Solvency ii News December 2012

Solvency ii Association
1200 G Street NW Suite 800 Washington, DC 20005-6705 USA
Tel: 202-449-9750 www.solvency-ii-association.com

Dear member,

We will start from a very interesting
speech:

Gabriel Bernardino
Chairman of EIOPA
EIOPA – Reflecting on the
achievements and preparing for the new challenges

Distinguished Guests, Ladies and
Gentlemen,

On behalf of EIOPA, I am delighted to
welcome you to our second Annual
Conference here in the Frankfurt Congress
Center.

In particular it is my pleasure to welcome all our panellists and
moderators.

I want to thank you all for coming and contributing to make this one of
the reference conferences in the insurance and pension’s landscape.

I would also like to thank the City of Frankfurt and the State of Hessen,
for their welcome and support.

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www.solvency-ii-association.com

EIOPA greatly enjoys being here in a city which is continuousl y gaining
global importance as a focal point for regulation and supervision of the
financial system.

I look forward to continuing in a spirit of enhanced co)operation in the
future.

We are happy to keep this tradition of annual conferences.

For us this is a very important way to maintain a constructive dialogue
with the insurance and occupational pensions stakeholders – to find out
more about your concerns, challenges and of course to answer your
questions.

The annual conference also represents a perfect opportunity for EIOPA
to update you on our activities, on the achievements and the upcoming
challenges.

I am pleased to see that many members of the EIOPA Board of
Supervisors and Stakeholder Groups are also attending the conference
and I am sure that they are going to contribute to all the formal and
informal discussions that will take place today.

I hope that all together we will make this day interesting and fruitful.

In my opening speech today I will share with you some thoughts about
the issues at stake in each of the panel discussions and I will provide a
short reflection on the achievements of EIOPA and some of the
challenges ahead.

Let me start by the Conference programme, which as usual reflects some
of the most relevant issues that EIOPA has been focused on.

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Pensions

We will start with pensions because reshaping the European pensions
system is one of the most challenging projects in the EU agenda, which
is very important for all the EU citizens without exception.

The EU Commission has launched this year a white paper called “An
agenda for adequate, safe and sustainable pensions”, identifying a
number of initiatives to be taken in the coming years.

In this document there is a clear recognition that complementary private
retirement savings have to play a greater role in securing the future
adequacy of pensions.

This poses on all of us a great challenge and an enormous responsibility.

We need to review the European pension’s regulatory framework to
improve the safety and affordability of private pensions and provide
confidence to consumers.

This should be done by developing a risk)based approach to the
regulation of retirement savings, encompassing a number of
fundamental elements:

1. A realistic valuation of pension promises

All occupational schemes throughout Europe should have sufficient
resources to meet their promises under a reasonable, but realistic and
transparent, framework.

We have abundant lessons from the consequences of ignoring the
economic based value of assets, liabilities and the inherent risks.

That is why we recommended for the IORP Directive review the
application of such principles as the market consistent valuations and

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the inclusion of the actuarial value of all enforceable obligations of the
IORP in the valuation.

Taking due account of the diversity of IORPs, we proposed the concept
of a “holistic balance sheet” that will enable the consideration of the
various adjustment and security mechanisms in an explicit way.

This will allow a better understanding of the economic value of assets
and liabilities and will give an indication of where the risk is and who
bears it.

The “holistic balance sheet” should be seen as a prudential supervisory
assessment tool rather than a “usual” balance sheet based on generally
agreed accounting standards.

2. A robust solvency regulation

The occupational pension’s solvency regime should be based on the
“holistic balance sheet” and should incorporate appropriate periods for
the achievement of the funding targets, taking into account the nature of
the promise, the duration of the liabilities and other elements like the
sponsor support.

It should also be sufficiently flexible to deal with short term volatility and
avoid pro-cyclical behaviour, for example by using a corridor approach
and allowing appropriate recovering periods.

3. An enhancement of the governance requirements

Good governance is crucial for the members and beneficiaries of the
occupational pension schemes.

It is essential that those who run IORPs are individuals of competence
and integrity, with respective education and work experience.

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IORPs should also be subject to robust internal and external controls in
areas such as risk management, internal control and audit, appointments
of a custodian and a depository.

The Solvency II principles should be applied, taken into account due
proportionality.

The regulatory framework should also give concrete incentives to good
risk management.

The use of modern risk management tools like diversification strategies
in asset allocation according to the duration of the liabilities, lifecycle
approaches, hedging techniques and protection against shortfall risks
can effectively provide sponsors and members of pension schemes better
outcomes under a risk control environment.

4. An increase in transparency

It is crucial to maintain members and beneficiaries of pension funds
duly informed about their pension rights and prospectives.

Furthermore, the move towards defined contribution (DC) schemes,
where the risk is born by the members, poses new challenges in terms of
transparency.

That’s why EIOPA’s advice recommends the introduction in the IORP
Directive of a Key Information Document (KID) to be distributed to
potential members containing a set of basic elements like risks, costs,
charges etc.

This will surely improve transparency.

EIOPA is continuing its work on the occupational pension’s area by
running a Quantitative Impact Study (QIS) exercise.

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The QIS exercise aims to assess the financial impact on IORPs of
valuing assets and liabilities in the holistic balance sheet and
introducing a solvency capital requirement (SCR) under various policy
options of the EIOPA’s Advice.

We expect to finalize the report on the QIS findings in spring 2013.

Finally, we should not forget that there is also a need to look at the
individual retirement savings in the EU.

The current framework applicable to 3rd Pillar products is very much
fragmented with a number of different vehicles being subject to different
types of EU regulations.

I believe that there are merits in developing an EU wide framework for
the activities and supervision of individual retirement savings,
containing both prudential and consumer protection measures.

Improving consumer information and protection is necessary to enhance
citizens’ confidence in financial products for retirement savings.

In this context, I believe that we should explore the development of an
“EU retirement savings product”.

This product could be developed to finance individual or collective
DC plans and should clearly differentiate from other types of investment
products by being focused on the long)term nature of their objective
(retirement savings), avoiding the traps of the short term horizon.
It should be based on a simple framework, allowing for reduced cost
structures and be managed using robust and modern risk management
tools.

It should rely on clear and transparent governance structures and
provide full transparency to its members and beneficiaries.

It should have access to a European passport allowing for cross)border
selling.
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An EU certification scheme could give to EU citizens a certainty in the
quality of all marketed “EU retirement savings products”.

In my view these products could also play an important role in the EU
economy by assuring a focus on long)term investments and, thus,
fostering the sustainable growth.

Insurance Regulation

Our second panel session is dedicated to the insurance regulation.

We called it “The Way Ahead” and I am sure that we will have a
thoughtful discussion not only on Solvency II but also on international
developments.

The European Union is faced today with an outdated and fragmented
regulatory and supervisory regime on insurance.

The Solvency I regime is not risk sensitive, contains very few qualitative
requirements regarding risk management and governance and does not
provide supervisors with adequate information on the undertaking’s
risks.

Consequently, national authorities have been introducing different
elements on their regimes in order to cope with market developments.

Solvency II was built with the objective of an increased policyholder
protection, using the latest international developments in risk based
supervision, actuarial science and risk management.
Coming back to the basics, it is fair to say that Solvency II is based on
fundamentally sound principles:

• A total balance sheet approach and a market consistent valuation of
assets and liabilities in order to have a realistic basis for assessing risks;

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• Two capital requirements, MCR and SCR, assuring a risk based
calculation but also a more robust and simpler floor designed for
ultimate supervisory action;

• An overall level of prudence for the calibration of capital requirements;

• The explicit recognition of risk diversification;

• The possibility to use internal models after a process of validation by
supervisors that is focused not only on the quality of risk modelling but
also on the actual use of the model in the day to day business decisions;

• An updated group supervision approach with the definition of a group
solvency requirement and clear powers assigned to the group supervisor;

• A robust system of governance, including the definition of a number of
key functions;

• An Own Risk and Solvency Assessment (ORSA) that is now considered
as the best practice at an international level;

• EU harmonized templates for supervisory reporting;

• Enhanced public disclosure.

In the meantime the financial crisis had a number of consequences on
the discussions on Solvency II.

Some of them were dealt early in the project, some are still creating
uncertainties on the final design and calibration of the regime.

The huge market volatility proved to be a challenge in a market
consistent regime, especially for long term guarantees.

The sovereign crisis led to questions on the concept of the risk free rate.

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The changes in banking regulation make more important the role of
insurers as providers of long-term bank funding.

The low interest rate scenario is threatening some insurance business
models.

Without diminishing all these challenges, I believe it is time to move on.

This reform is important and is needed.

In order to keep the momentum and to be consequent with all the
financial and human resources already dedicated to this project both by
supervisors and the industry we need to move forward.

So, what steps do we need to take?

In first place we need a strong commitment from the EU political
institutions towards the implementation of Solvency II.

This should prompt the definition of a clear and credible timetable based
on a realistic assessment of the expected time needed to deliver the
different milestones of the regime.

Secondly, we need to agree on a sound and prudent regime for the
valuation of long term guarantees.

A regime that preserves the risk based economic approach on the
valuation and assessment of risk and that adequately captures the
characteristics of certain long term liabilities with sufficiently predictable
matchable cash flows.

This should be viewed as an opportunity to continue to offer long term
guarantees to consumers, but under a robust framework that would price
correctly any options embedded in the contracts.

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The new regime should not work as an incentive to maintain
unsustainable practices and products that are already challenged by the
economic reality.

We welcome the role that the EU political institutions are willing to
attribute to EIOPA on the assessment of the long term guarantee
package and we hope to receive a clear mandate within the terms of
reference in order to start the assessment as soon as possible.

Thirdly, even if a credible timetable will probably point out to an
implementation date not earlier than 2016, it should be possible in an
interim phase to start to incorporate in the supervisory process some of
the key features of Solvency II.

EIOPA is exploring this possibility, based on its powers under the
EIOPA Regulation.

This interim phase should be coordinated by EIOPA in order to ensure a
consistent application throughout the EU.

Solvency II has been viewed internationally as a reference in risk based
regulation of insurance.

In that sense many countries have considered elements from Solvency II
while developing their own regimes.

The lack of certainty about Solvency II implementation is challenging
the EU credibility in the international discussions.

Financial Stability

Our third panel session will focus on financial stability and on the role of
insurers.

The crisis prompted a new look at systemic risk, including in the
insurance sector.

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The identification and regulation of Globally Systemically Important
Insurers is currently being discussed under the umbrella of the Financial
Stability Board and the International Association of Insurance
Supervisors (IAIS).

EIOPA is keen to contribute to a robust identification process of G-SIIs
and to develop appropriate regulatory and supervisory tools to deal with
their characteristics.

Traditionally, systemic risk was a banking concept.

However, the recent crisis showed us that certain activities developed
under the insurance sector can also pose systemic risk.

Insurance companies or groups that engage in non-traditional, or non-
insurance, activities (for example: CDS, financial guarantees or
leveraging assets to enhance investment returns through securities
lending) are more vulnerable to financial market developments and,
importantly, more likely to amplify, or contribute to systemic risk.

Of course, this assessment may change over time, depending on the
innovations and changes in insurance business models, especially in life
insurance, as well as in the complex interactions between insurance
groups and financial markets.

We should be especially attentive to any kind of maturity transformation
and leveraging occurring in the insurance sector.

Also extremely relevant are the policy measures under discussion.

In line with the FSB recommendations, the IAIS proposed measures on
enhanced supervision, effective resolution and higher loss absorbency.

I welcome this approach.

We need to be clear and transparent on the objectives of the framework.

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If insurance groups heavily develop their business into non-traditional or
non-insurance activities than they should expect to be treated in relation
to those businesses as if they were banks.

We need to limit any potential incentive for typical banking risks to be
transferred to the insurance sector because some stricter regulation of
systemic risk is applied in the banking sector.

As the development of the international approaches to deal with
systemic risk in insurance is closer to an end, EIOPA will proceed,
according to its regulation, and in consultation with the ESRB, with the
development of criteria for the identification and measurement of
systemic risk that may be posed by insurance, reinsurance and
occupational pension’s institutions within the EU context.

EIOPA’s achievements and challenges

Let me finalize by sharing with you some of EIOPA´s achievements and
highlight a number of challenges ahead.

In spite of the natural constrains on human and financial resources and
the huge challenges posed by the crisis, I believe that EIOPA has been
quite successful in delivering an ambitious plan covering all areas
assigned to us by the European Law.

I’ve already commented on the huge work developed by EIOPA on the
regulatory side both on insurance and on occupational pensions.

Let me now turn to supervision.

EIOPA has an enhanced role as a member of the colleges of supervisors.

We developed an Action Plan with concrete deliverables and timings for
the Colleges.

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This has clearly increased the consistency of the work of the colleges and
improved the exchange of information between supervisors.

During this crisis EIOPA has been monitoring and assessing market
developments on a permanent basis, by using efficiently the public
information available and collecting more granular information directly
from the national supervisory authorities, both through specific
quantitative and qualitative queries and by dedicated visits by EIOPA
staff.

This allowed us to reinforce the coordination of the EU supervisor’s
actions, highlight particular risks and activities that need to be further
monitored and overall to be better prepared in the case of adverse
developments.

On consumer protection, that was identified as one of EIOPA’s
priorities, I am very proud to mention that our first set of Guidelines was
developed in the consumer protection area.

The Guidelines on complaints handling by insurers fill an important
regulatory gap at the EU level and are an important step towards
promoting more transparency, simplicity and fairness in the market for
consumer financial products and services.

Furthermore we issued a Good Practices Report analyzing the disclosure
and sale of variable annuities that identifies how consumer interests can
be better protected as regards the sales of this type of complex products.

We have also published an initial overview of consumer trends in the
European insurance and occupational pensions sectors, identifying three
key consumer areas that are presently subject to further review and
analysis:

(1) Consumer protection issues around payment protection insurance;

(2) Increased focus on unit-linked life insurance products and

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(3) Increased use of comparison websites by consumers.

On financial stability, I want to emphasize the development and
publication of EIOPA’s risk dashboard containing a set of quantitative
and qualitative indicators that help to identify and measure the evolution
of risk in the EU insurance market.

EIOPA has also run a low-yield stress test for the insurance sector that
showed that the insurance industry would be negatively affected if a
scenario were to materialize where yields remain low for a prolonged
period of time.

In the international relations area, EIOPA has been quite active,
performing Solvency II full equivalence assessments of the Swiss,
Bermudan and Japanese supervisory systems and running gap-analyses
of the regulatory regimes of 8 further countries that had expressed an
interest in being included in a transitional regime.

Furthermore, EIOPA has dedicated a special effort to a project with the
US federal and state insurance authorities aimed to increase mutual
understanding and cooperation with a view to promote business
opportunities, consumer protection and efficient supervision.

The public report that identifyies in a factual way the main similarities
and differences of the insurance regulatory and supervisory regimes in
the EU and in the US is a very important step forward.

As you can see EIOPA has already made a significant impact in the EU
regulatory and supervisory landscape.

This was only possible because of the dedication of our staff and the
excellent contribution from experts coming from the National
Supervisory Authorities.

It is their knowledge, experience and dedication that allow us to fulfil
our mandate and respond to an increasingly demanding environment.

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Furthermore, the continuous commitment and cooperation of the
members of the Board of Supervisors and Management Board was of the
utmost importance in fulfilling our mission and vision.
Paramount to our activity was also the constant involvement with the
Insurance and Reinsurance Stakeholder Group and the Occupational
Pensions Stakeholder Group.

The exchange of views and the opinions from the Stakeholder Groups
were essential in the development of EIOPA’s work.

Looking forward, I am convinced that in a few years the setting up of the
European Supervisory Authorities will be recognized as one of the most
fundamental reforms in the European financial sector coming from the
financial crisis.

The potential benefits from the creation of a single rule book are huge,
both for stability and consumer protection within the internal market.

Nevertheless, EIOPA is confronted with a number of important
challenges.

Let me mention three relevant ones:

1. How to assure the consistency of supervisory practices?

I firmly believe that the consistency of supervisory practices is as
important as the single rule book.

Only by assuring that day-to-day supervision of financial institutions is
done within a consistent framework, we can effectively contribute to an
increased level of protection of policyholders and beneficiaries in the
European Union.

The single market requires it and EIOPA is committed to deliver it.

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A first step should be the development of a Supervisory Handbook that
would work as a guidebook for supervision in Solvency II, setting out
good practices in all the relevant areas of supervision.

This handbook will foster the implementation of a more consistent
framework for the conduct of supervision. EIOPA is starting to work in
this area.

On the institutional side we observe the evolution in the banking area
with the proposals to create a single supervisory mechanism for the Euro
area banks.

As a truly convicted European I welcome this step.

I also recognize that the insurance sector is in a different situation.

Insurance is not banking.

There are indeed fundamental differences on the risks and on the
business models.

Nevertheless, I believe that it is fundamental to rely on the experience of
what has been already achieved by EIOPA under the current Regulation
and to start a reflection on further tasks, powers and resources needed to
deliver a truly consistent supervisory process and, in particular, to assure
a more consistent oversight of cross-border insurance groups.

In the short term EIOPA should be ready to play its challenging
oversight role according to the Regulation, by conducting inquiries into
a particular type of financial institution, or type of product, or type of
conduct in order to assess potential threats to the stability of the
financial system and make appropriate recommendations for action to
the competent authorities concerned.

In order to perform this independent assessment in a transparent,
efficient and risk-based way, EIOPA needs to reinforce its human
resources, should have access to the relevant individual information
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available to the national supervisors and also have direct access to the
individual institutions.

In the medium term the evolution to a more European focused
supervision for the EU cross-border insurance groups should also be
discussed, namely in face of the potencial arbitrage opportunities
coming from the new supervisory reality in the banking sector.

2. The power to ban or restrict financial activities

On the Consumer protection area I want to highlight the urgent need to
include provisions in the insurance and pension Directives allowing
EIOPA to ban or restrict financial activities as established in Article 9 of
the EIOPA Regulation.

This will assure an effective way to deal, for example, with situations of
flawed product design or governance that could lead to severe consumer
detriment.

Without these provisions EIOPA cannot fulfill its mandate as described
in the Regulation.

3. Competence on 3rd Pillar pensions

In the pensions area EIOPA’s mandate only covers occupational
pensions, the so called 2nd pillar.

However, I believe that the implementation of the EU agenda for
adequate, safe and sustainable pensions calls for a sufficient level of
regulation and supervision of personal pensions, the so called 3rd pillar.

Consequently, EIOPA’s mandate should be extended to all 3rd pillar
pensions.

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This is also recommended by EIOPA’s Occupational Pensions
Stakeholder Group in their comment to the Commission’s White paper
on Pensions.

Ladies and gentleman,

My vision is to build up EIOPA as a modern, competent and
professional organization that acts independently in an effective and
efficient way towards the creation of a common European supervisory
culture.
We are living extraordinary times and we should feel priviledged to be
part of this process.

As Bob Dylan so nicely singed: The times they are a-changin'.

Thank you.

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Opinion of the European Insurance and
Occupational Pensions Authority of on
interim measures regarding Solvency II

Legal Basis

1. This opinion is issued under the provisions of Article 29(1) (a) of
Regulation (EU) No 1094/2010 of the European Parliament and of the
Council of 24 November 2010 (hereafter the ‘Regulation’) in conjunction
with Directive 2009/138/EC of the European Parliament and the
Council of 25 November 2009 on the taking-up and pursuit of the
business of Insurance and Reinsurance (hereafter Solvency II Directive).

2. As established in Article 29(1) (a) of the Regulation, EIOPA shall play
an active role in building a common Union supervisory culture and
consistent supervisory practices, as well as in ensuring uniform
procedures and consistent approaches throughout the Union.

3. As established under Article 1 (6) of the Regulation EIOPA shall
contribute to improving the functioning of the internal market, including
in particular a sound, effective and consistent level of regulation and
supervision, (Art. 1(6)(a)) preventing regulatory arbitrage and promoting
equal conditions of competition (Art. 1(6)(d)). EIOPA shall also
contribute to enhancing consumer protection (Art. 1(6)(f)).

4. As established under Article 8 (1) of the Regulation EIOPA’s task is to
contribute to the establishment of high quality common regulatory and
supervisory standards and practices (Art. 1(6)(a)) and to contribute to the
consistent application of legally binding Union acts ensuring consistent,
efficient and effective application of the acts referred to in Art. 1 (2) of
the Regulation (Art. 1(6)(b)).

The fact that the Solvency II Directive has entered into force, means that
it is considered “Union law”, but it will not have legally binding effect
until after the date of its application, which is currently set to 1

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January 2014 in accordance with the ("Quick Fix") Directive
2012/23/EU of 12 September 2012.

5. This opinion is addressed to the national competent authorities
represented in EIOPA’s Board of Supervisors.

Context

6. During the Board of Supervisors (BoS) meeting of September 2012,
Members expressed their strong concerns with respect to the current
status of the OMNIBUS II negotiations which might further delay the
application of the Solvency II Directive.

7. In its explanatory memorandum to the Proposal for the Solvency II
Directive the European Commission states:

“The present solvency rules are outdated.

They are not risk sensitive, they leave too much scope to Member States
for national variations, they do not properly deal with group supervision
and they have meanwhile been superseded by industry, international and
cross-sectoral developments.

This is the reason why a new solvency regime, called Solvency II, which
fully reflects the latest developments in prudential supervision, actuarial
science and risk management and which allows for updates in the future
is necessary.”

8. In addition, in the absence of a final agreement on Solvency II,
European supervisors may be forced to develop national solutions in
order to ensure sound risk sensitive supervision.

Instead of reaching consistent and convergent supervision in the EU,
different national solutions may emerge to the detriment of a good
functioning internal market.

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9. The BoS mandated the Chair of EIOPA to write to the OMNIBUS II
trialogue parties setting out its concerns.
In his letter, dated 4 October 2012, the Chair not only expressed the need
for a stable and reliable time plan but also the need to reflect on an
earlier implementation of some Solvency II elements.

{Note: Do you remember the letter?}

Undertakings which are well-governed and which, in particular, measure
correctly, mitigate and report the risks which they face will be more
likely to be prepared for the new regulatory framework and act in the
interests of policyholders.

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10. In that regard it is of key importance that there will be a consistent
and convergent approach with respect to the preparation of Solvency II.

In the run-up to the new system the following key areas of Solvency II
need to be addressed in order to ensure proper management of
undertakings and to ensure that supervisors have sufficient information
at hand.

These are the system of governance, including risk management system
and a forward looking assessment of the undertaking's own risks (based
on the ORSA principles), pre-application of internal models, and
reporting to supervisors.

11. EIOPA sets out below its expectations for the national competent
authorities.

These actions are consistent with EIOPA’s obligation to foster
supervisory convergence.

12. EIOPA will, taking into account its objective under Article 1 Para 6
and its tasks and powers under Article 8 of the Regulation, contribute to
the consistent efficient and effective preparation of supervisors and
insurance and reinsurance undertakings for the application of the
Solvency II Directive.

13. As a follow-up to the opinion, and by making use of its powers under
Article 16 of the Regulation, EIOPA will publish guidelines addressed to
national competent authorities on how to proceed in the interim phase
leading up to Solvency II.

14. Within 2 months of the issuance of the guidelines, each national
competent authority shall confirm whether it complies or intends to
comply with the guidelines.

In the event that a national competent authority does not comply or does
not intend to comply, it shall inform EIOPA, stating its reasons.

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15. EIOPA will publish the fact that a national competent authority does
not comply or does not intend to comply with that guideline.

Proposed actions by national competent authorities
16. As part of the preparation for Solvency II, national competent
authorities should put in place, starting on 1 January 2014 certain
important aspects of the prospective and risk based supervisory
approach to be introduced in order to address the concerns set out
above.

17. National competent authorities are expected to ensure that insurance
and reinsurance undertakings have in place an effective system of
governance which provides for sound and prudent management of the
undertaking and an effective risk management system including a
forward looking assessment of the undertaking's own risks (based on the
ORSA principles).

18. National competent authorities are expected to ensure that insurance
and reinsurance undertakings have in place an effective risk-
management system comprising strategies, processes and reporting
procedures necessary to identify, measure, monitor, manage and report,
on a continuous basis the risks, at an individual and at an aggregated
level, to which they are or could be exposed, and their
interdependencies.

19. National competent authorities are expected to review and evaluate
with respect to the undertakings concerned the system of governance,
the assessment of the risks which those undertakings face or may face
and the assessment of the ability of those undertakings to assess those
risks taking into account the environment in which the undertakings are
operating.

20. Through internal model pre-application processes, national
competent authorities engaged in pre-application of internal models

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should continue to work with undertakings to form a view on
undertakings’ degree of readiness for internal model applications, and
should also follow subsequent evolutions to the internal model
framework.

21. National competent authorities are encouraged to request all the
information necessary for applying a prospective and risk based
supervisory approach.
22. National competent authorities are expected to ensure that the
requirements mentioned above are applied in a manner which is
proportionate to the nature, scale and complexity inherent in the
business of the insurance and reinsurance undertaking.

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Aruoba-Diebold-Scotti
Business Conditions
Index
The Aruoba-Diebold-Scotti business conditions index is designed to
track real business conditions at high frequency.

Its underlying (seasonally adjusted) economic indicators (weekly initial
jobless claims; monthly payroll employment, industrial production,
personal income less transfer payments, manufacturing and trade sales;
and quarterly real GDP) blend high- and low-frequency information and
stock and flow data.

The average value of the ADS index is zero. Progressively bigger positive
values indicate progressively better-than-average conditions, whereas

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progressively more negative values indicate progressively worse-than-
average conditions.

The ADS index may be used to compare business conditions at different
times.

A value of -3.0, for example, would indicate business conditions
significantly worse than at any time in either the 1990-91 or the 2001
recession, during which the ADS index never dropped below -2.0.

The vertical lines on the figure provide information as to which
indicators are available for which dates.

For dates to the left of the left line, the ADS index is based on observed
data for all six underlying indicators.

For dates between the left and right lines, the ADS index is based on at
least two monthly indicators (typically employment and industrial
production) and initial jobless claims.

For dates to the right of the right line, the ADS index is based on initial
jobless claims and possibly one monthly indicator.

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Financial services supervision: Commission
requests Belgium, France, Greece,
Luxembourg, Poland and Portugal to
implement EU rules

The Commission has requested Belgium, France, Greece, Luxembourg,
Poland and Portugal to notify within two months measures to implement
EU rules in the financial sector (Directive 2010/78/EU) concerning the
powers of the three new European supervisory authorities for banks
(European Banking Authority), insurance and occupational pensions
(European Insurance and Occupational Pensions Authority) and
securities (European Securities and Markets Authority).

The Directive aims at adapting the provisions of key financial services
Directives to the new supervisory framework.

This will make sure that European Supervisory authorities will be fully
allowed to carry out all the tasks conferred upon them.

Member States were due to implement the Directive, no later than 31
December 2011.

The Commission's requests take the form of reasoned opinions under
EU infringement procedures.

If the Member States fail to notify measures to implement the Directive
within two months, the Commission may decide to refer them to the EU
Court of Justice.

Electronic money: Commission asks Court of Justice to
fine Belgium for not implementing EU rules
The European Commission has decided to refer Belgium to the Court of
Justice of the EU for failing to implement the Directive on the taking
up, pursuit and prudential supervision of the business of electronic
money institutions.
_________________________________________

The Commission has also decided to ask the Court to impose daily
penalty payments on Belgium, until it fully implements the Directive.

The Commission proposes a daily fine of € 59 212,80 which would be
paid as from the date of the Court's ruling until Belgium notified the
Commission that it had fully implemented the rules into national law.

_________________________________________

Basel 3 –
The Timing Dilemma
Last month the United States (US) regulatory authorities announced that
they did not expect their rules implementing Basel 3 would become
effective on 1 January 2013, although they are working as “expeditiously
as possible” to complete their rulemaking process.

Similarly in the European Union (EU), the trilogue between the
European Commission, the European Parliament and the Council of
Ministers to agree the text of Capital Requirements Directive IV (CRD
IV, the EU version of Basel 3 is still ongoing and, even if a political
agreement can be reached by year-end (which still appears to be the
intention), it is recognised in the EU that there will not be sufficient time
for CRD IV to be codified as legislation and put into effect on 1 January
2013.

So, does it necessarily follow that we should delay Basel 3
implementation in Hong Kong because the US and the EU cannot meet
the internationally agreed timeline?

Or should we follow the timeline set by the Basel Committee on Banking
Supervision and begin the first phase of Basel 3 implementation from 1
January 2013?

Our Basel 3 rules (the Banking (Capital) (Amendment) Rules 2012) are
currently tabled at LegCo and notwithstanding the expected delays in
the US and the EU, the Basel Committee’s timeline remains unchanged.

Its gradual phase-in of the new capital standards over six years begins
from January 2013 and extends until 2019.

In resolving the timing dilemma, it might first be instructive to remind
ourselves that Basel 3 is being introduced to rectify weaknesses made all
too starkly apparent in the recent global financial crisis.

_________________________________________

Or, put another way, Basel 3 is considered good for financial stability.

The Basel 3 capital standards are designed to strengthen banks’
resilience by requiring more and better quality capital and by addressing
and capturing risks not adequately recognised previously.

The aim is to ensure that banks can weather future financial storms
without disruption to their lending.

This should in turn make them less likely to create or amplify problems
in other areas of the economy and facilitate their contribution to long-
term sustainable economic growth.

The roller-coaster of excessive leverage pre-crisis and excessive
deleveraging post-crisis is not conducive to sustainable growth.

Regulation is all about balance.

If regulation is too lax, excessive risk-taking may result with devastating
effects.

If regulation is too tight, it may suppress beneficial financial activity and
reduce growth.

In our view, Basel 3 represents an appropriate balance in bolstering
resilience whilst at the same time (with its extended phase-in) not
unduly hampering lending to business and households today and
ensuring banks can continue to lend in any downturn tomorrow.

For this reason we propose to begin implementing Basel 3 from 1
January 2013.

We are not alone in this.

Our regional peers, Mainland China, Japan, Singapore and Australia
have all published their final rules for Basel 3 implementation next year.

_________________________________________

As has Switzerland, another important financial centre.
But notwithstanding the intrinsic benefits of Basel 3, should we
nevertheless be swayed by the argument put to us that Asia is taking the
“medicine” designed for the countries worst affected by the crisis, whilst
the intended “patients” defer and thereby give their banks significant
“competitive advantages” over our own?

This competitive advantage argument would seem to be based on two
assumptions.

First that US and EU global banks (i.e. those banks that could
realistically compete with our own) are currently holding much lower
levels of capital than required by Basel 3 (and hence will have a genuine
cost advantage);

and second that our banks will, come 1 January 2013, have to hold more
capital than they currently hold (and hence will incur additional cost).

Are these assumptions correct?

Well even though adoption of Basel 3 is delayed in the US and the EU,
this certainly does not mean that banks in these regions remain at their
pre-crisis capital levels.

There has been significant re-capitalisation.

The Dodd Frank Wall Street Reform and Consumer Protection Act in the
US already requires the regulatory agencies to conduct stress-testing
programmes to ensure banks and other systemically important financial
institutions have enough capital to weather severe financial conditions
and, even before the passage of the Dodd Frank Act, the US Federal
Reserve Board put some of the largest US bank holding companies
through stress-tests, the results of which have led to significant increases
in capital.

By 2012, the 19 bank holding companies subject to the Fed’s
Comprehensive Capital Analysis and Review had increased their
_________________________________________

aggregate tier 1 common capital to US$803 billion in the second quarter
of the year from US$420 billion in the first quarter of 2009, with their tier
1 common capital ratio (which compares high quality capital to assets
weighted according to their riskiness) doubling to a weighted average of
10.9% from 5.4%.

In the EU, under a recapitalisation exercise in 2011 that covered 71 of the
EU’s major banks, the European Banking Authority (EBA) required
most to attain a “core tier 1 ratio” of not less than 9% by the end of June
2012.

In October 2012, the EBA indicated that it will focus on capital
conservation to “support a smooth convergence to the CRD IV…..
regulatory requirements” and require the banks to maintain an absolute
amount of core tier 1 capital corresponding to the level of the 9% core
tier 1 ratio.

So even absent formal adoption of Basel 3, the capital levels of the
largest banks in the US and the EU have increased significantly post-
crisis to levels comparable with, or even in excess of, those required
under Basel 3 and so the prospect of such banks “competing” by being
allowed to maintain much lower capital levels than Basel 3 banks would
seem more apparent than real.

Turning to the second “competitive” assumption, will the first phase of
Basel 3, which starts next year, require local banks to hold significantly
more capital than they do at present, to the extent that they may become
constrained in their ability to lend and compelled to pass on the costs of
the extra capital to borrowers?

Well, the results of the HKMA’s quantitative impact studies tell us that
our local banks are already very well-placed to meet the new Basel 3
capital ratios.

Their capital levels are already in excess of the standard taking effect on
1 January 2013 and the issuance of ordinary shares (common equity)
already accounts for a very significant proportion of their capital base,
_________________________________________

positioning them well for Basel 3’s new focus on common equity as the
highest quality capital for the purpose of loss absorption.

In summary then, irrespective of any delay in formal implementation of
Basel 3, major banks in the US and EU are inexorably moving to higher
levels of capital.

This, together with the benefits offered by Basel 3 and the relative ease
with which local banks can comply, serves to underpin our view that we
should proceed to implement the first phase of Basel 3 in line with the
Basel Committee’s timeline.

Generally speaking, jurisdictions in Asia have in the past tended to adopt
regulations that are in some respects higher than the Basel Committee’s
minimum standards.

This may have helped Asia weather the global financial crisis relatively
unscathed when compared with the jurisdictions worst affected.

There would, therefore, seem little to be gained from seeking to engage
in, or indeed prompt, a “race-to-the-bottom” in regulatory terms by
deliberately delaying the introduction of Basel 3 at this point in time.

In implementing on 1 January 2013, we will be fulfilling our commitment
both as an international financial centre which customarily adopts best
international standards and as a member of the Basel Committee on
Banking Supervision.

Karen Kemp
Executive Director (Banking Policy)

_________________________________________

Dear member,

The regulatory arbitrage challenges and opportunities between the
banking and the insurance sector are always important and profitable for
many, especially for consultants that are experts in both areas.

For example, you can see an interesting job description:

“Head of Risk & Compliance - Up to £200,000 package”

The candidate needs to have strong expertise in the core Risk
Management areas like:
- Compliance to Basel II, II.5 and Basel III
- Compliance to Solvency II

You can read more at:
http://jobview.monster.co.uk/getjob.aspx?jobid=115693460&WT.mc_n
=Indeed_UK&from=indeed

I have to confess: I am a collector of ideas that lead to regulatory
arbitrage opportunities, especially between the banking and the
insurance balance sheet.

Almost every financial product is subject to some form of supervision
and regulation, which is usually different in banking and insurance. This
is an opportunity. The same product can be structured to become a
“banking product” or an “insurance product”.

I know. Basel iii and Solvency ii are supposed to eliminate regulatory
arbitrage opportunities.

Every time I think something like that, I have to admit that firms (and
countries) will always do their best to exploit opportunities and have
competitive advantages.

This week I will start from an interesting phrase:

_________________________________________

“The changes in banking regulation make more important the role of
insurers as providers of long-term ***bank funding***”

Who said that?

Gabriel Bernardino, the Chairman of EIOPA (the European Insurance
and Occupational Pensions Authority, one of three European
Supervisory Authorities).

_________________________________________

Solvency II Speakers Bureau
The Solvency II Association has established the Solvency II Speakers
Bureau for firms and organizations that want to access the expertise of
Certified Solvency ii Professionals (CSiiPs) and Certified Solvency ii
Equivalence Professionals (CSiiEPs).

The Solvency II Association will be the liaison between our certified
professionals and these organizations, at no cost. We strongly believe
that this can be a great opportunity for both, our certified professionals
and the organizers.

To learn more:
www.solvency-ii-association.com/Solvency_II_Speakers_Bureau.html

_________________________________________

Course Title
Certified Solvency ii Professional (CSiiP):
Preparing for the Solvency ii Directive of the EU (3 days)
Objectives:

This course has been designed to provide with the knowledge and skills
needed to understand and support compliance with the Solvency ii
Directive of the European Union.

Target Audience:

This course is intended for decision makers, managers, professionals
and consultants that:

A. Work in Insurance or Reinsurance firms of EEA countries.

B. Work in Groups - Financial Conglomerates (FC), Financial Holding
Companies (FHC), Mixed Financial Holding Companies (MFHC),
Insurance Holding Companies (IHC) - providing insurance and/or
reinsurance services in the EEA, whose parent is located in a country of
the EEA.

C. Want to understand the challenges and the opportunities after the
Solvency ii Directive.

This course is highly recommended for supervisors of EEA countries
that want to understand how countries see Solvency II as a Competitive
Advantage.

This course is also recommended for all decision makers, managers,
professionals and consultants of insurance and/or reinsurance firms
involved in risk and compliance management.

_________________________________________

About the Course

INTRODUCTION
 The European Union’s Legislative Process
 Directives and Regulations
 The Financial Services Action Plan (FSAP) of the EU
 Extraterritorial Application of European Law
 Extraterritorial Application of the Solvency II Directive
 Solvency ii and the Lamfalussy Process
 Level 1: Framework Principles
 Level 2: Detailed Technical MeasuresLevel 3: Strengthening
Cooperation Among Regulators
 Level 4: Enforcement
 Weaknesses of Solvency I
 From Solvency I to Solvency II
 Solvency ii Players
 Solvency ii Objectives

THE SOLVENCY II DIRECTIVE
 A Unified Legislative Basis for Prudential Regulation of Insurers
and Reinsurers
 Risk-Based Capital Allocation
 Scope of the Application
 Important Definitions
 Value-at-Risk in Solvency II
 Authorisation
 Corporate Governance
 Governance Functions
 Risk Management
 Corporate Governance and Risk Management - Level 2
 Fit and proper requirements for persons who effectively run the
undertaking or have other key functions
 Internal Controls

_________________________________________

 Internal Audit
 Actuarial Function
 Outsourcing
 Board of Directors: Role and Solvency ii Responsibilities
 12 Principles – System of Governance (Level 2)

PILLAR 2
 Supervisory Review Process (SRP)
 Focus on Risk Management and Operational Risk
 Own Risk and Solvency Assessment (ORSA)
 ORSA - The Internal Assessment Process
 ORSA - The Supervisory Tool
 ORSA - Not a Third Solvency Capital Requirement
 Capital add-on

PILLAR 3
 Disclosure Requirements
 The Solvency and Financial Condition Report (SFC)

PILLAR I
 Valuation Of Assets And Liabilities Technical Provisions
 The Solvency Capital Requirement (SCR)
 The Value-at-Risk Measure Calibrated to a 99.5% Confidence
Level over a 1-year Time Horizon
 The Standard Approach
 The Internal Models
 The Collection of Additional Historical Data
 External Data
 The Minimum Capital Requirement (MCR)
 Non-Compliance with the Minimum Capital Requirement
 Non-Compliance with the Solvency Capital Requirement
 Own Funds
 Investment Rules

_________________________________________

INTERNAL MODEL APPROVAL
 CEIOPS Level 2 - Tests and Standards for Internal Model
Approval
 CEIOPS Level 2 - The procedure to be followed for the approval of
an internal model
 Internal Models Governance
 Group internal models
 Statistical quality standards
 Calibration and validation standards
 Documentation standards

SOLVENCY II, GROUP SUPERVISION AND THIRD COUNTRIES
 Solvency I: Solo Plus Approach
 Group Supervision under Solvency II
 Rights and duties of the group supervisor
 Group Solvency - Methods of calculation
 Method 1 (Default method): Accounting consolidation-based
method
 Method 2 (Alternative method): Deduction and aggregation
method
 Parent Undertakings Outside the Community - Verification of
Equivalence
 Parent Undertakings Outside the Community - Absence of
Equivalence
 The head of the group is in the EEA and the third country regime
is not equivalent
 The head of the group is in the EEA and the third country regime
is equivalent
 The head of the group is outside the EEA and the third country is
not equivalent
 The head of the group is outside the EEA and the third country
regime is equivalent
 Small and Medium-Sized Insurers: The Proportionality Principle
 Captives and Solvency II
_________________________________________

EQUIVALENCE WITH SOLVENCY II AROUND THE WORLD
 Solvency ii and Countries outside the European Economic Area
 The International Association of Insurance Supervisors (IAIS)
 The Swiss Solvency Test (SST) and Solvency ii:
 Solvency ii and the Offshore Financial Centers (OFCs)
 Solvency ii and the USA
 Solvency ii and the US National Association of Insurance
Commissioners (NAIC) - The Federal Insurance Office created
under the Dodd-Frank Wall Street Reform and Consumer
Protection Act in the USA, and the ORSA in the USA

FROM THE REINSURANCE DIRECTIVE TO THE SOLVENCY II
DIRECTIVE
 Directive 2005/68/EC of 16 November 2005 on Reinsurance - The
Reinsurance Directive (RID)

CLOSING
 The Impact of Solvency ii Outside the EEA
 Providing Insurance Services to the European Client
 Competing with Banks
 Learning from the Basel ii Framework
 Regulatory Arbitrage: A Major Risk for Countries that see
Compliance as an Obligation, not an Opportunity
 Basel II, Basel III, Solvency II and Regulatory Arbitrage
 Challenges and Opportunities: What is next
 Regulatory Shopping after Solvency II

To learn more about the course:
www.solvency-ii-association.com/Certified_Solvency_ii_Training.htm

_________________________________________

Solvency ii News December 2012

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