew Bailey, discussingSolvency II.Solvency ii
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  21. 21. P a g e | 21Erkki Liikanen: Banking structureand monetary policy – what have welearned in the last 20 years?Presentation by Mr ErkkiLiikanen, Governor of the Bank of Finlandand Chairman of the Highlevel ExpertGroup on thestructure of theEU bankingsector, at the conference“Twentyyearsoftransition– experiencesandchallenges”,arrangedbytheNational BankofSlovakia, Bratislava.How is today‟s perspectiveon monetarypolicy different from whatprevailed 20 years ago?Twentyyearsago, the worldof todaywasbeing formed in manyways.1993wasthe year whenthe Economic and MonetaryUnion project wasbecomingpolitical reality: theMaastricht treaty had been signedandwasin theprocessof beingratified.It wasalsothetime when themainstream approach to monetary policywasbeginningto convergetothe flexibleinflationtargetingframework.Anumber of countrieshad then just adopted an explicit inflationtargetingstrategy.In the sphereof banking regulation, too, a new era wasbeginning.Asignificant reorientationwasgoingon, awayfrom regulating theconduct of banks and towardsthenew risk-basedapproach.Theregulatorytrend, based on increased freedom for banksbut subjecttorisk based capital requirements,wouldcontinueall the wayto theeruptionof thefinancial crisisin 2008.Solvency ii
  22. 22. P a g e | 22In the EU, the second bankingdirectivetook effect from thebeginningof 1993,creatinga singlemarket in banking.Thedirectivesought to prevent discriminationand to increase efficiencythrough competition.There wasdiscussionon the implicationsof thisfor supervision, butlittleaction.So, whileEuropean banking marketswerebeingintegrated, financialsupervision remained a national competence.In the U.S., deregulation wasalsomoving forward.For instancethe Glass-SteagallAct, separatingbanking from securitiesand insurance, wasunder growingcriticism and wouldbe ultimatelyrepealedin 1995.One reason for the dissatisfaction with the Glass-Steagall system in theUS was competition from European banks which were less restricted inwhat theycould do.Twentyyearsago, the striking improvement in macroeconomicperformance, later named “the great moderation” by chairmanBernanke, wasspreadingtothe wholedeveloped world.Thealmost surprisingsuccessof monetary policy in improving pricestability and reducingfluctuationsin economic activity, while alsokeepinginterestratesat historicallylow levels, wasinterpreted asamajor victory for theart of economic policymaking.Now weknow that there wastroublebrewingunder the surface.Theunderpinningsof global financial stabilitywerebecoming weaker.Global indebtednessincreased, fuelledby current account balancesandthe“deepening” of international financial markets(read: recycling thesamefundsseveral timesover).Solvency ii
  23. 23. P a g e | 23Thedecline of inflation wasnot only due to monetary policy, but alsotheavalancheof cheap consumer goodsfrom the emerging economiessuchasChina contributed to it.For banks, the new financial environment wascharacterizedby lowinterest ratesand low perceived risks.It alsoturned out that the new risk-basedcapital requirementsallowedthe banks to expand their balancesheetsenormously without increasingtheir equitycapital in the same proportion.So, graduallythe largebanking groupsstarted toincreasetheir tradingportfolios.This development happened in a gradual fashion in the 1990‟sbutaccelerateddramaticallyfrom about 2004.Banks redirected their businessfocusfrom interestmarginstofee-basedandtrading activities.Universal banking, asit had been knownin Europe, startedtochange.Theasset mix of thelargest banks changedsothat securitiesportfoliosactivitiesgrew more and more important.Onlynow, from theperspectivegivenby theworstfinancial crisis sincetheSecond World War, do wesee clearlythefragilityand weaknessoftheregulatoryarrangementswhichcameintoforce in the 1990s.From today‟s point of view, theyperformed well only aslong asno majorsystemic risksmaterialized.Even worse,theyallowedrisksto accumulate in the financial systemwhichwereonly waitingtobe realized.Then came 2007and the collapseof theUS propertymarket; 2008and thecollapseof interbank money marketsfollowingthe Lehman Brotherscrisis;and 2009withThe Great Recession.Solvency ii
  24. 24. P a g e | 24Thepainful processof competitivedeleveragingstarted.Thereassessment of economicpoliciesfollowedin the lasttwodecadeshasalsostarted.Especiallyfinancialregulation hasbeenreconsideredand is beingstrengthened.We needto think of monetary policy, too, especiallyin itsconnection tofinancial stability.Monetary policy and financial stabilityThere is a common dictum that a stable financial system is a necessarycondition for successful monetary policy, and that price stability in turncreatesthebest preconditionsfor financial stability.I agree.Still, the experienceof this crisishasthought usa lot more.First of all, wenow know that pricestability doesnot by itself guaranteefinancial stability.Riskscan accumulatein thebankingsystem even if monetary policysucceedsin maintainingprice stabilityand controllinginflationaryexpectationsreallywell.Second, wealsoknow that central bankscan maintain an admirabledegreeof pricestabilityeven when financial stabilityis under a lot ofstrain.Dothesetwopointsmean that financial stability and monetary policyare not connected after all?No.Solvency ii
  25. 25. P a g e | 25Theyare very closely related.Independence of monetary policyOne of thelastinglessonslearned in thelast decadesisthe value of theindependenceof monetarypolicy.The independence of central banks has been essential keeping inflationexpectations as well anchored as they have been in this crisis despite alltheturmoil in thefinancial markets.Independencehasalsomade it easierfor central banksto act quicklywhenit hasbeen necessaryin order tomaintainfinancial stability.It is especiallyimportant to avoid twothreatstoindependence:fiscaldominanceand financial dominance.Fiscaldominanceisthe older concept of thetwo.It wouldarise if thegovernment financing constraint wouldbecome anoverridinginfluenceon monetary policy.Theideaof fiscal dominancewasformalized by Tom Sargent and NeilWallacein 1981,but of coursethe worrythat deficit financingmay causeinflationhasmuch longer rootsin monetary thought.Theideathat tight monetary policymay become impossiblewithoutaccompanyingfiscal adjustment wasalsowellunderstood whentheblueprintsfor the EMU werebeingprepared.This is whythe Maastricht treatyhad itsfiscal policy clausesand alsowhythe Stabilityand GrowthPact wasconcluded.Also the prohibition of direct central bank credit to the government andtheinstitutional independenceof the central banks are in effectprotectionsagainst fiscal dominance.Solvency ii
  26. 26. P a g e | 26Now weknow, of course, that thefiscal frameworkasput in placebeforethestart of the EMU wasnot strong enough to prevent fiscalproblemsfrom emerging.Somehave argued that fiscaldominancehastakenhold in thein thebigindustrializedcountries during thecrisiswhen the central banks haveused government bond purchasesin order tostabilize the markets(astheECB) or to produceadditional monetary stimuluswhenthe interestrateinstrument hasalready been used tothemaximum (like the FederalReserveand theBank of Japan).As to the euroarea, for me there isnow noevidenceof fiscaldominance.Fiscaldominanceimpliesthat monetarypolicy wouldbreak its pricestability objectivefor the sake of maintainingthe solvencyof thegovernment sector.This is not the case.Price stability hasnot and will not be abandoned.We have well knownfiscal problemsin some of the euro area countries.Still, theECB‟sabilityto goon maintainingpricestabilityhasnot beenweakened.In particular theinflation expectations,whichare themost essentialindicatorsof thecredibility of monetarypolicy, have remainedwell inlinewiththeprice stabilityobjective.Theparallel ideaof financial dominanceis more recent than fiscaldominance.Financial dominancerefers tothe possibility that the condition of thebankingsystem could become a constraint, or dominant influence,onmonetary policy, effectivelyforcing the central bank to pursuesecond- orthird-best monetary policiesin order tomaintainfinancial stability.Solvency ii
  27. 27. P a g e | 27Is thespill-over from financial instabilityto monetary policy a realisticthreat?Can financial stabilityconsiderationslead the central bankstotoleratetoohigh inflation, just tokeep the banking sector afloat?In principleit is easyto see whyit could be.One can imagine a central bank whichwouldhavetotightenitsmonetarypolicy for price stabilityreasons,but is preventedfrom doingsofor the fear that the value of theassetsof thebanking system woulddecreaseand a financial crisiscould ensue.Episodeswhichfit the description of financial dominancehave beenobserved in emergingeconomiesafter some banking crisesin the past.But lookingat recent experience, this hasnot been thecasein thedeveloped economies.Thebust of the credit boom hasnot led monetary policyto tolerate ahigher-than-mandatedrateof inflation.Instead, in the largedeveloped economiesat least, the burstingof thebubblehascoincidedwitha sudden contraction of private demand and adeep recession.Thenegativeeffect of thebust on economicactivityhas actuallyreducedinflationarypressuresand in some cases(such asin Japan in the 1990‟s)created a real danger of deflation.Themain problem hasthen becomehow to prevent the creditcontraction from startinga deflationaryspiral.In such conditions,the same monetary policy will then both easethestrain onthe banking sector and support price stability.Solvency ii
  28. 28. P a g e | 28This observationdoesnot mean that financial instabilitywouldnot posea seriouschallengetomonetary policy.On thecontrary, thedownwardimpact of a bust, if it is large, may bemore difficult tocontrol than the preceding period of credit expansion.There was a famous discussion on how monetary policy should relate toasset prices in the Jackson Hole conference of 2007, where Rick Mishkinintroduced thetopic.At that time, the prevalent thinkingin central bankingcircleswaswhatprofessorIssinglater called “theJacksonHole consensus”,meaningthat it isbetter for monetary policy onlyto“clean” (up afterwards) thanto“lean” (againstthe wind).After thehard lessonswelearned over thelast five years thecaseforbenign neglect of asset boomsand onlypickingup the piecesafterwardsis not sostrong any more.Thecrisisexperiencesupportsrather theidea that financial excessesarebetterprevented astheyhappen than onlymanaged after theyhavecauseda recession.This would be the best wayto prevent “downwardfinancialdominance”whichcould ariseif monetary policy could not effectivelycounteractcredit contraction.Unconventional toolsand the independence of monetary policyRecent experienceshowsthat the central banks‟box of potential toolsisactuallyvery deep, and if it hasbecomenecessaryto utilizeunconventional tools, asin thepresent crisis, these new toolshave beendeveloped and deployed.In the caseof the ECB, the new toolshave includedthe transitiontofullallotment auctions,thelong term refinanceoperationsup tothreeyears, wideningof the scope of eligible collateral, and the variousbondpurchaseprogrammes.Solvency ii
  29. 29. P a g e | 29Themost recent of theseis theOMT programme announcedlastsummerbut not yet commenced in practice.Thedevelopment of new toolshasbeen justified.The slip of the depressed economies to dangerous deflation has beenaverted, and the debt and banking problems have not developed intosystemic financial meltdownsin the affectedcountries.We have seen that central bankscan pursuesuccessful pricestabilitypolicy alsounder very difficult conditions.Theeventsaround the worldsincethecollapseof Lehman Brothersareevidenceof that.Deflationhasbeen avoideddespite a severe recessionin many countries.However, there are alsocertainproblemswithrelying on theenlargedtoolkit of thecentral banks.Theabilitytoact in crisishasled to thecentral banksbeingeven called“theonlygame in town”.We should resistthisidea and bewareof thedanger that problemswhichare fundamentallypolitical could be pushedtocentral banksto solve.Adivision of responsibilitiesbetweenappointed officialsand electedpoliticiansshould be preserved.Monetarypolicy cannot administer the needed structural transformationin thereal sector of the economy or solve excessivedeficit problemsofgovernments.There aresituationswherethe central banks just haveto act and dotheirbest to stabilize theeconomy, even if they wouldhave to usetoolswhichgobeyond just adjustingtheshort rate of interest or the aggregateliquidityof the banking system.Solvency ii
  30. 30. P a g e | 30Thepresent financial crisishasconstitutedone suchsituation.Avoiding the bustswhichseem to followcredit boomsand periodsof“financial exuberance”wouldmake thetasksof monetarypolicy mucheasierand protect the independenceof central banks.But thereare alsodifficultieswiththe leaningagainst the wind.One hasto dowiththe problem of detectingthecredit cycle in time, andcorrectlytiming themonetary policyresponse.Another problem isthat price stabilitymight get lessattention.Tomitigatetheseproblems,somethingelsebesidesmore vigilant interestrate policy isneededtoprevent low and stableinterestratesfrom leadingtoexcessesin banks and financial markets.One development can be the development of macro-prudentialinstrumentswhichare designed to improve the stability of the financialsystem asa whole.Themajor workin this fieldwasdonebythe deLarosière group.Otmar Issingwasa member of thegroup.Especially interesting are those macro-prudential instruments whichhave a time dimension so that they can be adjusted according to thechangingsituationin the credit markets.Such instrumentsinclude,in particular, thecountercyclical capitalrequirements,aswell asthe adjustablerestrictionson Loan-to-Valueratios.TheCRD IV directivewill make the former instrument obligatoryin theEU countries; implementationof the latter is left to national discretion.Solvency ii
  31. 31. P a g e | 31Now it is very important to establishan effectivetoolkit for bothEuropean and national authorities.We must alsocreateinstitutional conditionswhichdonot prevent thesetoolsto beused when needed.Therefore, weneed clear decision makingcompetencesat all levels.Theconnectionbetweenmacro-prudential policy and itstimedimensionwith monetary policyis sointimatethat central banksmust be closelyinvolvedin macro-prudential analysis and decisionmaking.Macro-prudential policy is important, but it needstobe supported bystructural reformswhichwouldmake thebanking system more resilient,and - I emphasise- lessprone tounstablebehaviour.The Structural reform proposalsIn order toprevent the present crisisfrom beingever repeated,governmentsand authoritieshave started a large-scaleoverhaul offinancial regulation.Theregulatoryagenda can bebroadly dividedintothe followingareas:•Strengtheningof the prudential regulation of solvencyand liquidity•Improving the institutional basisfor supervision and crisismanagement•Introduction of macro-prudential instrumentstoprevent systemic risksin thebankingsystem and financial markets• Regulatingthe structure of the banking sectorSolvency ii
  32. 32. P a g e | 32Thestructural reform proposalswhichappear asthe last item on thislistaim toseparatethe riskiestsecuritiesand derivativesbusinessfrom thedeposit banking activities.This is theessentialcontent of the proposalsby the EU High LevelExpert Group, whichI chaired, published last autumn.It is alsoat the core of the Volcker rule whichis being implementedintheUS, and the Vickersproposal in theUK.Thecurrent legislativeproposalswhichare underwayin FranceandGermanyare alsoin thesame vein.Aparticular concern of theseproposalshasbeen tolimit theextent ofexplicit or implicit public guarantees,sothat theywouldnot induceadditional risk taking.This kind of competitivedistortion could result in securitiestradinggettingconcentratedin the largest deposit banks, and thesedepositbanksbecoming enormousrisk concentrationsbuilt on implicit or evenexplicit public guarantees.Separation proposalstry toisolatesecuritiesbusinessfrom thesourcesofthisdistortion and reducethe incentivesto excessiverisktaking and riskconcentration.In must be emphasizedthat thestructural reform weproposed is not acure-all but should be seen asa part of acomprehensive regulatoryagendawhichisalready moving forward.This includesbetter solvencyand liquidityrules.Also, theEU will finallyget supervisionand resolution frameworksat theunion level.Thedifferent componentsof thecurrent regulatory agenda complementand support each other.Solvency ii
  33. 33. P a g e | 33In thisEuropean context, thestructure and stability of thebankingsector is of vital importancetothe economy.It is imperativeto improve itsresiliency.TheHigh Level Expert Group report containsfive mainrecommendationson how to reform thebankingsector.I will just refer tothreeof them here:•Thefirst is toseparate anysignificant proprietary trading in securitiesandderivativesfrom deposit banks.These activities could be carried out in a separately capitalized andfunded subsidiary, a trading entity, which could belong to the samebankinggroup asthedeposit bank.We proposed that alsomarket makingbe allocated to the tradingsubsidiary in order toprevent the useof tradinginventoryto circumventthe prohibition on proprietary trading.•Theuse of trading subsidiarieswouldallowthebankinggroupsto offer“one-stop banking” totheir clients,but without thepossibilityof fundingtradingactivitieswithinsuredretail deposits.Financial linkagesbetweenthe deposit bank and the trading unit wouldhavetobe restricted in accordancetonormal largeexposurerules.•Another of our proposalsisto develop specific, designatedbail-ininstrumentsto improve the lossabsorbencyof banks.Arequirement toissuesuch bail-in debt wouldhelp ensure theparticipationof investorstothe recapitalizationof a bank if this shouldbecomenecessary.Solvency ii
  34. 34. P a g e | 34Such designatedbail-in instrumentswouldclarifythehierarchyof debtcommitmentsand allowinvestorstopredict theeventual treatment oftherespectiveinstrumentsin caseof recapitalizationor resolution.•Thegroup alsoproposed that the capital requirementson tradingassetsand real estaterelated loansbe reviewed.Both of theseasset categoriescame to have very lowrisk weightsin theBasel II regime, mostlybecausethewayinternal models wereapplied.Why banking structure matters for monetary policyLet me recapitulatemy main points.First, for monetary policy, financial stabilityis very important.While monetary policyhasproven tobeableto pursue price stability evenunder rather strainedfinancial conditions,the central banks arenot ableto insulate thereal economy completely from the after-effectsof financialcrises.Amore stablebanking sector whichis lesspronetocrisis will reducethelikelihoodof crisesand thereforeprotect thebalancesheetsof the centralbank from financial risksand therebyprotect itsindependenceandcredibility.Second, themost important part of stability policy is crisisprevention.Improvinglossabsorbencyof banks and thecrisismanagement powersof the authoritiesare necessary, but it iseven more important tomakesurethat excessivegrowthof credit and indebtednesscan be bettercontrolledin the future.In thisway, credit crunchesand banking crisescanbe made lesslikely –andmilder, should theyhappen.Solvency ii
  35. 35. P a g e | 35Third, financial stability wouldbenefit from structural reform of thebankingsystem.By separatingthe most risky securitiesand derivativeactivitiesfromdeposit banking, thespill over from deposit protection tospeculativerisktakingwouldbe prevented.This would reducethe distorted incentivestoexpand tradingactivitiesand concentraterisksin deposit banks becauseof their privilegedpositionin the deposit market.Finally, the structural reform of bankingis a complement, not asubstitutefor other regulatory improvements.For central banks, thedevelopment of macro-prudential policiesandinstrumentsis especiallyrelevant.Thosemacro-prudential instrumentswhich can be adjustedover time tomanagethe conditionsin the credit market will offer a waytobettercontrol the accumulation of excessrisk and help prevent future crises.Theseinstrumentsoperatesoclosetomonetary policy that central banksshould be very closelyinvolved, if not themselvesresponsible,indeveloping and using them.Solvency ii
  36. 36. P a g e | 36Changesin the Large ExposureRegimeCONSULTATION PAPERGUERNSEY FINANCIALSERVICES COMMISSION1:Executive Summary1.1OverviewThis paper containsfull details of theproposalstosubstantiallyalter theLargeExposure principlesand guidancethat apply to licensed deposittakersthat are incorporatedin Guernsey.It is proposedthat the new regime wouldtake effect from 1January2014.Theseproposalsincludechangestoenhancethequarterlyprudentialreporting totheCommissionand thiswouldaffect not only licenseddeposit takersincorporatedin the Bailiwick, but alsothoselicenseddeposit takerswhoseprincipal place of businessisoutsidethe Bailiwick.Thecontext for the review is that the existingPrinciple1/ 1994/ 24“Principlesand Guidancetobe followedby a locallyincorporatedlicenseddeposit takinginstitution enteringintoa largeexposure” paperpublishedby the Commissionin 1994nolonger adequatelyaddressestherisksassociated withlargeexposures,particularly thosearisingfrom thesystemic and market risks that became evident asa result of the2007/ 2008financial crisis.In respect of largeexposures,the Commission hastended to be a“pragmatic” supervisorrather than a rigid standard basedsupervisor,and, it hasfrom timeto time allowedsuitablycollateralisedlargeexposuresin excessof 25% of net capital base.Solvency ii
  37. 37. P a g e | 37Given that anychange to a more restrictiveapproach may have abusinessimpact on licenseesthe Commission feelsthat it isappropriatetoseek theviewsof industry.The Commission is proposing to retain several elements of its pragmaticapproach and in seeking the views of industry it will be open to bilateraldiscussionswithlicenseesabout particular types of exposures.2. What is proposed?Thesubstantivechangesbeing proposed in updated guidanceare asfollows:- Exposurestocentral governmentsand market loansof lessthan 12months‟maturity, whichare exempt from the current largeexposureregime, will be deemedtobe largeexposuresunder the new regime.- Thecurrent upstreamingregime will changeto expressagreedexposure limitsto parent/ group banksasa proportion (i.e. %) ofcapital baserather than aproportion of assets.Theupstreamingregimewill includeon balancesheet and off balancesheetexposures.- Exposurestothird party bankswill normallybe limitedtoamaximum of 100% of net capital base and will comprise cashplacements,holdingof debt instrumentsand off balancesheetexposures.Themaximum proportion (%) of exposure will bedetermined accordingto the rating of thethird partybank, althoughlimited flexibilitywill be permittedin the caseof exceptional short-term excesses.- In relationto exposuresto sovereigns,the concept of ZoneAandZoneB countrieswill be replaced withtwodifferent OECD-basedgroupings- High IncomeOECD countries and other countries.Solvency ii
  38. 38. P a g e | 38Exposureswill be capped at a maximum of 1000%of net capital baseand will be determinedaccordingto the ratingof the sovereign.- Exposurestoclientsor groupsof connectedclientswill be capped ata maximum of 25% of net capital base, unlessthe exposure issecuredbycashand/ or High Income OECD government securities, or theexposure issubjecttoa parental guarantee(whichin itselfwouldneed to be includedin any upstreaminglimit).Sub-participationagreementsthat transfer credit risk off thebalancesheet of the Guernseybank will alsobe considered.- Better definition of what constitutes“connectedclients”will beprovided.- Theprudential reportingformswill be changed tobetter capturelargeexposuresthat have not previouslybeen reported; e.g. holdingsof debt that equatetomore than 10% of a bank‟snet capital base.In accordancewithexpected international developments, theCommission alsoproposestocapture thetop twenty, rather thanthecurrent top ten, largest exposures.Brancheswill be askedtoreport similar details,but in termsof theirparental capital, sothat data on any significant credit concentration riskin a branch in Guernseythat may impact on a head office elsewherecanbecollected.- Breachesof largeexposure limitswill be a reportable event. TheCommissionisproposinga staged approach todealing withexposuresthat cannot be regularised.- The800% aggregatelimit on exposureswouldbe retained, butexposurestoGroup, to third party banks and tosovereignswouldbeexcludedfrom thisaggregate.Solvency ii
  39. 39. P a g e | 39- Largeexposuresexistingprior tothe intendedeffectivedate for thenew regime of 1January 2014wouldbe grandfatheredin.1.3 Rationale for changeThe large exposure regime is all about capturing concentration risk andit is covered by s24 of The Banking Supervision (Bailiwick of Guernsey)Law, 1994.Conventional wisdom, asdictatedbythe Capital RequirementsDirectiveandthe Basel Core Principlesfor EffectiveBanking Supervision, statesthat no exposure toa client or connected group of clientsshould equatetomore than 25% of net capital.Short term interbank exposureshavehistoricallybeen exempt from thisrequirement.Our current environment reflectstheseexemptionsand alsopermitsexposurestoclientstoexceed the 25% limit.Whilst pure concentrationrisk to singleobligor counterpartieswasnotseen asa majordirect contributor tothe2008financial crisis,nonethelesselementsof concentration risk wereseen asindirect contributors.Interconnectednesswithin and betweengroupswereseen asmagnifiersof some exposures and concentrationsthroughsectoral exposurestoparticular economicsectors(e.g. the Irish property development sector)affected credit assessmentsof many organisations.That said, the guidanceon largeexposuresremainshistoricin nature;theBasel Committee guidanceon measuring and controllinglargeexposuresdatesback to1991,and our ownlocalregime hasnot beensignificantlyupdated since1994.However, there havebeen substantial changestothe EU largeexposureregime.Solvency ii
  40. 40. P a g e | 40Thesesubstantial changeshave their origin in late2007and early2008, when theCommitteeof European Banking Supervisors(CEBS), whichhassincebecome theEuropean BankingAuthority, reported totheEuropean Commission onthe effectivenessofthelargeexposureprovisionsof the Capital RequirementsDirective.Thereport concluded that market failuresassociatedwith systemic riskand moral hazard applied tointerbank exposuresregardlessof maturity.Accordingly, thelargeexposure regimefor EU member stateswasrevisedwitheffect from December 2010totighten largeexposurelimits,particularlyin relationto interbank and intra-grouplending, whichtheEuropean Commission agreed wasa major systemicrisk in the wakeof the financial crisis.Under the revised EU regime, short term loanstobanks areno longerexempt and whilst limitednational discretionis availabletomemberstatesin relationtointra-group lending, loanstothird partybanksarenow capped at 25% of net capital, unlessthe lendingbank is very small.In reality, by the timethe changestotheEU regime came along, marketpracticehad alreadychangedtoreflectthis more cautiousapproach tointerbank lending.It is worthnoting that the CEBSconclusionswerealsoreflectedin theUK Government‟s responsetothe report on banking reform by theIndependent Commission on Banking (“the VickersReport”).TheHM Treasury whitepaper “BankingReform – deliveringstabilityand supporting a stableeconomy” publishedin June 2012 envisagesthelimitingof a ring-fencedbank‟sexposure to financial institutionsinorder to prevent systemic shocks.ClearlyGuernseyis not in the EU, but neverthelesswewouldnot wishtobea completeoutlier in respect of largeexposures.Solvency ii
  41. 41. P a g e | 41TheBasel Core Principlesfor EffectiveBankingSupervision do givethesupervisorsome latitudein permitting “minor deviations”from the 25%limit, but the economicclimatethat hasprevailed for all but the last fewyears combinedwiththe Commission‟swishtobe a pragmatic regulatorhasmeant that these“minor deviations”havebeen permittedmorefrequentlyin thepast than isarguablynow prudent in the currenteconomicand regulatoryclimate.Theguidance however, remainsthe same and a changeis needed tomanageexpectationsand formalise a prudent approach.In developing proposalsfor a new largeexposureregimetheCommissionhashad regard toa number of other regimes, includingthoseoperatingin theUK and the other Crown Dependencies.None of theseare a good fit in their entirety for the type of bankingbusinessdone in and from within the Bailiwick.The Commission has therefore tried to balance the requirements of otherregimes against the type of banking business that exists in theBailiwick, recognising also the intra-group funding that many licenseesprovide.1.4 Who would be affected?Licensed deposit takersthat are incorporatedin Guernseywouldbethoseprincipallyaffected, given that limitson exposuresarebeingproposedin relation to capital.However, the proposed revisions to the large exposure regime includeenhanced quarterly prudential reporting for all licensees and brancheswouldthereforebe affectedby thesechangestothe BSL/ 2 reports.The CommissionTheGuernsey Financial Services Commission is the regulatorybody forthefinancesectorin theBailiwick of Guernsey. TheCommission‟sSolvency ii
  42. 42. P a g e | 42primaryobjectiveis toregulateand supervise financial servicesinGuernsey, with integrity and efficiency, and in sodoing help toupholdtheinternational reputation of Guernsey asa financecentre.Tolearnmore:http:/ / Banking/ News/ Documents/ Consultation%20paper%20for%20Commission%20website.pdfSolvency ii
  43. 43. P a g e | 43Adjustment and growth in the euroareaSpeech by Mr Peter Praet, Member of theExecutive Board of the European CentralBank, at the European BusinessSummit, Brussels, 16May2013.IntroductionThank you very much for invitingme tospeak at this conferenceof the EuropeanBusinessSummit.Thethemeof my addresstoday is“Adjustment and Growth in the EuroArea”.This is a titlethat, to some, may sound contradictory.Many of you will have come acrosscommentatorswhoclaim thatadjustment is in fact inimical togrowth;and that consolidatinggovernment budgetswhileintroducingstructural reformsisthe maincauseof our current difficulties.Yet, in my view, thisis a short-sightedassessment.While it is clearthat fiscal consolidationhasaffected economic activityin theeuro area in theshort-term, it doesnot followfrom thisthatadjustment and growth are incompatible.Restoringthe sustainabilityof publicfinancesand implementingwell-designedstructural reformsare key to restoring confidence.Solvency ii
  44. 44. P a g e | 44Measuresthat are now beingundertakenhelp tolaythe foundationsforfuturegrowthand bring back a climate of confidencealreadyin theshort-term.First, by prioritisingfiscalconsolidation, euro area countriescan anchormedium-term expectationsabout public debt sustainability, whichisessential to support confidenceamong investorsand taxpayers.As many euro area countriesalreadyhave high public debtlevels,and some have seentheir market accessthreatened, crediblefiscalconsolidationensuresthat debt can be refinancedat affordableratesinthefuture, and fiscal crisesavoided.Moreover, if consolidationisfocused to the greatest extent possibleonunproductiveexpenditureitemsrather thanthose, like investment, thatare conducive tolong-term growth, thenegativeeffectson growthcan becontained.Second, by implementingstructural reforms, euro area countries shouldraisetheir future growthpotential.Researchhasshownthat a comprehensive packageof product andlabour market reformscould significantlyincreaseeuro area output – bymore than 4.5% over 5 years, accordingtoa recent IMF study.This improved outlook, whenincorporatedintomedium-termexpectations,shouldencourage forward-lookingfirmsto increaseinvestment, and could hencelead to higher growthalsoin theshort-term.Such reformsshould be undertaken withdue protection of the mostvulnerable membersof society.Thekey point is that for adjustment and growthtobe mutuallysupportive, the commitment to reform hasto be credible.Solvency ii
  45. 45. P a g e | 45Investors,firmsand householdshave to be convincedbeyond doubt thatgovernmentswill staythe course.If theyfear policy commitmentsmay bedelayed or reversed in thefuture, they will neither besufficientlyconfident in the sustainability ofpublic financesnor in future growthpotential toalter their behaviourtoday.“Wait-and-see” will remain the rational responseand short-term growthwill lagbehindpotential.In other words,proposingtoreversecourseon fiscal and structuralreforms doesnot support growth.In fact, it onlyweakenscredibilityand henceunderminesthehard workthat hasalreadybeen done toput theeuro area on a surer footing.For theremainder of my remarks, I wouldlike to first review the ongoingprocessof adjustment acrossthe euro area and what hasbeen done bynational authorities, and the ECB actingwithin itsprice stabilitymandate, to facilitatethat process.Thereafter, I will put forward some suggestionsfor what remainstobedone by euro area governmentsto ensurea return to growthasspeedilyaspossible.1. Restoring growth and employment in the euroareaLet me begin by reviewingthe economic situation.Euro area real GDP still remainsabout three percentagepointsbelow itspre-crisispeak, although thisaggregate figure hidessome divergence.For thegroup of countrieswhich are still under some financial stress(Greece,Spain, Ireland, Italy, Portugal, Cyprusand Slovenia), real GDPremainsnear thetrough of the crisisreachedin 2009.Solvency ii
  46. 46. P a g e | 46Other euro area countries, however, had by 2011alreadyrecoveredthepreviousmaximum level of real GDP.Thesame is true of labour markets.Theemployment rate in the euro area asa wholeis still more than twopercentagepointsbelow its peak, accordingtoOECD figures.However, Germanyhasincreased itsemployment rate by more thanthreepercentagepoints(to73.1%) while, at theother extreme, Greecehasseen its employment ratedroppingby more thanten percentagepoints(to50.1%).Youth unemployment ratesin a number of stressed countries alsoremain unacceptablyhigh.Looking forward,weexpect the euroareaeconomy toresumegrowthata modest pacelater in 2013,although it will take more timefor this tofeed through intohigher employment.Why isgrowthnot rebounding more quicklyand evenlyacrossthe euroarea?Akey explanationisthat the adjustment processhasbeen hinderedbyadversefeedback loopsresultingfrom the interactionof accumulatedfiscaland macroeconomic imbalances, weakbank balancesheetsandthelack of a genuinely European approach tobank resolution andrecapitalisation.Togive just one exampleof such interactions,largefiscal imbalancesina Member State can lead financial marketstodriveup yieldson itssovereigndebt.This in turn createshigher fundingcostsfor itsdomestic banksandreduces their profitability, therebyhamperingcredit growthtothe realeconomy.Solvency ii
  47. 47. P a g e | 47Lower credit growththen contributesto lowernominal GDP, whichnotonlyfurther weakensbanks‟balancesheetsby increasingnon-performing loans,but alsoincreasesconcernsabout the sustainability ofsovereigndebt through the denominator effect;and thus, the feedbacklooprestartsagain.Without a European approachto banking sectorrepair, if the sovereignintervenesto break the feedback loop byrecapitalisingor resolvingbanks,it may only heightenmarket concerns about itsdebtsustainability and aggravatethesituation.a. Actions by governmentsAddressing such adversefeedback loopsbetweengovernmentfinances,credit and growth impliesa triplepolicyresponsefromgovernments:First, fiscal consolidationand current account rebalancingtosecurepublic debt sustainability and lowerexternal financingneeds.Second, structural reformsto increasepotential growthand offset thepotential negative effects of fiscal consolidation.Third, comprehensivebanking sector repair toacknowledgeimpairedassetsand strengthen bank balancesheets.Fortunately, in all three areastheeuro area is headingin the rightdirection.First, fiscal and macroeconomic imbalanceshaveimproved significantly:fiscaldeficitshavedeclinedfrom their 2009peaksthroughout the euroarea based on sizeableconsolidation effortsand despitestrongeconomicheadwinds,while there hasbeen a pronounced reduction of currentaccount deficits.However, thesesizeableflowadjustmentshavenot yet fullytranslatedintoimprovementsin theaccumulatedstock of imbalances– public debtSolvency ii
  48. 48. P a g e | 48ratios on the fiscal side, net internationalinvestment positionson themacroeconomicside– becauseof depressednominal GDP growth.Most EU countries made significant progresstowardsfurther reducingbudgetaryimbalancesin 2012,in an environment of weakerthanexpectedoutput growth.Theeuro area government deficit hasdecreasedto 3.7% of GDP (3.1% ofGDP excludingone-off government support for financial institutions).In 2013,the Commission expectstheeuroarea deficit toreach 2.9% ofGDP – i.e. below theMaastricht referencevalue.This level wouldbe lessthan half the peak reached in 2009(6.4% ofGDP), and it putstheeuro area asa wholeon track tocomply withthecommitment madeby G-20leadersin Torontoin 2010to halve fiscaldeficitsby 2013.It hastobe stressedthat correctingfor theeffectsof the weakcycle thefiscaladjustment hasbeen even larger than suggestedby thesefigures.Progresswithfiscal consolidation hasbeen particularlystrong incountriessubject toan economicadjustment programme.Theprimary structural deficit (cyclically-adjusteddeficit net of interestpaymentsand net of one-off factorsand temporarymeasures) asa ratioof GDP over the period2009–2012hasfallenby around 14percentagepointsin Greece, 6 percentagepointsin Portugal and 4percentagepointsin Ireland.Thetrue adjustment effort is likely tohave been even larger thanthesenumberssuggest due to significant revenueshortfallsin a context ofrebalancingfrom (tax-rich) domestic demand towards(taxpoor) exports.This rebalancinghasalsobeen associatedwithsignificantimprovementsin current account positions.Solvency ii
  49. 49. P a g e | 49Current account deficitsfell on averageby 10 percentagepointsofGDP in Greece, Ireland and Portugal from 2008–2012,and by 8percentagepointsof GDP in Spain over the same period.Second, the euro area witnesseda renewedmomentum toimplementstructural reforms.It hasbeen well-understoodby euro area countriesthat restoring fiscalsustainability must rest not onlyon fiscal adjustment to achievesizeableprimarysurpluses,but alsoon measuresto revive growthtoavoidadversesnowball effectsundoing thedebt-stabilisingimpact of primarysurpluses.This requiresstructural reformsthat improve labour market and productmarket functioningand henceincreasepotential growth.There arenumerousstudies, for instanceby theOECD and theIMF, showingthesignificant benefitsin termsof employment and growththat could accrueto theeuro area from such measures– and not only inthemedium-term.Acrediblecommitment by euro area governmentstoimplementstructural reforms could alreadycreatea permanent upwardshift inexpectationsof futuregrowth, improve labourmarket performance, andasa welcomeside-effect, improve thehealth of public financesover themedium-term.And to a certainextent, this iswhat weare seeingin theeuroarea today.As regardslabour market reforms, several euro area countrieshavemovedtowardsa negotiatingframeworkfor wagesand workingconditionsbased more on firm-level agreements.This should enhancecompetitivenessby promoting a closerlinkbetweenwagesand productivityand, at thesame time, allowfirms torapidlyadjust their internal organisationof labour and production inresponseto changingeconomic conditions.Solvency ii
  50. 50. P a g e | 50In addition, labour market functioninghasbeen strengthenedbyaddressingdistortionsrelatedtothe“two-tier” systemsthat characterisea number of euro area economies – in particular Spain and Italy.Thesemeasuresshould support social fairnessby bringingto an end thesituation wherevulnerable temporaryworkers,mainlyyoung people, defactobear the full burden of theadjustment.Moreover, theyshould increasepotential growthby improvingtheemployment conditionsof young workersand their relativelyloweropportunitiesfor on-thejob training, whichsignificantlyhampershumancapital formation; and by reducinginefficient labour turnover, sincefirmswouldbe lessreluctant to transform temporaryjobsinto permanent ones.At the same time, to reduce unemployment trapsand createincentivesfor job-seeking, welfaresystems arebeingreformed soastoshift from asystem providing security“onthe job” tooneproviding income support“in themarket”, whilesettingup strict eligibilitycriteria and a system ofactivelabour market policies.Together with theselabour market measures,reform effortshavefocused on increasingcompetitionin a number of sectors,includingretail and wholesale,transport, energy, and professional services;reducingthe administrativerequirementsto set up or expandbusinesses;and improvingtheefficiencyof civil justice and publicadministration.Third, euro area countrieshavetaken a series of measurestoaddressbalancesheet weaknessesin the bankingsector.Capital requirementsare in the processof being strengthened followingtheconclusion of theCapital RequirementsIV Directive, whichtransposesthe BaselIII agreement intoEU law.At the same time, a number of banksraisednew capital to addressbalancesheet weaknesses.Solvency ii
  51. 51. P a g e | 51Thegreatest progressin financial sector repair hasof coursetaken placein thecountriesunder EU-IM F programmes,wherethere hasbeen acomprehensiverestructuringand recapitalisationof the domesticbankingsectors.Spain hasalsotakendecisivemeasurestoaddressthe imbalancesof thepast via itsESM indirect bank recapitalisationprogramme.b. Actionsby the ECBWhat is the role of theECB in this process?While theECB hasconsistentlyplayed itspart and maintainedpricestability in the euro area, it is important tokeep in mind that therole thatthecentral bank can play in termsof crisis resolution is limited.TheECB‟smonetary policy can onlyplaya crisismitigationrole.Hence, our monetary policy approach hasfocused on providingliquiditysupport, intended to relieve banksof liquidityand funding stressbygivingthem unlimitedaccessto central bank money at a fixedpriceagainst adequatecollateral.Tofacilitatethis support, weexpanded the set of eligible assetsthat canbeused ascollateraland extended thematurityof our lending.It is widelyrecognisedthat thesemeasureshave been effectiveinavertinga disorderlyspiral of deleveragingin thebankingsystem, whichwouldhave taken place in an environment of severe liquidityconstraintsand fire sales.This wasnecessaryin order toavoid deflationarydownwardpressuresthat wouldhaveprevented usfrom deliveringon our mandate ofpreservingprice stability in theeuro area.Solvency ii
  52. 52. P a g e | 52However, to mitigatethe crisiswehave alsohad togobeyond liquiditysupport, in particular tocounter financial fragmentation in the euro area– created by the adverse feedback loopsI described above– that wasdisruptingthe transmission of monetary policy acrosstheeuro area.Divergingcredit conditionsbycountries,by sectorsand by size ofcompanies have prevented the ECB‟s very accommodativemonetarypolicy stancefrom beingpassedon evenlyin the financingconditionsfaced by euroareafirms and households.As the euro area economyreliesheavily on bank credit, thishasseriousimplicationsfor growthand ultimatelyfor our abilitytomaintain pricestability.In particular, in the first half of last year weperceiveda situationlastyearwheresevere upward pressureon sovereignyieldswasbeing drivenbyunfounded fearsabout thefuture of the euro area.Thesefearswerecausing investorstochargerisk premia to lend tosomeMemberStatesthat could not be justifiedby economicfundamentals.We thereforedecided toopen the possibility of undertaking OutrightMonetaryTransactions(OMTs), entailingex anteunlimitedinterventionsin short- tomedium-term securitiesissued by governmentswhichhavesubmitted to strict and effectiveconditionality, in order to eliminate thepricingof un-warrantedtail risksin the bond markets.This hasplayed an important role in reducingfinancial marketfragmentation, asfinancial marketsunderstood OMTsasa crediblebackstop for counteringredenominationrisk.2. What remains to be doneThesemeasuresbythe ECB, however, can onlybuy time; theycannotsubstitutefor the responsibilitiesof national governmentsto addresstheSolvency ii
  53. 53. P a g e | 53unsoundfiscal,economicand financial policiesthat are the root causesof the crisis.And while a great deal has already been done by euro area authoritiestoaddresstheseroot causes,there arethree areasin whichmore progressstill needstobe made.First, the euro area needstocontinuetodeepen structural reforms aimedat enhancingcompetition, flexibility, efficiency, and productivity.Thereform processtakestime, and soa medium-term, comprehensiveapproachiscrucial toanchor expectationsand maximisethe positiveeffectsof adjustment in theshort-term.Thegreatest challengetodayis tomaintain reform momentum andimplement fullythosechangeswhichhavealready been announced oreven enacted intolaw.Concretely, this means, for the labour markets, addressing the remaininginsider-outsiderdualitiesand enhancinglabour mobility, includingacrossborders.For product markets, the key challengeisto openup regulatedprofessionsand networkindustriesthat are shelteredfrom competitionbygovernment regulations.This requiresa simplificationand streamliningof regulations, areduction of barriersto entry and limitstocompetition, a resolutedeepeningof theSingleMarket in Europe.Going forward, structural reformsalsoneed to gointothe governmentsector itself.In several euro areacountries, modernisation of public administration isessential to increaseefficiencyin the provisionof public goods,likeinfrastructure,and essential services, likecivil justice.Solvency ii
  54. 54. P a g e | 54This will alsosupport fiscal consolidation, by reducingthe size of thegovernment sector.Second, the euro area needstoperseverein fiscal consolidation effortsand reducesteadily thegovernment debt ratio.Despitethe important progresson fiscal consolidation, debt ratioshaveyet failed to stabilise in most euro area countries,asimprovementsinprimarybalanceswereoutweighedbythe debt-risingimpact ofunfavourabledevelopmentsin interest-growthdifferentialsand deficit-debt adjustments.Theeuro area government debt ratio isprojectedtorise further toabove95% of GDP in 2013– far abovethe 60% Maastricht referencevalue– withdebt ratiosdisplaying largedifferencesacrosscountries.Further adjustment isthus inevitable,and unfortunately it must takeplacein an environment of rising consolidation fatigue.Fiveyears intothe crisis thisrise in consolidationfatigue isunderstandable.Going forward,it will be important for policymakersto communicateeffectivelyboth on the need for further adjustment and how thisadjustment will be distributedin an equitablewayacrossdifferentgroupsof the population.In thiscontext, it is necessaryto review consolidationstrategiesthat havereliedpredominantlyon tax rateincreases,exacerbatingthe burdenonalreadycompliant taxpayers, without much broadeningof thetax bases.Such an approach hashad substantial negativeeffectson disposableincome and demand, at thesame time raisingresistanceand negativereactionsin theelectorate,basedon inter-temporaluncertaintyandfairnessconsiderations.Due protection of themost vulnerableis needed here.Solvency ii
  55. 55. P a g e | 55On theexpenditure side, adjustment hasrelied disproportionallyon cutsin government investment, therebyweakeningthe prospectsfor long-term growth.Going forward, thereis a needto focusadjustment on unproductiveexpenditurewhile asfar aspossiblesafeguarding governmentexpenditurethat is conducivetolong-term growth.Third, the euro area needstopressahead withconstructinga genuineBankingUnion.Afirst and important stephasbeen made withthe decision tocreatetheSingleSupervisoryMechanism(SSM), the responsibilityfor which wasassignedto theECB.Political agreement by the ECOFIN Council and theEuropeanParliament wasreached on a legislativepackagein March, and technicalagreement isexpectedvery soon, sothat national parliamentaryproceedingscan start, whichshould be concluded by the summer.Theexistenceof theSSM, by reducingregulatory captureand increasingsupervisoryconsistencyand coherence, should play an important role inincreasingconfidencein the overall euroarea banking system, and asaresult, reduce fragmentation of interbank and other financial markets.However, for the Banking Union to be fullyeffective,a SingleResolutionMechanism(SRM) toaccompanytheSSM is essential.This is thecasefor a number of reasons.First, an SRM would allow for the euro area to complete the process ofbanking sector repair without aggravating market concerns over publicdebt sustainability, which would help break the adverse feedback loop Idescribedabove and restorethefunctioningof the credit channel.Second, thisconfidencein EU level resolution capacitywouldensurethat the SSM can be a crediblesupervisor, asit wouldbe abletopushSolvency ii
  56. 56. P a g e | 56non-viablebankstowardswindingdown without endangeringfinancialstability.Third, an SRM would facilitate speedy and effective resolution of largeand complex cross-border banks, removing the need for drawn-out andinefficient cooperationbetweenmultiplenational authorities.Togeneratethesebenefits,in our view theSRM must be built around aSingleResolutionAuthority and a European Resolution Fund.ConclusionLet me nowconclude.Theongoing processof adjustment in the euroarea, if perseveredwith, will createa path out of the crisis.There is no doubt that thispath is a challengingone, asit dependsondeeprootedreformstothe structure of theeuro area‟seconomies,andtheserequire courage to implement and a willingnessto confront vestedinterests.But it is critical that governments stay the course, as this will allow theconfidence effects of a brighter outlook to start being felt already in theshort-term.For itspart, the ECB will continueto fulfil its mandate to maintainpricestability, and touseitsstandard and non-standard measurestosupporttheflow of credit to the real economy.But one must alsorecognisethe limitstowhat weasthe central bankcan achieve.We cannot remove barriers to bank lendingthat stem from insufficientcapital or lack of bank repair: thesecan onlybe addressedbygovernments.Solvency ii
  57. 57. P a g e | 57This is whyestablishinga Banking Union with a strong SingleResolution Mechanismis a priority.I am gladthat the elementsof a Banking Union are beginningto fall intoplace.Aswift implementation of the remaining elementsisneeded.Significant progresshasbeen made on fiscal consolidationandstructural reform.Looking ahead, credibilityis crucial.Therefore, I welcomethe stronger rulesfor fiscal and macroeconomicpolicieslike theFiscal Compact.All theseongoing important adjustment effortsin the euro areashouldrestoreconfidencein the short-term and lead steadily back tosustainablegrowth.Thank you for your attention.Solvency ii
  58. 58. P a g e | 58DisclaimerThe Association tries to enhancepublic accessto information about risk andcompliancemanagement.Our goal is to keep this information timely and accurate. If errorsarebrought to ourattention, wewill tryto correctthem.This information:- is of a general nature only and isnot intended to addressthe specificcircumstances of any particular individual or entity;- should not be relied on in the particular context of enforcement or similarregulatoryaction;- is not necessarily comprehensive, complete, or up to date;- is sometimeslinked to external sites over which theAssociation has nocontrol and for which theAssociation assumesno responsibility;- is not professional or legal advice (if you need specific advice, you shouldalwaysconsult a suitably qualified professional);- is in no wayconstitutive of an interpretative document;-doesnot prejudge the position that the relevant authorities might decideto take onthe same mattersif developments, including Court rulings, wereto lead it to revisesomeof the viewsexpressedhere;-doesnot prejudge the interpretation that the Courts might place on themattersat issue.Pleasenote that it cannot be guaranteed that these information and documentsexactly reproduce officially adopted texts.It isour goal to minimize disruption causedby technical errors.However somedataor information mayhave been createdor structuredin filesor formats that are noterror-free and wecannot guaranteethat our service will not be interrupted orotherwiseaffectedby such problems.The Association acceptsno responsibility with regard to such problemsincurred asaresult of using this site or any linked external sites.Solvency ii
  59. 59. P a g e | 59Solvency II SpeakersBureauTheSolvencyII Association hasestablishedthe SolvencyII SpeakersBureau for firmsand organizationsthat want to accesstheexpertiseofCertified Solvencyii Professionals(CSiiPs) and Certified SolvencyiiEquivalenceProfessionals(CSiiEPs).TheSolvencyII Association will be theliaison betweenour certifiedprofessionalsand theseorganizations,at no cost. We stronglybelievethat this can be a great opportunity for both, our certified Solvency_II_Speakers_Bureau.htmlSolvency ii
  60. 60. P a g e | 60Course TitleCertified Solvency ii Professional (CSiiP):Preparing for the Solvency ii Directive of the EU (3 days)Objectives:This coursehasbeen designed toprovidewiththe knowledgeand skillsneeded to understand and support compliancewiththeSolvencyiiDirectiveof theEuropean Union.TargetAudience:This course isintendedfor decision makers, managers, professionalsand consultantsthat:A.Work in Insuranceor Reinsurancefirmsof EEAcountries.B.Work in Groups- Financial Conglomerates(FC), Financial HoldingCompanies(FHC), MixedFinancial Holding Companies(MFHC), InsuranceHolding Companies(IH C) - providing insuranceand/ orreinsuranceservicesin theEEA, whoseparent islocatedin acountry of theEEA.C.Want tounderstand thechallengesand the opportunitiesafter theSolvencyii Directive.This course ishighlyrecommendedfor supervisorsof EEA countriesthat want to understand how countriesseeSolvencyII asa CompetitiveAdvantage.This course is also recommended for all decisionmakers, managers, professionalsand consultantsof insurance and/ orreinsurancefirmsinvolved in risk and compliancemanagement.Solvency ii
  61. 61. P a g e | 61About the CourseINTRODUCTIONTheEuropean Union‟sLegislativeProcessDirectivesand RegulationsTheFinancial ServicesAction Plan (FSAP) of theEUExtraterritorialApplication of European LawExtraterritorialApplication of the SolvencyII DirectiveSolvencyii and theLamfalussyProcessLevel 1: FrameworkPrinciplesLevel 2: Detailed Technical MeasuresLevel3: StrengtheningCooperationAmong RegulatorsLevel 4: EnforcementWeaknessesof SolvencyIFrom SolvencyI toSolvencyIISolvencyii PlayersSolvencyii ObjectivesTHE SOLVENCY II DIRECTIVEAUnified LegislativeBasisfor Prudential Regulation of InsurersandReinsurersRisk-BasedCapitalAllocationScope of theApplicationImportant DefinitionsValue-at-Riskin SolvencyIIAuthorisationCorporateGovernanceGovernanceFunctionsRiskManagementCorporateGovernanceand Risk Management - Level 2Fit and proper requirementsfor personswhoeffectivelyrun theundertakingor haveother key functionsInternal ControlsSolvency ii
  62. 62. P a g e | 62InternalAuditActuarial FunctionOutsourcingBoard of Directors:Role and Solvencyii Responsibilities12Principles– System of Governance (Level 2)PILLAR 2SupervisoryReview Process(SRP)Focuson Risk Management and Operational RiskOwn Risk and SolvencyAssessment (ORSA)ORSA- TheInternal Assessment ProcessORSA- TheSupervisoryToolORSA- Not a Third Solvency Capital RequirementCapital add-onPILLAR 3DisclosureRequirementsTheSolvencyand Financial Condition Report (SFC)PILLAR IValuationOf AssetsAnd LiabilitiesTechnicalProvisionsTheSolvencyCapital Requirement (SCR)TheValue-at-RiskMeasureCalibratedtoa 99.5% ConfidenceLevel over a 1-year Time HorizonTheStandardApproachTheInternal ModelsTheCollectionofAdditional HistoricalDataExternal DataThe Minimum Capital Requirement (MCR)Non-CompliancewiththeMinimum Capital RequirementNon-CompliancewiththeSolvencyCapital RequirementOwn FundsInvestment RulesSolvency ii
  63. 63. P a g e | 63INTERNAL MODEL APPROVALCEIOPSLevel 2 - Testsand Standardsfor Internal ModelApprovalCEIOPSLevel 2 - The procedure tobe followedfor theapproval ofan internal modelInternal ModelsGovernanceGroup internal modelsStatistical qualitystandardsCalibrationand validationstandardsDocumentation standardsSOLVENCY II, GROUP SUPERVISION AND TH IRD COUNTRIESSolvencyI: SoloPlusApproachGroup Supervisionunder SolvencyIIRightsand dutiesof the group supervisorGroup Solvency - Methodsof calculationMethod1(Default method):Accounting consolidation-basedmethodMethod2 (Alternative method): Deduction and aggregationmethodParent UndertakingsOutsidethe Community - Verification ofEquivalenceParent UndertakingsOutsidethe Community - Absence ofEquivalenceThehead of thegroup isin theEEA and the third country regimeis not equivalentThehead of thegroup isin theEEA and the third country regimeis equivalentThehead of thegroup isoutsidethe EEAand the third country isnot equivalentThehead of thegroup isoutsidethe EEAand the third countryregimeisequivalentSmall and Medium-SizedInsurers:TheProportionalityPrincipleCaptivesand SolvencyIISolvency ii
  64. 64. P a g e | 64EQUIVALENCE WITH SOLVENCY II AROUND THE WORLDSolvencyii and Countriesoutsidethe European EconomicAreaTheInternationalAssociation of InsuranceSupervisors(IAIS)TheSwissSolvencyTest (SST) and Solvencyii:Solvencyii and theOffshoreFinancial Centers(OFCs)Solvencyii and theUSASolvencyii and theUS NationalAssociation of InsuranceCommissioners(NAIC) - The Federal InsuranceOffice createdunder the Dodd-Frank Wall Street Reform and ConsumerProtectionAct in theUSA, and the ORSAin theUSAFROM THE REINSURANCE DIRECTIVE TO THE SOLVENCY IIDIRECTIVEDirective2005/ 68/ EC of 16November 2005on Reinsurance- TheReinsuranceDirective(RID)CLOSINGTheImpact of Solvencyii OutsidetheEEAProvidingInsuranceServicestotheEuropean ClientCompeting withBanksLearningfrom theBaselii FrameworkRegulatoryArbitrage:AMajorRisk for Countriesthat seeComplianceasan Obligation, not anOpportunityBasel II, Basel III, SolvencyII and RegulatoryArbitrageChallengesand Opportunities:What is nextRegulatoryShopping after SolvencyIITolearnmore about Certified_Solvency_ii_Training.htmSolvency ii
  65. 65. P a g e | 65Solvency ii