G-SII List Delayed

Risk Magazine is reporting that the initial list of global systemically important insurers (G-SIIs), originally due to be published in April 2013 by the Financial Stability Board (FSB) and the International Association of Insurance Supervisors (IAIS), has now been delayed until the end of Q2 2013.

Elsewhere, the FT is reporting that the IAIS is set to publish proposals on Wednesday which will mean the G-SIIs will not be subject to capital surcharges on their entire balance sheets, but only on that part of the balance sheet which constitutes non-traditional non-insurance business.  Moreover, insurers that take steps to segregate these businesses in separately capitalised entities will be subject to lower charges than those that allow co-mingling with other business lines to take place.

Defining Systemic Importance for Insurers

On 12 February 2013, Julian Adams, FSA Director of Insurance, gave a speech at the Economist Insurance Summit in London on the lessons for insurance supervisors from the financial crisis.

Mr Adams explained that the overall objective of the FSA is to create an environment in which no insurer is too big, too complex or too interconnected to fail, and where participants are able to exit the market in an orderly fashion which ensures continuity of access to critical services.

He noted that the UK currently does not have a resolution regime for insurers, instead relying on ‘run-off’, Schemes of Arrangement and formal insolvency.  However, each of these options carries attendant risks meaning that it is necessary to at least consider whether a resolution regime for insurers in necessary.  Any such regime would be consistent with the Financial Stability Board’s ‘Key Attributes’ document and would also take a lead from the International Association of Insurance Supervisors, which is due to publish its initial list of Globally Systemic Important Insurers in the summer of 2013.  The key challenge is to recognise the specificities of insurance compared to other financial sectors – particularly the factors that make an insurer ‘systemically important’.  On this topic, Mr Adams highlighted three issues:

Use of Leverage – such as:

  • engaging in stock lending in order to invest proceeds in higher yielding (and therefore higher risk) paper; or
  • facilitating borrowing by non-insurance group members on the strength of an insurance business;

Asset Transformation – such as the sale of long-term investment products by life insurance companies; or

Assumption of Credit Risk – such as:

  • the securitisation of corporate paper; or
  • the funding of annuity liabilities through exposure to subordinated corporate debt.

If the answer to any one of these questions, alone or in combination, is positive then the FSA would “consider carefully” whether the firm in question was systemically significant.

FSB to Complete G-SIFI RRP Reforms Before Concentrating on Non-Banks

The Financial Stability Board (FSB) has published a press release regarding the meeting which took place in Zurich on 28 January 2013 to discuss vulnerabilities affecting the global financial system and progress to strengthen global financial regulation.

On the subject of resolving failing financial institutions, the FSB confirmed that, in April, it will publish its final peer review of resolution regimes.  Thereafter, the FSB’s work on resolution in 2013 will focus on three main objectives:

  • addressing remaining obstacles to the implementation of resolution strategies for G-SIFIs;
  • launching an effective resolvability assessment process for G-SIFIs; and
  • developing guidance for the resolution of non-bank financial institutions.

FSB Press Release on RRP Consultation

On 18 December 2012, the Financial Stability Board (FSB) published a press release regarding responses received to its 2 November 2012 consultation on Recovery and Resolution Planning, together with links to the responses of the following institutions:

  • Association of British Insurers
  • Barclays
  • BNP Paribas
  • British Bankers’ Association
  • Credit Suisse
  • Deutsche Bank
  • Federation Bancaire Francaise
  • FirstRand Bank
  • Global Financial Markets Association
  • Institute of International Finance
  • International Banking Federation
  • Investment Management Association
  • Polish Financial Supervision Authority
  • Santander
  • UBS

 

Deadline for G-SIB Resolution Plans Pushed Back

On 5 November 2012, the Financial Stability Board (FSB) published a letter dated 31 October 2012 addressed to the G20 regarding progress made with respect to financial regulatory reforms.

The FSB reported ‘solid but uneven’ progress” in the four priority areas identified by the G20, being:

  • building resilient financial institutions (i.e. Basel III);
  • ending “too big to fail” (i.e. RRP);
  • strengthening the oversight and regulation of shadow banking activities; and
  • completion of OTC derivatives and related reforms.

On the subject on ending “too big to fail”, the FSB noted that a peer review of national actions taken to legislate its “Key Attributes of Effective Resolution Regimes” document will now be published in the first half of 2013.  More importantly, however, on the subject of resolution planning for Globally Systemically Important Financial Institutions (G-SIFIs), the FSB confirmed that the deadline for completion of operational resolution plans for Globally Systemically Important Banks (G-SIBs) has been extended by six months until mid-2013.  Consequently, the FSB’s peer-based resolvability assessment process will now be delayed until the second half of 2013.

Changes to the G-SIFI List

In November 2011, the Financial Stability Board (FSB) published its initial list of Global Systemically Important Banks (G-SIBs).  On 1 November 2012, the list was updated, with BBVA and Standard Chartered being added to the list and Commerzbank, Dexia and Lloyds all being removed.

The significance of being classified as a G-SIB lies in the fact that, under Basel III, any bank identified as a G-SIB in November 2014 will be required to maintain additional loss absorbency.  This requirement will be phased in between January 2016 and January 2019 and ranges between 1% and 2.5% of risk weighted assets depending on the significance of the individual firm.  G-SIBs are also required to meet higher supervisory standards for risk management functions, data aggregation capabilities, risk governance and internal controls.  Any firm newly designated as a G-SIB is required to implement certain resolution planning requirements within specified deadlines.  Furthermore, even where a financial institution is no longer designated as a G-SIB it will continue to be subject to the requirement to prepare an RRP to the extent that it is assessed by its national regulator to be systemically significant or critical in the event of failure.

For the first time, the current list of G-SIBs has been allocated into provisional buckets corresponding to the required level of additional loss absorbency, as set out in more detail in Annex 1 below.  The timetable for implementation of resolution planning requirements for newly designated G-SIFIs is detailed in Annex 2 below.

Annex 1

  

Bucket

G-SIB in alphabetical order within each   bucket

5

(3.5%)

(Empty)

 4

(2.5%)

Citigroup

Deutsche Bank

HSBC

JP Morgan Chase

3

(2.0%)

Barclays

BNP Paribas

 2

(1.5%)

Bank of America

Bank of New York Mellon

Credit Suisse

Goldman Sachs

Mitsubishi UFJ FG

Morgan Stanley

Royal Bank of Scotland

UBS

1

(1.0%)

Bank of China

BBVA

Group BPCE

Group Credit Agricole

ING Bank

Mizuho FG

Nordea

Santander

Societe Generale

Standard Chartered

State Street

Sumitomo Mitsui FG

Unicredit Group

Wells Fargo

Annex 2

G-SIFI Requirement Deadline for completion following date of G-SIFI designation
Establishment of Crisis Management Group (CMG)

6 months

 

Development of recovery plan

12 months

 

Development of resolution strategy and review within CMG

12 months

 

Agreement of institution specific cross-border cooperation agreement

18 months

 

Development of operational resolution plan

18 months

 

Conduct of resolvability assessment by CMG and resolvability assessment process

24 months

 

 

FSB Launches RRP Peer Review

On 3 August 2012 the Financial Stability Board launched a peer review of member jurisdictions’ existing resolution regimes.  The objectives of the review are to:

  • assess the resolution regimes that apply to different types of financial  institutions;
  • highlight good practice, inconsistencies and gaps in national resolution regimes;
  • evaluate progress in implementing reforms to national resolution regimes and identify challenges arising from their implementation; and
  • clarify or revise resolution regime criteria, where necessary.

The review uses the FSB’s “Key Attributes of Effective Resolution Regimes for Financial Institutions” (“Key Attributes”) as a benchmark, but does not directly assess jurisdictions’ compliance with the Key Attributes.  Rather, the intention of the review is to provide a comparative analysis of existing regimes and of progress made by different jurisdictions, both across individual Key Attributes and across different financial sectors (including banking, insurance, securities, financial market infrastructures).  The deadline for the receipt of feedback is 28 September 2012.

The primary source of information for the peer review will be member jurisdictions’ responses to a questionnaire. The questionnaire is divided into two sections.  Section 1 seeks general information about recent experiences, lessons learned and planned reforms with respect to the resolution of  systemically important financial institutions.  Specifically, information is requested as to whether:

  • resolution powers and funding arrangements were generally adequate;
  • public authorities were adequately prepared;
  • there was effective coordination and information sharing between resolution authorities; and
  • sufficient information about the institution and its related entities was available to the relevant authorities.

Section 2 seeks to create an overview of national resolution regimes and assess their consistency with the Key Attributes.  Specifically, it focuses on:

  • the scope and application of existing resolution regimes;
  • the way in which systemic importance is defined;
  • the identity, objectives and powers of resolution authorities;
  • the triggers to resolution;
  • safeguards for creditors;
  • funding of resolution regimes;
  • frameworks for cross-border cooperation;
  • requirements for the preparation of recovery and resolution plans and resolvability assessments; and
  • information access and sharing.

Recovery and Resolution Plans for Globally Systemically Important Insurers by Mid-2014

Introduction

On 31 May 2012 The International Association of Insurance Supervisors (the “IAIS”) published a consultation paper (endorsed by the FSB) concerning its proposed assessment methodology for the identification of globally systemically important insurers (“G-SIIs”), being any insurer “whose distress or disorderly failure, because of their size, complexity and interconnectedness, would cause significant disruption to the global financial system and economic activity”.

The Assessment Methodology

The assessment methodology is based broadly on that used to identify globally systemically important banks (“G-SIBs”) but tailored to the insurance industry.  In developing the methodology, the IAIS took account of the apparent absence of evidence to suggest that traditional insurance business either generates or amplifies systemic risk.  Accordingly, in determining whether an insurer is a G-SII, more emphasis is placed on those insurers who participate in non-traditional and non-insurance activities, such as derivatives.

The proposed assessment methodology involves three steps:

  • Collection of data;
  • Methodical assessment; and
  • Supervisory judgment and validation.

Collection of data

To ensure the quality and relevance of underlying data, the IAIS based is assessment on data requested from 48 of the largest insurance groups active across 13 jurisdictions as of year-end 2010.

Methodical Assessment

The IAIS proposes to measure ‘systemic importance’ in terms of the impact that distress or failure of an insurer might have on the global financial system and the wider economy rather than in terms of the probability of a failure of the insurer in question.  An indicator-based approach based on the five categories listed below is proposed.  This will provide a first indication of the relative importance of each insurer under consideration.  Within each category are a number of indicators the purpose of which is to capture the degree and nature of each insurer’s systemic importance.

Category

Indicator 

Size

Total assets

Total revenues

Global Activity 

Revenues derived outside of home country

Number of countries

Interconnectedness 

Intra-financial assets

Intra-financial liabilities

Reinsurance

Derivatives

Large exposures

Turnover

Level 3 Assets (i.e. assets the fair value of which cannot be   determined by using observable measures)

Non-traditional   and Non-insurance Activities 

Non-policy holder liabilities   and non-insurance revenues

Derivatives trading (notional CDS protection sold)

Short-term funding

Financial guarantees

Variable annuities

Intra-group commitments

Substitutability

Premiums for specific business lines

In addition, it seems likely that the final methodology will incorporate additional factors, such as:

  • The amount (in economic terms) of derivatives trading without hedging purposes; and
  • The liquidity of insurance liabilities.

Relevant Importance of each Category

The two most important categories for assessing the systemic importance of insurers are:

  • Non-traditional insurance and non-insurance activities – because the longer timeframe over which insurance liabilities can normally be managed (which is considered to be a mitigating factor in assessing systemic risk) may not be present; and
  • Interconnectedness – because of the strong connections between the insurance and banking sectors.

Calculating Systemic Importance

The Assessment Methodology will be used to calculate a systemic importance ranking of all of the 48 insurance companies under consideration.  The overall score for a particular insurer is calculated as the sum of all of the weighted category scores for that insurer.  In turn, each category score is calculated as the amount that the insurer in question represents with respect to that category as a proportion of the entire sample for the category in question, after weightings are applied.  Within a category, all indicators are given an equal weighting.  As a result, category weightings are very important to the calculation.  The weightings assigned to each category are:

Category

Weighting

Non-traditional insurance and non-insurance activities

40%-50%

Interconnectedness

30%-40%

Size

5%-10%

Global Activity

5%-10%

Substitutability

5%-10%

At this point a number of methodologies will be employed in order to determine the cut-off point between G-SIIs and non-G-SIIs, one being a comparison of publicly available data which is common to all of the insurers under consideration as well as G-SIBs.

Supervisory Judgment and Validation

The Supervisory judgment and validation stage introduces both a qualitative as well as an quantitative assessment, in recognition of the fact that no single methodology can perfectly measure systemic importance across all global financial institutions.  Additional analysis will be conducted in order to validate the results of the indicator-based approach conducted under the “Methodical Assessment” section.  This analysis (the “IFS Assessment”) divides the business portfolio of an insurer into:

  • Traditional insurance;
  • Semi-traditional insurance;
  • Non-traditional insurance;
  • Non-insurance financial; and
  • Industrial activities.

Again, risk weightings are used to calculate systemic importance, the highest ratings being allocated to the “Non-insurance financial” and “Non-traditional insurance” categories.  The findings are then compared to the results from the indicator-based approach to provide a check on their reasonableness and to assist informed discussions with relevant group-wide supervisors.  Based on these assessments and discussions, the IAIS will determine if additional analysis is required, or whether an insurer should be added to the list of G-SII candidates.  Once a candidate list is finalised, the IAIS will make recommendations as to which insurers should be regarded as G-SIIs to the FSB, who will ultimately make the decision.

Policy Measures for G-SIIs

The IAIS will develop policy measures to be applied to G-SIIs, which will be the subject of a separate consultation exercise later on this year.  The measures are likely to include:

  • More intensive and co-ordinated supervision of SIFIs;
  • A requirement to develop Recovery and Resolution Plans on the basis set out in the FSB’s “Key Attributes for Effective Resolution Regimes”; and
  • Higher loss absorbency for SIFIs to reflect the greater risks that these institutions pose to the global financial system.

Timeline

An initial list of G-SIIs is expected from the FSB in the first half of 2013 and a revised list of G-SIIs is to be published in November every year.  The IAIS expects that the G-SII measures would be applied with an 18 month time lag compared to those for G-SIBs due to the different overall timetable concerning the G-SIFI insurance project.  This would mean that Recovery and Resolution Plans would be expected to be in place by mid-2014 for G-SIIs compared with the end of 2012 for G-SIBs.

The IAIS consultation paper is open for comment until 31 July 2012.  The consultation paper, press release and FAQ document are all available here:

http://www.iaisweb.org/Consultations-918

 

FSB to Commence Peer Reviews on RRP Implementation in July 2012

On 30 May 2012, the Financial Stability Board published a press release following its meeting in Hong Kong on 29-30 May 2012, the purpose of which was to discuss vulnerabilities currently affecting the global financial system and the progress in authorities’ ongoing work to strengthen global financial regulation.

Amongst the topics discussed were measures designed to further develop the regulatory regime for systemically important financial institutions (“SIFIs”), specifically:

  • extending the framework to domestic systemically important banks, and
  • establishing a process to ensure consistent implementation of policy measures for global SIFIs, particularly with respect to resolvability.

The FSB recognised the need to establish international guidance on common terms for information sharing and the handling of client assets on resolution.  Additionally, it confirmed that, from July, it will commence the first in an iterative series of peer reviews on the implementation of the recommendations documented in its “Key Attributes of Effective Resolution Regimes for Financial Institutions” guidance.

The press release is available here:

http://www.financialstabilityboard.org/press/pr_120530.pdf

The FSB’s “Key Attributes” guidance is available here:

http://www.financialstabilityboard.org/publications/r_111104cc.pdf

Progress Report on Resolution Planning

On 3 May 2012, Paul Tucker, Deputy Governor of the Bank of England and Chair of the FSB’s Resolution Steering Group gave a progress report on Resolution Planning at the Institute for Law and Finance Conference in Frankfurt.  Mr Tucker discussed a number of issues which will be of interest to those involved in recovery and resolution planning.

The appropriate trigger for resolution

Mr Tucker stated that a firm should go into resolution “when its time is up”, which he described as being the point at which its recovery strategies have been exhausted and it has been unable to reverse its decline.  Specifically, this should occur when the bank no longer meets the criteria for being authorised and when there is no reasonable prospect of it doing so again.

 Resolving Systemically Important Financial Institutions

Mr Tucker noted that the traditional approach to resolution, involving the separation of good assets from bad assets, faces a number of problems with respect to SIFIs doing business in multiple markets and jurisdictions.  As such, resolution authorities are exploring how to execute ‘top-down’ resolutions of complex groups, employing bail-in of debt issued by the holding company or top-level operating company.

The resolution of deposit-funded international commercial banking groups

Bail-in does not work particularly well in the case of commercial banks that are funded entirely or largely from insured deposits rather than debt issuances due to the absence of bond-holders to bail in.  In addition, the usual approach of separating good assets from bad may not be suitable for complex cross-border commercial banking groups and may result in the excess destruction of value, particularly to a deposit insurer.  One possible solution proposed by Mr Tucker was to bail in the deposit insurer.  In doing so, the deposit insurer would know ex-ante how much it stood to lose, rather than having to wait until the end of an insolvency process.  This particular suggestion is also advocated within the recent EU Commission discussion paper on Bail-in, and would seem to be a sensible proposal.

Creditor Waterfalls

Thankfully, Mr Tucker gave his support to the proposition that, whatever the resolution tool employed, creditors should be affected in the same was as in a standard insolvency situation.  It may be that he is not a fan of the “sequential bail-in model” described in the EU Commission’s discussion paper.  Under this option, “long-term” liabilities are subject to bail-in before “short-term liabilities”, the dividing line being drawn with respect to instruments which have an original maturity of one year.  It would seem that this option does little more than layer additional complexity and scope for arbitrage on a situation which is already likely to be prove incredibly difficult to administer in ways that nobody can quite yet imagine.  Simplicity is definitely the order of the day here.

The full text of the speech can be found here:

http://www.bankofengland.co.uk/publications/Documents/speeches/2012/speech568.pdf