On 8 January 2014, the Financial Stability Board (FSB) and the International Organization of Securities Commissions (IOSCO) published a consultation paper on “Assessment Methodologies for Identifying Non-Bank Non-Insurer Global Systemically Important Financial Institutions” (NBNI G-SIFIs). The consultation period closes on 7 April 2014. Continue reading
On 12 December 2013, the European Banking Authority (EBA) published a consultation paper on draft regulatory technical standards (RTS) on the methodology for the identification of global systemically important institutions (G-SIIs) and draft implementing technical standards (ITS) on uniform formats and dates for the disclose of the values of the indicators used for determining the score of G-SIIS. Continue reading
On 11 November 2013, the Financial Stability Board (FSB) published an updated list of global systemically important banks (G-SIBs) using end-2012 data.
The Basel Committee on Banking Supervision (BCBS) has also separately published the denominators used to calculate G-SIB scores and the Cut-off score and bucket thresholds that were used to allocate G-SIBs to particular buckets. The denominators are to be updated annually, while the cut-off score and bucket thresholds will remain fixed until November 2017, the date when the first three year review of the G-SIB assessment methodology is due to completed. Continue reading
In the context of the continuing industry and regulator discussion regarding CCP resolvability, last week ISDA published a position paper entitled “CCP Loss Allocation at the End of the Waterfall”. The paper addresses two scenarios:
- “Default Losses” – i.e. losses that remain unallocated once the ‘default waterfall’ is exhausted following a clearing member (“CM”) default; and
- “Non-default Losses” – i.e. losses that do not relate to a CM default but exceed the CCP’s financial resources above the minimum regulatory capital requirements.
ISDA recognises the importance of central clearing for standard OTC derivatives, the difficulty of achieving optimal CCP recovery and resolution and the fact that no loss allocation system can avoid allocating losses to CMs. It takes the view that residual CCP losses should be borne not by the taxpayer, nor solely by surviving CMs who as guarantors have no control over losses. Rather, ISDA believes that all CMs with mark-to-market gains since the onset of the CCP default should share the burden of CCP losses. Accordingly, ISDA is an advocate of Variation Margin Gains Haircutting (“VMGH”) being applied at the end of the default waterfall.
Under a VMGH methodology, the CCP would impose a haircut on cumulative variation margin gains which have accumulated since the day of the CM default. In doing so, ISDA believes that:
- losses fall to those best able to control their loss allocation by flattening or changing their trade positions;
- CMs with gains at risk are incentivised to assist in the default management process; and
- in the event that the CCP runs out of resources, VMGH mimics the economics of insolvency.
ISDA believes that a VMGH methodology should not have an adverse impact on the ability of a CM to net exposures or gain the appropriate regulatory capital treatment for client positions held at the CCP. In contrast to contractual tear-up provisions or forced allocation mechanisms, VMGH allows a CM to assume that its portfolio of cleared transactions outstanding as of any given date will be the same as of the point of a CCP’s insolvency (because there is no mechanism by which they can be extinguished prior to any netting process). As such, because it has certainty with respect to its legal rights in the CCP’s insolvency, the CM should be able to conclude that netting sets remain enforceable. In addition, to the extent that VMGH provides incremental resources to the CCP, ISDA believes that it effectively protects initial margin held at a CCP and therefore strengthens segregation.
In theory, VMGH should always be sufficient to cover a defaulting CM’s mark-to-market losses in the same period. However, if in practice this was not the case (e.g. because the CCP was not able to determine a price for the defaulting CM’s portfolio) and in the absence of other CMs voluntarily assuming positions of the defaulting CM, ISDA advocates a full tear-up of all of the CCP’s contracts in the product line that has exhausted its waterfall resources and has reached 100% haircut of VM gains. ISDA contends that there should be no forced allocation of contracts, invoicing back, partial non-voluntary tear-ups, or any other CCP actions that threaten netting. Furthermore, prior to the point of non-viability, ISDA believes that resolution authorities should not be entitled to interfere with the CCP’s loss allocation provisions (as detailed within its rules) unless not doing so would severely increase systemic risk.
An example of Non-default Loss (“NDL”) would be operational failure. ISDA views NDL in a different light to Default Losses believing there to be no justification for reallocating NDL amongst CMs and other CCP participants. Accordingly, it does not believe that VMGH (or similar end-of-the-waterfall options) are appropriate for allocation of NDL. Rather, it considers that NDL should be borne first by the holders of the CCP’s equity and debt.
The ISDA paper is a useful contribution to the ongoing discussion around CCP resolvability. It suggests a sensible CCP default waterfall, but is probably most noteworthy for its opposition to initial margin (“IM”) haircutting as a resolution tool. In ISDA’s view, IM haircutting would distort segregation and “bankruptcy remoteness”. In doing so it would have significant adverse regulatory capital implications and would create disincentives for general participation in the default management process. In this sense, it adopts the opposite position to that detailed by the Committee on Payment and Settlement Systems (“CPSS”) and the International Organization of Securities Commission (“IOSCO”) in their recent consultative report on the Recovery of financial market infrastructures (see this blog post for more detail). CPSS/IOSCO see IM haircutting as an effective tool which may facilitate access to a much larger pool of assets than VMGH.
There is general agreement on the principle that the taxpayer should never again have to pick up the tab following the failure of a systemically important firm. On this basis alone, one suspects that IM haircutting will ultimately be included in the suite of resolution tools, if only to act as additional buffer between derivatives losses and the public purse. In fairness, it’s difficult to see how a general tear-up of contracts is consistent with one of the underlying goals of CCP resolution – to ensure the continuity of critical services. Ultimately, however, we will have to wait to see whether the contagion which may result from ISDA’s tear-ups outweighs the regulatory impact associated with CPSS/IOSCO’s IM haircutting.
On 12 August 2013, the Financial Stability Board published a consultation document regarding the “Application of the Key Attributes of Effective Resolution Regimes to Non-Bank Financial Institutions”, inviting comments by 15 October 2013.
The consultation document proposes draft guidance on how the Key Attributes should be implemented with respect to systemically important non-bank financial institutions. It deals with three main areas:
- The resolution of financial market infrastructure (FMI) and systemically important FMI participants;
- Resolution of insurers; and
- Client asset protection in resolution.
The proposed rules are, to a large extent, little more than the formalisation of existing thought and best practice regarding the resolution of non-bank financial institutions. However, this does not detract from the value of the document. Indeed, it highlights the practical challenge that institutions which are subject to the rules will face in providing the data necessary to facilitate the implementation of resolution measures by regulators.
Both FMIs and insurers will be required to maintain information systems and controls that can promptly produce, both in normal times and during resolution, all data needed for the purposes of timely resolution planning and resolution. In the case of FMIs, this will include:
- Information on direct and indirect stakeholders, such as owners, settlement agents, liquidity providers, linked FMIs and custodians;
- Exposures to each FMI participant (both gross and net);
- Information on the current status of obligations of FMI participants (e.g. whether they have fulfilled their obligations to make default fund contributions);
- FMI participant collateral information, such as:
- holding arrangements; and
- rehypothecation rights; and
- netting arrangements.
Insurers will also be required to generate data regarding:
- sources of funding;
- asset quality and concentration levels; and
- derivatives portfolios.
In addition, any entity holding client money, must have the ability to generate a wide variety of data that would facilitate its speedy return in a resolution scenario. That data must be in a format understandable by an external party such as a resolution authority or an administrator and includes information on:
- the amount, nature and ownership status of client assets held by the firm (directly or indirectly);
- the identity of clients;
- the location of client assets;
- the identity of all relevant depositories;
- the terms and conditions on which client assets are held;
- the applicable type of segregation (e.g. “omnibus” or “individual”);
- the effects of the segregation on client ownership rights;
- applicable client asset protections (particularly where client assets are held in a foreign jurisdictions);
- any waiver, modification or opting out by a client of the client asset protection regime;
- the ownership rights of clients and any potential limitations to those rights;
- the existence and exercise of rehypothecation rights; and
- outstanding loans of client securities arranged by the firm as agent, including details of:
- contract terms; and
- collateral received.
If the experience of banks is anything to go by, the capture, analysis, delivery and updating of this type of data is a significant undertaking. The FSB is clearly laying out its intentions and the direction of travel on this issue. As such, non-bank financial institutions would do well to start analysing their capabilities in these areas, with a view to upgrading their data architectures where necessary.
On 18 July 2013, the Financial Stability Board (FSB) published a press release endorsing the assessment methodology and policy measures published by the International Association of Insurance Supervisors (IAIS) discussed below, and naming the first nine globally systemically important Insurers (G-SIIs). The list will be published each November, starting in 2014 and initially comprises:
- Allianz SE;
- American International Group, Inc.;
- Assicurazioni Generali S.p.A.;
- Aviva plc;
- Axa S.A.;
- MetLife, Inc.;
- Ping An Insurance (Group) Company of China, Ltd.;
- Prudential Financial, Inc.; and
- Prudential plc.
On the same date the IAIS announced that it had published:
- a G-SII Initial Assessment Methodology;
- G-SII specific policy measures, and
- an overall G-SII framework for macroprudential policy and surveillance.
G-SII Initial Assessment Methodology
The methodology (which has already been criticised as being “opaque and arbitrary” on account of the fact that it contains no quantitative cut-off point for G-SII designation, preventing firms from knowing what actions would help them remain below the G-SII threshold) is designed to assess the systemic importance of insurers, using year-end 2011 data collected from selected insurers in 2012 and employing a three-step process involving:
- the collection of data;
- a methodical assessment based on five weighted categories and 20 indicators;
- non-traditional insurance and non-insurance (NTNI) activities (45% weighting);
- interconnectedness (40% weighting);
- substitutability (5% weighting);
- size (5% weighting); and
- global activity (5% weighting); and
- a supervisory judgment and validation process.
G-SII Policy Measures
The IAIS policy framework for G-SIIs is three-pronged, consisting of:
These measures entail the development of Systemic Risk Management Plans, enhanced liquidity planning and management and the granting of direct powers over holding companies to group-wide supervisors. There is also a reasonably detailed discussion of:
- the nature of traditional insurance versus NTNI activities; and
- effective separation of NTNI business.
Traditional versus NTNI Insurance
Traditional Insurance is broadly characterised by insured events which are accidental in nature, random in occurrence and subject to the law of large numbers. In contrast, NTNI broadly includes activities that are more financially complex than traditional insurance, where liabilities are significantly correlated with financial market outcomes (such as stock prices, and the economic business cycle) and have financial features such as leverage, liquidity or maturity transformation, imperfect transfer of credit risks, (i.e.“shadow banking”), credit guarantees or minimum financial guarantees.
Effective separation of NTNI
Whether NTNI activities are effectively separated goes to the heart of G-SII resolvability and the amount of Higher Loss Absorption (HLA) to be applied to a G-SII. The following conditions are relevant in this determination:
- Self-sufficiency: an effectively separated entity will be able to operate without the support of parent or affiliates;
- Operational independence of management;
- Regulated status: the effective separation of NTNI activities must not result in a non-regulated financial entity;
- Arm’s length dealings: any intragroup transactions or commitments with the separated NTNI entities must be executed “at arm’s length”; and
- Reputation risk: the risk that a parent or affiliate provides financial support to an entity even though there is no legal obligation to do so must be limited.
The IAIS’s proposals for the effective resolution of G-SIIs are based on the FSB’s Key Attributes of Effective Resolution Regimes for Financial Institutions but takes account of the specificities of insurance. This entails the establishment of Crisis Management Groups, the development of recovery and resolution plans (RRPs), the conduct of resolvability assessments, and the adoption of institution-specific cross-border cooperation agreements.
Higher Loss Absorption Capacity
G-SIIs will be required to have HLA capacity. This may only be met by “highest quality capital”, being permanent capital that is fully available to cover losses of the insurer at all times on a going-concern and a wind-up basis. In applying this requirement a distinction may be made based upon whether a firm’s NTNI activities have been effectively separated from traditional insurance business. HLA may be targeted at the entities where systemically important actives are located and also take account of whether group supervisors have authority over any non-regulated financial subsidiaries.
Report on Macroprudential Policy and Surveillance in Insurance
In addition to the microprudential supervision measures constituting the G-SII Policy Measures, the IAIS also released a framework for implementing macroprudential policy and surveillance (MPS) in the insurance sector, designed to maintain financial stability. Its focus is on enhancing the supervisory capacity to identify, assess and mitigate macro-financial vulnerabilities that could lead to severe and wide-spread financial risk. Over time, the MPS framework will be refined through the issuance of guidance on the practical application of IAIS Insurance Core Principles, and the development of a toolkit and data template regarding early warning risk measures.
Key implementation dates are as detailed below:
|Implementation of enhanced supervision for G-SIIs||
|FSB to designate the initial cohort of G-SIIs based on the IAIS methodology||
|For designated G-SIIs, implementation commences of resolution planning and resolvability assessment requirements||
|IAIS to prepare a workplan to develop a comprehensive, group-wide supervisory and regulatory framework for internationally active insurance groups (IAIGs)||
|Finalisation of IAIG framework||
|Systemic Risk Management Plan (SRMP) to be completed||
|Crisis management groups (CMGs) to be established for initial set of G-SIIs||
|G-SII designation of major reinsurers||
|IAIS to develop straightforward, backstop capital requirements to apply to all group activities, including non-insurance subsidiaries||
|CMGs to develop and agree RRPs, including liquidity risk management plans for initial set of G-SIIs||
|IAIS to develop implementation details for HLA that will apply to designated G-SIIs starting from 2019||
|Implementation of SRMPs to be assessed||
|FSB to designate the set of G-SIIs, based on the IAIS methodology and 2016 data, for which the HLA policy measure will apply, with implementation beginning in 2019||
|HLA requirements to apply to those G-SIIs identified in November 2017||
On 18 April 2013, the Financial Stability Board (FSB) published a press release announcing the completion of a common data template for globally systemically important banks (G-SIBs).
The financial crisis highlighted major gaps in information on systemically important financial institutions, particularly the bilateral linkages between such institutions, or their common exposures and liabilities to financial sectors and national markets. In response, the G-20 charged the FSB with developing:
- a common data template for systemically important global financial institutions; and
- proposals for an international framework to support the collection and sharing of information on such institutions.
The G-SIB template represents the completion of stage 1 of the project. Stages 2 and 3 will involve the extension of the framework to include the collection of data on bilateral funding dependencies and consolidated balance sheet. The data will be held in a central data hub, hosted by the BIS, and will be shared on with national supervisory authorities which are part of the framework.