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The Financial Conglomerates Directive
Revision of the Financial Conglomerates
Directive -
Frequently Asked Questions
16 Aug 2010
1) What are financial conglomerates?
Financial conglomerates are financial groups that are active
in one or more country and operate in both the insurance and
banking business. They are often large and complex.
Due to their size, financial conglomerates are often of systemic
importance to our economy: either for one or more Member States or
even for the EU as a whole.
The fact that financial
conglomerates can impact our economy was highlighted during the
financial crisis in 2008. A number of financial conglomerates had
difficulties and governments across Europe had to resort to large
financial injections in order to keep these financial
conglomerates afloat.
2) How are financial conglomerates currently supervised?
Currently, supervision in Europe is mainly done at
the national level.
Each single legal entity that wants to operate in the banking
sector in an EU Member State needs authorisation from the national
financial supervisor and needs to comply with the relevant banking
regulation.
The same applies for legal entities that want to operate in the
insurance sector: such entities need to be authorized as insurance
companies and must comply with the relevant insurance regulation.
Supervision rules also allow for a group of authorised banking
entities to be subject to consolidated banking supervision.
Similarly, in the insurance sector, a group of authorised
insurance entities can be subject to insurance group supervision.
Financial conglomerates are often active in both banking
and insurance business and operate in several EU Member States.
The Financial Conglomerate Directive (2002/87/EC) gives national
financial supervisors additional powers and tools to watch over
these firms. More specifically, the Directive requires supervisors
to apply supplementary supervision on these conglomerates, in
addition to the specific banking and insurance supervision.
3) What is supplementary supervision?
Supplementary supervision becomes relevant when a financial
group (or a "conglomerate") consists of several legal entities
that are authorised to do business in banking, insurance or other
sectors of the financial services industry.
The number of legal entities within a conglomerate can exceed 500
or even 1.000. All of these entities are controlled by a parent
entity, where decisions are made regarding business strategies,
internal governance and group-wide risk management.
While a parent entity can be a regulated entity itself, such as a
bank or an insurance company, it can also take the form of a
holding company.
Supplementary supervision focuses on
problems that can arise from:
Multiple use of capital:
supervisors are to make sure that capital is not used twice or
more within a conglomerate.
For example, funds may not be included in the calculation of
capital on both the level of the single entity and the parent
entity.
Group risks: Group risks are risks that arise from
the group structure and which are not related to specific banking
or specific insurance business.
They refer to risks of contagion (when risks spread from one end
of the group to another), management complexity (managing more
than 1.000 legal entities is a far more difficult challenge than
managing 20 legal entities), risk concentration (the same risk
materialising in several parts of the group at the same time), and
conflicts of interest (e.g. one part of the group has an interest
in selling an exposure, while another part of the group has an
interest in keeping that exposure).
The 2002 Financial
Conglomerates Directive allows national supervisors to monitor
those risks, for example by requiring conglomerates to provide
additional reporting.
Supervisors can also require conglomerates to present additional
risk management or internal governance measures.
The Directive also requires supervisors to cooperate across
sectors and across borders in order to control possible group
risks.
4) Why is the Commission now proposing a revision of the Financial
Conglomerates Directive?
In the light of the
financial crisis, the Commission evaluated the effectiveness of
the Financial Conglomerates Directive in 2008. It found that
supplementary supervision, as stipulated in the Directive, could
not be carried out on certain financial groups because of their
legal structure.
In some cases, national financial supervisors were left without
the appropriate tools because they had been obliged to choose
either banking or insurance supervision under the sector-specific
directives or supplementary supervision under the Financial
Conglomerates Directive as the definitions for banking and
insurance holding companies in the sector-specific directives and
for mixed holdings in the Conglomerates Directive were mutually
exclusive.
The main objective of the revision of the Directive is to correct
this unintended consequence of the current rules.
5) What is to change under the Commission's proposal?
The proposed amendments to the 2002 Directive can be
summarised as follows:
Under the current rules, supervisors
have to choose which supervision they apply when a group acquires
a significant stake in another sector and when the parent entity
is a holding company.
It is now proposed to change this: both sector-specific (banking
and insurance) supervision and supplementary supervision could be
applied on the conglomerate's parent entity, also if it concerns a
holding company.
Banking supervision would therefore remain applicable even if the
banking group acquires a significant stake in an insurance
business.
By the same token, insurance supervision would also remain
applicable if the insurance group acquires a significant stake in
a banking business.
When justified by potential group
risks as a whole, financial supervisors should be allowed to
identify a group as a financial conglomerate and apply
supplementary supervision.
The identification process of financial conglomerates should allow
for risk-based assessments, in addition to existing definitions
relating to size ("quantitative indicators").
Under the current rules, the balance sheet figures are
determinative when identifying conglomerates.
This approach sometimes results in a list of conglomerates that
are not necessarily exposed to group risks, while groups that are
evidently exposed to group risks are not always included within
the scope of supplementary supervision.
Financial
supervisors should be allowed to waive a group from supplementary
supervision if it is small (smaller than 60 billion total assets)
and if the supervisor assesses the group risks to be negligible,
even if the small group meets the quantitative indicators.
This should enable supervisors to allocate their resources to the
supplementary supervision of larger and systemically important
conglomerates.
The proposed revision of the 2002 Financial
Conglomerates Directive also amends the relevant banking and
insurance supervision legislation, namely the Capital Requirements
Directive (2006/48/EC and 2006/49/EC) and the Directive on
Supplementary Supervision of Insurance Undertakings in Insurance
Groups (98/78/EC). The Commission is also currently reflecting on
tying in this initiative with Solvency II, the next generation of
supervisory rules for insurance and reinsurance companies in the
EU.
6) When will these new rules come into force?
With the proposal now passing to the European Parliament and
the EU Member States for consideration, the Commission hopes to
see the changes enter into force in 2011.
7) How does this proposal tie in with the wider work on crisis
prevention and management the EU is doing? Will the European
Financial Supervision Authorities be involved?
The main objective of this initiative is to restore the full
spectrum of supervisory tools and powers, regardless of the legal
structures of financial conglomerates.
This unintended consequence of the current rules needs to be
addressed as soon as possible.
Nevertheless, the initiative will also strengthen the effective
supervision of financial conglomerates.
The Commission believes that supplementary supervision of large,
complex groups, operating in several countries, can only be
effective if the same supervisory approach is applied consistently
across all EU Member States
As regards financial
conglomerates operating in several EU countries, closer
coordination between national financial supervisors will be
required, particularly through the new European Financial
Supervision Authorities (see IP/09/1347).
The proposals regarding those Authorities are currently being
negotiated between the Council and the European Parliament.
The new European Banking Authority (EBA) and the new European
Insurance and Occupational Pensions Authority (EIOPA) are to form
a Joint Committee to oversee cooperation and coordination between
national supervisors in the case of financial conglomerates.
As a follow up to this proposal and in order to assist the
Commission in proposing further improvements of the framework of
supplementary supervision, the Joint Committee is also expected to
look into extending the scope of supplementary supervision to
non-regulated entities such as Special Purpose Entities.
These are legal entities where assets are stored off the groups'
balance sheets. During the crisis, it became clear that contagion
and risk concentration originated also from non-regulated parts of
financial conglomerates.
This issue has been highlighted also on international level in the
context of the G20 work.
It is the Commission's intention to continue to work on this
issue and present further amendments to the Directive on Financial
Conglomerates as regards this matter as well as other issues
linked in particular to the new European supervisory structure.
Financial
Conglomerates Directive
Once upon a time, there were statutory barriers that prevented
banking, securities and insurance firms from operating within the
same financial conglomerate. But, financial liberalization has
removed these barriers.
It is a wise decision to take advantage of the new international
regulatory framework (or the lack of it). Credit Suisse, Allianz,
ING, Fortis, and Citigroup for example, all made cross-sector
acquisitions to combine banking and insurance activities.
Conglomeration across financial sectors, especially between
insurance and banking is definitely an opportunity, but is can also
be a risk for the stability of the financial system. It is easier to
spread risks, but it can also give rise to new ones.
Financial
Conglomerates Directive -
The good
It makes
sense. Financial conglomerates provide under a single corporate
umbrella banking, insurance and other financial products. There are
significant opportunities: The ability to move resources among
segments in response to industry conditions, the ability to absorb
industry shocks, economies of scale, risk diversification.
Financial Conglomerates Directive
-
The bad
A.
Temptations
The lack of
an international legal framework is always an opportunity for fraud,
a “temptation” (according to the COSO committee).
Can, for example, corporate banking activities in the UK underwrite
risky trading activities in Singapore?
This is exactly what has happened with Barings.
B. Regulatory / capital arbitrage
It is not too difficult to transfer assets between conglomerate
divisions in order to avoid high capital charges.
Conglomerate diversification reduces bankruptcy risk. Shouldn’t it
be rewarded with reduced capital requirements?
A key question for supervisors: Is the same capital used to meet
capital requirements in more than one company within the group?
Financial
Conglomerates
Directive - The ugly
Risk assessment in financial conglomerates.
The totality of risks in a conglomerate is not the same as the sum
of the risks in each of its parts.
The first step of a risk assessment is definitely risk
identification. In conglomerates is very difficult even to
understand the full range of businesses (and how these businesses
interact). Risks in one company can contaminate other entities of
the group.
Since the
early 1990s, supervisors try to capture the risks generated by the
various types of business and their interactions. The complexity
of conglomerates always makes effective supervision and proper
corporate governance really difficult.
Some financial products can be considered as insurance products,
banking products or securities products. In fact the same financial
products are offered by either banks, investment banks or an
insurance companies. Or, from conglomerates.
Insurance companies and banks have different risk profiles, on both
the asset and the liability sides of their balance sheets. Insurance
companies often have are more exposed to commercial real estate,
equities, and long-term bonds. Banks are more exposed to credit and
liquidity risk.
Financial
Conglomerates
Directive
-
The response of the European Union (EU)
The
Financial Conglomerates Directive tries to introduce
supplementary supervision of financial
conglomerates on a group-wide basis, in
addition to both the prudential supervision of regulated
entities on a standalone basis and consolidated supervision on a sectoral
basis.
This directive is targeting the large global financial groups to
ensure that their activities do not destabilise the financial system
(the same with Basel ii). A group is a financial conglomerate if at
least 40% of its business is financial and at least 10% or Euro 6
billion of its financial business is in each of the combined
banking/investment sectors.
Regulation tends to be national in scope. Coordination of
supervision across borders is absolutely necessary, but it is not
always easy. Most conglomerates are international in nature.
Business lines ignore national boundaries and controls are located
in different countries or continents.
Financial
Conglomerates
Directive
(1) The current Community legislation provides for a comprehensive
set of rules on the prudential supervision of credit institutions,
insurance undertakings and investment firms on a stand alone basis
and credit institutions, insurance undertakings and investment
firms which are part of respectively a banking/investment firm
group or an insurance group, i.e. groups with homogeneous
financial activities.
(2) New developments in financial
markets have led to the creation of financial groups which provide
services and products in different sectors of the financial
markets, called financial conglomerates.
Until now, there has been no form of prudential supervision on a
group-wide basis of credit institutions, insurance undertakings
and investment firms which are part of such a conglomerate, in
particular as regards the solvency position and risk concentration
at the level of the conglomerate, the intra-group transactions,
the internal risk management processes at conglomerate level, and
the fit and proper character of the management.
Some of these conglomerates are among the biggest financial groups
which are active in the financial markets and provide services on
a global basis.
If such conglomerates, and in particular credit institutions,
insurance undertakings and investment firms which are part of such
a conglomerate, were to face financial difficulties, these could
seriously destabilise the financial system and affect individual
depositors, insurance policy holders and investors.
(3) The
Commission Action Plan for Financial Services identifies a series
of actions which are needed to complete the Single Market in
Financial Services, and announces the development of supplementary
prudential legislation for financial conglomerates which will
address loopholes in the present sectoral legislation and
additional prudential risks to ensure sound supervisory
arrangements with regard to financial groups with cross-sectoral
financial activities. Such an ambitious objective can only be
attained in stages.
The establishment of the supplementary supervision of credit
institutions, insurance undertakings and investment firms in a
financial conglomerate is one such stage.
(4) Other
international forums have also identified the need for the
development of appropriate supervisory concepts with regard to
financial conglomerates.
(5) In order to be effective, the
supplementary supervision of credit institutions, insurance
undertakings and investment firms in a financial conglomerate
should be applied to all such conglomerates, the cross-sectoral
financial activities of which are significant, which is the case
when certain thresholds are reached, no matter how they are
structured.
Supplementary supervision should cover all financial activities
identified by the sectoral financial legislation and all entities
principally engaged in such activities should be included in the
scope of the supplementary supervision, including asset management
companies.
(6) Decisions not to include a particular entity
in the scope of supplementary supervision should be taken, bearing
in mind inter alia whether or not such entity is included in the
group-wide supervision under sectoral rules.
(7) The
competent authorities should be able to assess at a group-wide
level the financial situation of credit institutions, insurance
undertakings and investment firms which are part of a financial
conglomerate, in particular as regards solvency (including the
elimination of multiple gearing of own funds instruments), risk
concentration and intra-group transactions.
(8) Financial
conglomerates are often managed on a business-line basis which
does not fully coincide with the conglomerate's legal structures.
In order to take account of this trend, the requirements for
management should be further extended, in particular as regards
the management of the mixed financial holding company.
(9)
All financial conglomerates subject to supplementary supervision
should have a coordinator appointed from among the competent
authorities involved.
(10) The tasks of the coordinator
should not affect the tasks and responsibilities of the competent
authorities as provided for by the sectoral rules.
(11) The
competent authorities involved, and especially the coordinator,
should have the means of obtaining from the entities within a
financial conglomerate, or from other competent authorities, the
information necessary for the performance of their supplementary
supervision.
(12) There is a pressing need for increased
collaboration between authorities responsible for the supervision
of credit institutions, insurance undertakings and investment
firms, including the development of ad hoc cooperation
arrangements between the authorities involved in the supervision
of entities belonging to the same financial conglomerate.
(13) Credit institutions, insurance undertakings and investment
firms which have their head office in the Community can be part of
a financial conglomerate, the head of which is outside the
Community.
These regulated entities should also be subject to equivalent and
appropriate supplementary supervisory arrangements which achieve
objectives and results similar to those pursued by the provisions
of this Directive.
To this end, transparency of rules and exchange of information
with third-country authorities on all relevant circumstances are
of great importance.
(14) Equivalent and appropriate
supplementary supervisory arrangements can only be assumed to
exist if the third-country supervisory authorities have agreed to
cooperate with the competent authorities concerned on the means
and objectives of exercising supplementary supervision of the
regulated entities of a financial conglomerate.
(15) This
Directive does not require the disclosure by competent authorities
to a financial conglomerates committee of information which is
subject to an obligation of confidentiality under this Directive
or other sectoral directives.
(16) Since the objective of
the proposed action, namely the establishment of rules on the
supplementary supervision of credit institutions, insurance
undertakings and investment firms in a financial conglomerate,
cannot be sufficiently achieved by the Member States and can
therefore, by reason of the scale and the effects of the action,
be better achieved at Community level, the Community may adopt
measures, in accordance with the principle of subsidiarity as set
out in Article 5 of the Treaty.
In accordance with the principle of proportionality, as set out in
that Article, this Directive does not go beyond what is necessary
in order to achieve this objective.
Since this Directive defines minimum standards, Member States may
lay down stricter rules.
(17) This Directive respects the
fundamental rights and observes the principles recognised in
particular by the Charter of Fundamental Rights of the European
Union.
(18) The measures necessary for the implementation
of this Directive should be adopted in accordance with Council
Decision 1999/468/EC of 28 June 1999 laying down the procedures
for the exercise of implementing powers conferred on the
Commission.
(19) Technical guidance and implementing
measures for the rules laid down in this Directive may from time
to time be necessary to take account of new developments on
financial markets. The Commission should accordingly be empowered
to adopt implementing measures, provided that these do not modify
the essential elements of this Directive.
THE FINANCIAL CONGLOMERATES DIRECTIVE IN AN EASY TO READ FORMAT
Basel Committee on
Banking Supervision, The Joint Forum
Review of the Differentiated
Nature and Scope of Financial Regulation
Key Issues and
Recommendations (January 2010)
Conglomerates
- Part 1:
Introduction, Mandate, Focus and guiding principles of this study,
Key issues and gaps
Conglomerates - Part 2:
Supervision and regulation of financial groups. Mortgage
origination. Hedge funds
Conglomerates - Part 3:
Recommendations and options for effective and consistent
financial regulation across sectors. Reducing key regulatory
differences across the banking, securities, and insurance sectors.
Strengthening supervision and regulation of financial groups.
Promoting consistent and effective underwriting standards for
mortgage origination. Broadening the scope of regulation to hedge
fund activities
Conglomerates - Part 4:
Strengthening regulatory oversight of credit risk transfer
products. Key differences in regulation across the banking,
securities, and insurance sectors.
Background and approach adopted by the Joint Forum. Key issues
and gaps
Conglomerates - Part 5:
Recommendations to reduce key differences in regulation across
the banking, securities, and insurance sectors. Supervision and
Regulation of Financial Groups. SPEs. Key issues and gaps.
Recommendations to strengthen supervision and regulation of
financial groups
Conglomerates - Part 6:
Mortgage Origination. United Kingdom, United States, Spain,
Canada, Germany. Key issues and gaps. Recommendations to promote
consistent and effective underwriting standards for mortgage
origination
Conglomerates - Part 7:
Hedge Funds. Key issues and gaps
Conglomerates - Part 8:
Recommendations and policy options to broaden the scope
of regulation to hedge fund activities.
Credit Risk Transfer Products.
Key issues and gaps common to both CDS and FG insurance (CDS -
Credit default swaps, FG - Financial guarantee)
Conglomerates - Part 9:
Key issues and gaps specific either to CDS or FG insurance.
Recommendations and policy options to strengthen regulatory
oversight of credit risk transfer products
Conglomerates - Part 10:
Annex 1-9
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