FSB and IOSCO Seek to Identify Non-bank Non-insurer G-SIFIs

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

FSB Updates G-SIB List

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

Non-bank RRP Update

On 25 October 2013, the Financial Stability Board (FSB) published a list of:

FSB Publishes Assessment Methodology for the Key Attributes of Effective Resolution Regimes

On 28 August 2013, the Financial Stability Board (FSB) published a press release announcing the launch of a proposed Assessment Methodology for the Key Attributes of Effective Resolution Regimes for Financial Institutions.  The Key Attributes of Effective Resolution Regimes for Financial Institutions (‘the Key Attributes’) were endorsed by G20 Leaders at the Cannes Summit in November 2011 as the international standard for resolution regimes. The Key Attributes sets out the core elements that the FSB considers to be necessary for an effective resolution regime.

The FSB developed the draft methodology to facilitate the objective and consistent assessment of a jurisdiction’s compliance with the Key Attributes and to assist jurisdictions in the implementation of legislative reforms.  The methodology proposes a set of assessment criteria for each Key Attribute and includes examples and explanatory notes to guide their interpretation.  The FSB welcomes comments on the draft methodology by 31 October 2013.

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.

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

FSB Issues RRP Guidance

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:

Guidance on developing effective resolution strategies

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.

Guidance on identification of critical functions and critical shared services

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:

Functions

  • Deposit taking;
  • Lending and Loan Servicing;
  • Payments, Clearing, Custody & Settlement;
  • Wholesale Funding Markets; and
  • Capital Markets and Investments activities.

Shared services

  • Finance-related shared services; and
  • Operational shared services.

Guidance on Recovery Triggers and Stress Scenarios

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.

First FSB thematic peer review report on resolution regimes

Introduction

On 11 April 2013, the Financial Stability Board (FSB) published its first “Thematic Review on Resolution Regimes” (the “Review”).

The objective of the Review is to evaluate FSB jurisdictions’ existing resolution regimes and any planned changes to those regimes using the FSB’s “Key Attributes of Effective Resolution Regimes for Financial Institutions” (“KAs”) as a benchmark.  The Review compares national resolution regimes across individual KAs and across different financial sectors.  It uses responses to an FSB questionnaire as the primary source of information.

The Review concludes that, while major legislative RRP-related reforms have already been undertaken by some jurisdictions, implementation of the KAs is still at an early stage and additional guidance from the FSB is necessary in order to assist implementation efforts.  More specific conclusions, loosely grouped by topic, are provided below.

Recovery and resolution planning

The Review reported that, in most jurisdictions, there is no explicit requirement in statute or regulation for the submission of recovery and resolution plans (“RRPs”) by domestic systemically important financial institutions.  In addition, most authorities have the power to ask, but lack the power to require, firms to make changes to their organisational and financial structures solely in order to improve their resolvability and in advance of resolution.

Resolution Powers

The Review concluded that all jurisdictions have enacted some of the resolution powers specified in the KAs in relation to banks and insurers, but few are equipped with a full set of powers.  Moreover, resolution powers are considerably more developed for banks than for insurance and, especially, for securities or investment firms and financial market infrastructures (“FMIs”), where both mandates and powers “fall well short of the standards in the KAs”.  Furthermore, not all powers are exercisable solely by resolution authorities and the approval of resolution actions by courts is still often required.

Very few authorities have the statutory power to full effect bail-in within resolution with respect to banks, and powers to do so in relation to insurers, securities or investment firms and FMIs are generally not available.  Most jurisdictions also lack the power to impose a temporary stay on the exercise of contractual early termination rights or to take control of the parent or affiliates of a failed financial institution, particularly if its holding company or significant operational affiliates are unregulated.  On the plus side, within most jurisdictions, the exercise of resolution powers is accompanied by safeguards, such as respect for the creditor hierarchy and rights of judicial review.

Resolution Funding

The Review found that most jurisdictions rely on privately funded resolution funds.  In general, resolution funding arrangements are available for banks, but less so for insurance and securities firms, and are largely non-existent for FMIs.  Notwithstanding the existence of private sources of funding, public financial support remains an important component of resolution funding.  Mechanisms for recovery of public funds from shareholders, participants or creditors of the failed firm, or the wider financial industry, are less well developed.

Cross-Border Cooperation

The Review noted that national legal frameworks for cross-border cooperation in resolution are, overall, less well-developed across all sectors than other areas of the KAs.  In particular, the cross-border sharing of information is limited due to the fact that FSB jurisdictions lack clear and dedicated statutory provisions for domestic authorities to share confidential information with foreign resolution authorities.  On the plus side, the Review found that, in general, creditors are not discriminated against by virtue of the location of their claim.

FSB Recommendations

The FSB makes a number of recommendations, grouped into the following actions areas:

  • full implementation of the KAs;
  • additional clarification and guidance on the application of the KAs by the FSB; and
  • on-going implementation monitoring.

Conclusion

The Review doesn’t really tell us much that we didn’t already know.  However, it presents an interesting snap-shot of the current global state of RRP and provides a large amount of information in a very digestible form.  Section II of the Review provides a good summary of the development of RRP through the course of the financial crisis, and of particular use are the summaries of:

  • the selected powers for resolving banks across FSB jurisdictions (Table 2);
  • the recent major RRP legislative reforms in FSB jurisdictions (Annex A); and
  • the selected features of resolution regime in FSB jurisdictions (Annex B).

FSB Completes Stage 1 of G-SIB Common Data Template

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.

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.