European Union -
Financial Conglomerates Directive
from
the
Sarbanes Oxley
Compliance Professionals Association (SOXCPA)
the largest
Association of Sarbanes Oxley professionals in the world
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 in 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.
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