RRP for Non-Banks – Is Your Data Up to Scratch?

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The consultation document proposes draft guidance on how the Key Attributes should be implemented with respect to systemically important non-bank financial institutions.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:
    • location;
    • 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:
    • counterparties;
    • 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.

Advertisements

First Nine G-SIIs Named

Introduction

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:

Enhanced Supervision

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.

Effective Resolution

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.

Implementation Timeframe

Key implementation dates are as detailed below:

Event

Date

Implementation   of enhanced supervision for G-SIIs

Immediate

FSB to designate the initial   cohort of G-SIIs based on the IAIS methodology

July 2013

For   designated G-SIIs, implementation commences of resolution planning and   resolvability assessment requirements

July 2013

IAIS   to prepare a workplan to develop a comprehensive, group-wide supervisory and   regulatory framework for internationally active insurance groups (IAIGs)

October 2013

Finalisation   of IAIG framework

End 2013

Systemic   Risk Management Plan (SRMP) to be completed

July 2014

Crisis   management groups (CMGs) to be established for initial set of G-SIIs

July 2014

G-SII   designation of major reinsurers

July 2014

IAIS   to develop straightforward, backstop capital requirements to apply to all   group activities, including non-insurance subsidiaries

September 2014

CMGs to develop and agree RRPs,   including liquidity risk management plans for initial set of G-SIIs

End 2014

IAIS to develop implementation   details for HLA that will apply to designated G-SIIs starting from 2019

End 2015

Implementation   of SRMPs to be assessed

July 2016

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

November 2017

HLA   requirements to apply to those G-SIIs identified in November 2017

January 2019

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.

Insurance and the Question of “Too Big To Fail”

More from the FT, which provides an interesting update on the initiative to identify globally systemically important insurers.  Plans drawn up by the International Association of Insurance Supervisors are described as being “incoherent, impractical and simplistic” by the industry, which expresses particular concern about the intention to include variable annuities on the list of activities that are “non-insurance”, “non-traditional” or “semi-traditional” and hence subject to increased capital requirements.

Insurers Less Systemically Important Than Banks Says Geneva Association

Introduction

On 11 December 2012, the Geneva Association, a think-tank for the insurance industry, published a cross-industry analysis comparing the 28 Global Systemically Important Banks (G-SIBs) to 28 of the world’s largest insurers on indicators of systemic risk.

The analysis studied 17 indicators that are regarded as being comparable between insurers and banks to provide an analysis of the size of each activity. The conclusions drawn were that:

Insurers are significantly smaller than banks

  • The average bank’s assets are 3.9 times larger than the average insurer;
  • The largest insurer would rank only 22nd in the list of G-SIBSs by size.

Insurers write considerably less CDS than banks

  • The average bank writes 158 times the value of gross notional Credit Default Swaps (CDS) than the average insurer;
  • The lowest ranked banks on average have 12.5 times the CDS sold by the average insurer.

Insurers utilise substantially less short-term funding than banks

  • Short-term funding as a percentage of total banks assets is 6.5 times higher than short-term funding as a percentage of insurer assets.

Insurers are less interconnected to other financial services providers than banks

  • Banks carry 219 times more gross derivative exposure than the insurer average;
  • The lowest ranked banks carrying 66 times more gross derivative exposure than the average insurer;
  • At the measurement date, banks owed on average 68 times more than insurers in gross negative derivatives;
  • Banks are owed 70 times more from derivatives counterparties through derivatives exposure than insurers.

 

IAIS consults on policy measures for global systemically important insurers

Introduction

On 17 October 2012, the International Association of Insurance Supervisors (IAIS) published a consultation document relating to proposed policy measures for global systemically important insurers (G-SIIs) i.e. insurers whose distress or disorderly failure would cause significant disruption to the global financial system.

The consultation remains open until 16 December 2012 and details policy measures designed to reduce the probability and impact of G-SII failure as well as to incentivise G-SIIs to become less systemically important and non G-SIIs not to become G-SIIs.  The policy measures are broken down into three main categories:

  • Enhanced supervision;
  • Effective resolution; and
  • Higher loss absorption (“HLA”) capacity.

Enhanced Supervision

Non-traditional and non-insurance (NTNI) activities of G-SIIs, such as derivates trading, are regarded as particular sources of systemic risk.  Within most G-SIIs, NTNI activities are carried out within separate group companies.  As such, it is necessary for supervisors of G-SIIs to have group-wide supervision powers.  Within this context, enhanced supervision will take the form of:

  • Enhanced liquidity planning and management; and
  • Systemic Risk Reduction Plans.

Enhanced Liquidity Planning and Management

G-SIIs will be required to have adequate arrangements in place to manage group liquidity risk, primarily in relation to NTNI activities and channels of interconnectedness.

Systemic Risk Reduction Plan

In addition to maintaining recovery and resolution plans (RRPs), G-SIIs will be required to develop Systemic Risk Reduction Plans (SRRP).  The purpose of an SRRP is to shield traditional insurance business from NTNI business (and vice versa), reduce the systemic importance of the G-SII and improve resolvability.  Where appropriate, an SRRP should include ex-ante measures to ensure the effective separation of systemically important NTNI activities from traditional insurance business into standalone, regulated entities.  GSIIs must ensure that any entities created as a result of this process do not benefit from subsidies in the form of capital and/or funding and are:

  • Structurally self-sufficient: meaning that the entity could be liquidated without impacting the remaining group and that intra-group transactions such as guarantees  and cross-default clauses are either prohibited or at a minimum adequately monitored and restricted; and
  • Financially self-sufficient: meaning that the entities in question are adequately capitalised.

 In addition, the following specific policy measures should be considered:

  • Direct prohibition or limitation of systemically important activities;
  • Requirements for prior approval of transactions that fund or support systemically important activities;
  • Requirements for spreading or dispersing risks relating to systemically important activities; and
  • Limiting or restricting diversification benefits between traditional insurance business and other businesses.

 Effective resolution

The FSB’s “Key Attributes of Effective Resolution Regimes for Financial Institutions” (Key Attributes) details the specific resolution requirements for all G-SIFIs and forms the basis for improving G-SII resolvability.  These requirements include:

  • The establishment of Crisis Management Groups (CMGs);
  • The elaboration of recovery and resolution plans (RRPs);
  • The conduct of resolvability assessments; and
  • The adoption of institution-specific cross-border cooperation agreements.

However, measures to resolve G-SIIs must also account of the specificities of insurance including:

  • Measures needed to separate NTNI activities from traditional insurance activities;
  • The possible use of portfolio transfers and run off arrangements as part of the resolution of entities conducting traditional insurance activities; and
  • The existence of policyholder protection and guarantee schemes (or similar arrangements).

Higher loss absorption (HLA) capacity

The IAIS proposes a cascading approach to increasing HLA capacity.  Initially, higher HLA requirements would be targeted on specific G-SII group entities depending on the extent to which it had demonstrated effective separation between traditional insurance and NTNI activities, with additional capital being required in relation to activities that have the potential to generate or aggravate systemic risk (e.g. NTNI businesses).  Subsequently, an assessment of the adequacy of group HLA levels would also be performed.  This would take into account the level of HLA in individual group companies and any entity separation that exists, but only where that HLA was not created by multiple-gearing through down streaming capital within the G-SII.  However, the IAIS acknowledges that there is an on-going internal discussion as to whether this subsequent step is required if targeted HLA and other measures (such as restrictions and prohibitions) are effective in reducing systemic importance to an acceptable level.  In all cases, higher HLA capacity could only be met by “the highest quality capital”, being permanent capital that is fully available to cover losses of the insurer at all times on a going-concern basis.

Implementation time frame

A detailed timeline for the implementation of G-SII policy measures is detailed below:

Key Implementation Dates and Timeframes

Action Required

 

April 2013

First G-SIIs designated (with annual designations thereafter   expected each November)

From 2013

Implementation of enhanced supervision and effective resolution   commences

End 2013

IAIS   to elaborate proposed HLA capacity measures

Within 12 months of designation

Crisis   Management Groups (CMGs) to be established

Within 18 months of designation

Other   resolution measures to be completed

Within 18 months of designation

Systemic   Risk Reduction Plan (SRRP) to be completed

Within 36 months of designation

Implementation of SRRP to be assessed

November 2014 to 2016

G-SIIs   designated annually (with HLA not applicable until 2019)

November 2017

G-SIIs   designated based on 2016 data (with HLA applicable from 2019)

January 2019

HLA   capacity requirements apply based on assessment of implementation of the   structural measures