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.

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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

 

Ending “Too-Big-To-Fail”: FSB Progress Report to the G20

Last week, the leaders of the G20 met in Los Cabos, to discuss, among other things, the progress of financial regulatory reform, a key aim of which is to address the issue of financial institutions which are ‘too-big-to-fail.  The Financial Stability Board (“FSB”), tasked with overseeing this reform programme, published a report detailing progress in the implementation of the G20 recommendations.

The FSB report addressed three main areas:

  • Improving the capacity to resolve firms in crisis;
  • Improving the intensity and effectiveness of systemically important financial institution (“SIFI”) supervision; and
  • Extending the SIFI framework.

Improving the capacity to resolve firms in crisis

General

The FSB Key Attributes of Effective Resolution Regimes for Financial Institutions outlines the essential elements of any resolution regime, highlighting the following requirements:

  • the establishment of Crisis Management Groups (CMGs);
  • the elaboration of recovery and resolution plans (RRPs);
  • the conduct of resolvability assessments;
  • the adoption of institution-specific cross-border cooperation agreements (COAGs); and
  • the establishment of cooperation arrangements with jurisdictions that are hosts to systemic operations of a G-SIFI but are not represented on its CMG.

Crisis Management Groups and RRPs

The FSB reported that 24 out of 29 G-SIFIs have established CMGs, of which a few have discussed resolution strategies and ‘started to develop operational plans to implement them.’  However, the FSB concedes that, in many cases, the work of CMGs and the development of RRPs is restricted by the absence of ‘clearly articulated resolution strategies’, and has given priority to resolving this matter by the end of 2012.

Resolvability Assessments

The aim of a resolvability assessment is to highlight obstacles to resolution.  Again, there is an acknowledgement that the development of resolution strategies is a precondition of effective resolvability assessments.  The FSB concludes that such assessments should be conducted from Q1 2013, after the development of the necessary resolution strategies.

Institution-specific cooperation agreements

The FSB report states that no institution-specific cooperation agreements have been agreed to date.  This is due, in part, to the lack of developed resolution strategies and also due to the difficulties of sharing information across jurisdictions.  Therefore, the FSB will examine obstacles to the exchange of information with a view to developing minimum common terms and content for information sharing to be included within cooperation agreements by early 2013.

Cooperation with Non-CMG host jurisdictions

The FSB acknowledges that channels of communication need to exist between a CMG and host authorities that are not represented in the CMG, and proposes to develop further guidance on the matter.

Improving the intensity and effectiveness of SIFI supervision

More intense and effective supervision of SIFIs is posited as a key pillar of the FSB’s financial reform framework, and focuses on four key areas:

  • Holding supervisors to higher standards;
  • Improving supervisory tools and methods;
  • Enhancing the effectiveness of supervisory colleges; and
  • Improving firms’ risk data aggregation capabilities.

The consensus is that progress is being made in these areas, but that more work is needed. The development of uniform principles of banking supervision, (based on the BCBS’s Core Principles for Effective Banking Supervision) is underway, with a projected publication date of autumn 2012. Significantly, on the subject of improving supervisory tools and methods, the FSB concludes that ‘while resources at supervisory authorities have increased since the financial crisis, the pace of increase has not been commensurate with higher regulatory and supervisory demands.’ The report also highlights the relative lack of expertise across supervisory bodies, and the need to improve the risk measurement capabilities of supervisory colleges.  Finally, the FSB is compiling guidelines concerning firms’ risk aggregation capabilities, to be published by the end of the year, with firms being expected to begin implementation in 2016.

Extending the SIFI Framework

Domestic Systemically Important Banks (“D-SIBs”)

At the 2011 G20 summit, it was proposed that the G-SIFI framework, addressing the issue of ‘too-big-to-fail’, should be extended to cover D-SIBs. Whereas the G-SIB framework considers the global impact of banking failures, by realigning the framework, it is hoped that the externalities of bank failure at the local level can be identified and addressed. The Basel Committee on Banking Supervision (“BCBS”), in collaboration with the FSB, is in the process of developing a D-SIB framework which is compatible with that of the G-SIB, facilitates home-host coordination and improves D-SIB loss absorbency. The findings of the FSB and BCBS will be presented to the G20 Finance Ministers and Central Governors meeting in November 2012.

Global Systemically Important Insurers (“G-SIIs”)

The report further notes that the International Association of Insurance Supervisors (“IAIS”) was tasked with the ‘development of an assessment methodology for the identification of G-SIIs’ and has made significant progress to this end, publishing a paper on policy measures that should apply to G-SIIs.  A consolidated paper on the assessment methodology and the policy measures will be delivered to the G20 in April 2013, with an initial list of G-SIIs being produced soon thereafter. For more information on this aspect, please see the post on this blog entitled “Recovery and Resolution Plans for Globally Systemically Important Insurers by Mid-2014” dated 7 June 2012.

Non-bank G-SIFIs

In recognition of the fact that non-bank G-SIFIs can also cause widespread disruption to the global financial system, G20 leaders asked the FSB, with the International Organisation of Securities Commission (“IOSCO”) to design a methodology for identifying such institutions.  However, no date was given by which IOSCO is due to report.

G20 Leaders Declaration – Los Cabos 18-19 June 2012

On 20 June 2012, the G20 published its leaders’ declaration following the close of the Los Cabos summit.  The declaration was wide-ranging, but on the subject of economic stabilisation and the global recovery, the G20 affirmed its support for the ‘consideration of a more integrated financial architecture, encompassing banking supervision, resolution and recapitalization, and deposit insurance’ within the EU.

More specifically, the G20 also provided guidance on the future timetable for financial sector reform:

  • reiterating its commitment to make national resolution regimes consistent with the FSB Key Attributes of Effective Resolution Regimes;
  • supporting the ongoing development of recovery and resolution plans and institution-specific cross-border cooperation agreements for all G-SIFIs;
  • reiterating its commitment to strengthen the intensity and effectiveness of the supervision of SIFIs and requesting the FSB to report on progress in this area in November 2012 at the G20 Finance Ministers and Central Bank Governors’ meeting;
  • welcoming progress on the development of a common framework for the identification of, and policy measures relating to, domestic systemically important banks (D-SIBs);
  • Requesting the FSB and the International Association of Insurance Supervisors (IAIS) to complete their work on identification and policy measures for global systemically important insurers by April 2013;
  • looking forward to the preparation by the FSB and the International Organization of Securities Commissions (IOSCO) of methodologies to identify other systemically important non-bank financial entities by end-2012;
  • calling on the Committee on Payment and Settlement Systems (CPSS) and IOSCO to continue their work on systemically important market infrastructures; and
  • requesting the IAIS to continue its work to develop a common framework for the supervision of internationally active insurance groups by end-2013.

The full declaration can be found here.

 

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