Here is a link to an article in today’s FT explaining that, following the FSB guidance issued on 16 July 2013 (see this blog post for more detail), banks seem likely to be given more ‘choice’ between single point of entry and multiple point of entry. This seems to represent a subtle shift away from the previous consensus that had been developing within regulatory circles regarding the benefits of single point of entry over multiple point of entry. However, the quid pro quo is that banks will have to implement potentially wide-ranging changes in order to make their business models more consistent with their chosen resolution mechanism.
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 16 July 2013, the Financial Stability Board (FSB) published the following three papers intended to assist authorities and systemically important financial institutions (SIFIs) in implementing the recovery and resolution planning (RRP) requirements set out under the FSB’s key attributes of effective resolution regimes for financial institutions:
This paper describes key considerations and pre-conditions for the development and implementation of effective resolution strategies, dealing with such issues as:
- the sufficiency and location of loss absorbing capacity (LAC);
- the position of LAC in the creditor-hierarchy, particularly with respect to insured and uninsured depositors;
- operational and legal structures most likely to ensure continuity of critical functions;
- resolution powers necessary to deliver chosen resolution strategies;
- enforceability, effectiveness and implementation of “bail-in” regimes;
- treatment of financial contracts in resolution, specifically the use of temporary stays on the exercise of contractual close-out rights;
- funding arrangements;
- cross-border cooperation and coordination;
- coordination in the early intervention phase;
- approvals or authorisations needed to implement chosen resolution strategies;
- fall-back options for maintaining essential functions and services in the event that preferred resolution strategies cannot be implemented;
- information systems and data requirements;
- post-resolution strategies;
- single point of entry (SPE) versus multiple point of entry (MPE) resolution strategies; and
- disclosure of resolution strategies and LAC information.
This guidance is designed to assist authorities and CMGs in their evaluation of the criticality of functions that firms provide to the real economy and financial markets. It aims to promote a common understanding of which functions and shared services are critical by providing shared definitions and evaluation criteria.
After describing the essential elements of a critical function and a critical shared service, the annex to the guidance provides a non-exhaustive list of functions and shared services which could be critical:
- Deposit taking;
- Lending and Loan Servicing;
- Payments, Clearing, Custody & Settlement;
- Wholesale Funding Markets; and
- Capital Markets and Investments activities.
- Finance-related shared services; and
- Operational shared services.
This guidance focuses on two specific aspects of recovery plans:
- criteria triggering senior management consideration of recovery actions (“triggers”), specifically: design and nature, firm’s reactions to breached triggers, and engagement by supervisory and resolution authorities following breached triggers; and
- the severity of hypothetical stress scenarios and the design of stress scenarios generally.
On 16 July 2013, the EU Presidency published a compromise proposal amending the EU Commission’s previous compromise proposal (dated 19 June 2013) relating to the Recovery and Resolution Directive (RRD).
As detailed in Annex 2 to the document, the main changes address issues such as:
- the scope of the bail-in tool; and
- resolution financing arrangements.
On 3 July 2013, the EU Parliament updated its procedure file on the Recovery and Resolution Directive (RRD). It seems that the RRD proposal will not now be considered until the Parliament’s plenary session scheduled for 18 to 21 November 2013, rather than the session scheduled for 21 to 24 October 2013, as was previously the case.
On 27 June 2013, the EU Council published a press release confirming an agreed position with respect to the Recovery and Resolution Directive (RRD) and calling on the EU Presidency to start trilogue negotiations with the EU Parliament with a view to adoption of the RRD at first reading before the end of 2013.
The press release focuses on three areas:
- Resolution funds; and
- Minimum loss absorbing capacity.
It does not contain much in the way of detail beyond that widely reported over the last week. However, it is perhaps noteworthy that only inter-bank liabilities with an original maturity of less than seven days are to be excluded from the scope of the bail-in tool.
On 20 June 2013, the Presidency of the Council of the EU published a note on the current “state of play” with respect to the Recovery and Resolution Directive (RRD), together with a compromise RRD proposal. It also invited the EU Council to agree the compromise and mandate the Presidency to undertake negotiations with the EU Parliament with a view to reaching an agreement on the RRD as soon as possible.
The “state of play” summary focuses on the need to achieve an optimal balance between three interlinked elements of the RRD, dubbed the “Resolution Triangle”:
- the design of the bail in tool;
- minimum requirements for own funds and eligible liabilities (MREL); and
- financing arrangements.
The Presidency has proposed a “mixed approach” to each ‘angle’ of the triangle, as set out below.
The Design of the Bail-in Tool (Article 38)
The Presidency is seeking to strike a balance between harmonisation and flexibility with respect to bail-in, proposing:
- a limited discretionary exclusion for derivatives – this would only apply in particular circumstances and only where necessary to achieve the continuity of critical functions and avoid widespread contagion; and
- a power for resolution authorities, available in extraordinary circumstances and limited to an amount equal to 2.5% of the total liabilities of the institution in question, to exclude certain other liabilities from bail-in where it is not possible to bail them in within a reasonable time, or for financial stability reasons.
Minimum Requirements for Own Funds and Eligible Liabilities (Article 39)
In recognition of the general consensus around the need for adequate MREL, but in an effort to marry the need for harmonisation in this area with the practical difficulty of defining an appropriate level of MREL (particularly with respect to different banking activities and different business models), the Presidency proposes that the MREL of each institution should be determined by the appropriate resolution authority on the basis of specific criteria, including:
- its business model;
- level of risk; and
- loss absorbing capacity.
The concept of a minimum percentage of MREL for global SIFIs will not be pursued.
Financing Arrangements (Articles 92 and 93)
The key features of the Presidency proposal in this area are that:
- Member States should be free to keep Deposit Guarantee Schemes (DGS) and resolution funds separate or to merge them; and
- a resolution fund should have a minimum target level of:
- 0.8% of covered deposits (and not ‘total liabilities’ of a Member State’s banking sector as suggested by some Member States) where kept separate from the DGS, or
- 1.3% where combined with the DGS.
The Presidency proposes to maintain the current 2018 date for the introduction of bail-in, rather than bring that date forward to 2015 as suggested by some Member States.
On 26 April 2013, the FCA published its first Policy Development Update (PDU) for April 2013 which details forthcoming FCA publications relating to a number of areas, including RRP, client assets and EMIR, as detailed below.
High level standards
Current Expected Publication Date
Previous Expected Publication Date
|Recovery and Resolution Plans: policy statement to CP11/16||
|Policy statement on non-EEA national depositor preference regimes||
Current Expected Publication Date
Previous Expected Publication Date
|Client assets regime – multiple client money pools – policy statement to part 2 of CP12/22||
|Client assets review – consultation paper||
|Review of the client money rules for insurance intermediaries – policy statement to CP12/20||
|CRD IV – consultation paper on strengthening capital standards||
Pursuant to Article 38(3) of the original EU Commission proposal for a EU Directive establishing a framework for the recovery and resolution of credit institutions and investment firms (the “RRD”), resolution authorities may exclude derivatives transactions from the scope of the Bail-in tool if that exclusion is “necessary or appropriate” to:
- ensure the continuity of critical functions; and
- avoid significant adverse effects on financial stability.
Much has already been written as to whether derivatives should be in- or out-of-scope as far as the Bail-in tool is concerned. The practical difficulties of implementing bail-in in relation to portfolios of derivatives transactions is generally recognised. In addition, whilst excluding derivatives from the scope of bail-in creates a clear regulatory arbitrage in the way in which deals can be structured between counterparties, this risk is mitigated by the fact that firms which are subject to the RRD will be required to maintain a minimum amount of bail-inable debt at all times.
In many ways, the greater risk lies not in whether derivatives themselves are in- or out- of scope, but in the fact that Member States are given discretion to choose whether they are or not. The extent to which this is really consistent with the concept of a single market is unclear, and some commentators have questioned whether this aspect of the EU Commission draft would survive the EU trialogue process under which the EU Commission, EU Parliament and the Council of Ministers thrash out their differing opinions with respect to proposed legislation with a view to arriving at a compromise position. However, this question was largely answered on 5 June 2013, when the EU Parliament’s Economic and Monetary Affairs Committee published a report which sets out the Parliament’s proposed amendments to the RRD, in anticipation of the beginning of the trilogue process. Within the EU Parliament document, the concept of Member State discretion in determining whether derivative transactions are in- or out-of-scope for the purposes of the bail-in tool remains intact and so seems unlikely even to arise during the trilogue discussions.
Interestingly, the EU Parliament has taken matters a step further, suggesting a different amendment which would, if passed, require that cleared derivatives are treated as more senior than non-cleared derivatives in a bail-in situation. In other words, non-cleared transactions stand to be bailed-in before cleared transactions. This is understandable in the context of the drive towards central clearing. However, it will potentially change the risk associated with counterparties which are subject to the RRD and are established in jurisdictions where derivatives are within the scope of the Bail-in tool. It will also potentially impact on the price at which such trades are executed. It remains to be seen just how this provision interacts with another exclusion from the scope of the Bail-in tool – that relating to secured liabilities. It may be that only uncollateralised non-cleared transactions would be affected. Moreover, in light of requirement to enact the BCBS/IOSCO “Margin requirements for non-centrally cleared derivatives” in Europe, there may not be much of this trading activity taking place in the future. Of course, excluding secured derivatives from the scope of the bail-in regime would likely defeat the point of bailing in derivatives in the first place. In this scenario the discretion afforded to Member States may be more illusory than real. Either way, as we don’t currently have answers to any of these questions we’ll be monitoring how this conversation develops, so watch this space.