Section 5: Issues in Supervision of International Financial Conglomerates

1
5th Annual International Seminar on Policy
Challenges for the Financial Sector
International Financial Conglomerates Issues
and Challenges

• Section 5 Issues in Supervision of
  International Financial Conglomerates

Danièle NOUY Secretary General of the French
Banking Commission and Vice-Chair of the
Committee of European Banking Supervisors - CEBS
Washington 2 June 2005
2
Outline

• I - The Committee of European Banking
  Supervisors (CEBS) role and tasks
• II - The objectives of financial conglomerates
  supervision
• III - The European framework

3
I CEBS role and tasks

• The Committee of European Banking Supervisors
  (CEBS) is in charge of the efficient and
  consistent implementation of EU banking rules in
  Europe
• CEBS was established on 5 November 2003 and first
  met in January 2004 its Secretariat is based in
  London
• It has been created within the  Lamfalussy
  Approach  and is a so-called  Level 3
  Committee
• It is comprised of supervisory authorities and
  central banks
• It represents a new, more formalised, and
  efficient banking supervisory framework in
  Europe some kind of EU decentralised banking
  supervisory model.

4
I CEBS role and tasks

• The Lamfalussy approach
• Level 1- Legislative framework proposals by the
  Commission to the Council of Ministers and the
  European Parliament for co-decision.
• Level 2- Implementation measures are defined,
  proposed and decided by the Commission with the
  assistance of level 2 regulatory committees and
  the technical advice received from the level 3
  supervisory committees.
• Level 3- European supervisors work in close
  cooperation to ensure consistent implementation
  of Level 1 and 2 acts within the Member States
  and to promote convergence of supervisory
  practices.
• Level 4- The Commissions enforcement of
  Community law.

5
I CEBS role and tasks

CEBS and the Lamfalussy framework
6
I CEBS role and tasks

• The CEBS organisation
• CEBS members are high level representatives from
  the banking supervisory authorities and central
  banks of the European Union, including the
  European Central Bank.
• The CEBS is comprised of 25 member countries and
  46 member organisations, observers from EEA
  countries, the European Commission and the
  Banking Supervision Committee of ESCB (European
  System of Central Banks).
• Chairman - José María RoldánSecretary General -
  Andrea Enria
• Iceland, Liechtenstein, Norway and soon Romania
  and Bulgaria.

7
I CEBS role and tasks

• The institutional tasks of CEBS
• To advise the European Commission on banking
  policy issues, in particular for the preparation
  of draft measures for the implementation of
  European legislation
• To foster the consistent implementation of the
  Directives and to the convergence of supervisory
  practices
• To promote supervisory co-operation and exchange
  of supervisory information.

8
II The objectives of conglomerates supervision

• To take better into account the increasing
  complexity of financial groups
• To implement internationally agreed principles
• To address risks not captured in traditional
  sectoral supervision

9
II The objectives of conglomerates supervision

• 1- To take better into account the increasing
  complexity of financial groups
• Some groups provide financial services pertaining
  to the 3 financial sectors bank, insurance,
  investment services
• The magnitude of possible problems is
  particularly important, when such groups are
  cross-border EU or international groups
• The risks of such cross-sector groups are not
  adequately captured in traditional sectoral
  supervision
• Concerns about cross-sectoral risk transfers, and
  possible regulatory arbitrage have increased
  recently.

10
II The objectives of conglomerates supervision
2 - To implement internationally agreed principles

• Supervision of financial conglomerates (Joint
  Forum, February 1999)
• Risk concentration principles (Joint Forum,
  December 1999)
• Intra-group transactions and exposures principles
  (Joint Forum, December 1999)
• Trends in risk integration and aggregation (Joint
  Forum, August 2003)
• Credit risk transfers (Joint Forum, March 2005).

11
II The objectives of conglomerates supervision

• 3 - To address risks not captured in traditional
  sectoral supervision

• Ensure that financial conglomerates have
  sufficient capital basis, without double gearing
  of own funds and unreasonable capital leverage
• Address intragroup transactions and possible
  excessive concentration of risks
• Ensure adequate internal control as well risk
  measurement and management across the whole
  group
• Designate a single  lead coordinator to monitor
  the supervision of the whole group .

12
III The European framework

1. Definition of an EU financial conglomerate
2. Designation of competent supervisors
3. Content of supplementary supervision
4. Means of supplementary supervision

13
III The European framework
1. Definition of an EU financial conglomerate

• It is a group,
• With at least one regulated entity within the
  Group,
• Which activity is mainly financial,
• With significant involvement in the
  banking/investment services sector and the
  insurance sector.

14
III The European framework

• 1. Definition of an EU financial conglomerate
• It is a  Group 

• Meaning a parent-subsidiary relationship
  (including participations) or
• An horizontal structure.

• Or a  Sub-Group 

• A financial conglomerate may be a sub-group of
  another financial conglomerate
• In such cases, they are in principle both subject
  to supplementary supervision but possibility to
  waive supplementary supervision at sub-group
  level.

15
III The European framework

• Definition of an EU financial conglomerate
• With  at least one regulated entity 
  within the Group

• A bank ( credit institution ), or a securities
  firm/broker dealer ( investment firm ), or an
  insurance company,
• With its head office in the EU.

16
III The European framework

• Definition of a financial conglomerate
• The Groups activities must be mainly
  financial

Total balance sheet of the financial sector
entities gt 40 of total consolidated balance
sheet of the whole group.
17
III The European Framework

• Definition of a financial conglomerate
• And cross-sector financial activities
  must be significant
• a) The micro-economic parameter 

The weight of the less important financial sector
must not be less than 10. This is assessed by
comparing the total of the balance sheet and the
capital adequacy requirements of each financial
sector against those of the whole group.
18
III The European Framework

• Definition of a financial conglomerate
• Cross-sector financial activities must be
  significant
• b) The macro-economic parameter

• The total of the balance sheet of the smallest
  financial sector gt EUR 6 Billions
• Waiver by relevant competent authorities if
• - micro-economic parameter 10, and
• - if not necessary or inappropriate or
  misleading with respect to the supervisory
  objectives.

19
III The European Framework
2. Designation of competent supervisors

• Current solo supervisors keep exclusive
  responsibility for solo supervision
• Current sectoral group supervisors keep their
  responsibilities for sectoral supervision at both
  solo and consolidated levels
• Appointment of a unique lead coordinator for
  conglomerate supervision.

20
III The European Framework
2. Designation of competent supervisors

• The Lead coordinator is appointed according to
  precise criteria determined by the Directive. In
  practice, most of the time, it is the supervisor
  in charge of the main financial sector
• Nevertheless, the Directives criteria may be
  waived by the team of the  relevant
  supervisors , when needed
• The coordinator is assisted by the team of other
  relevant  supervisors.

21
III the European Framework
2. Designation of competent supervisors The
missions and powers of the lead coordinator
consist in

• Information gathering and dissemination, on an
  on-going basis and in crisis situations
• Assessment of financial soundness and compliance
  with financial conglomerate regulation
• Compulsory coordination arrangements
• But he has no enforcement powers with respect
  to regulated entities located outside his
  jurisdiction.

22
III The European Framework
3. Content of supplementary Supervision
a) Capital adequacy, b) Risk concentration, c)
Intra group transactions, d) Internal control and
risk management requirements.
23
III The European Framework
3. Content of supplementary Supervision

1. Capital adequacy

The basic principle is that The overall capital
at conglomerate level must be sufficient to meet
the total capital requirements of all entities
within the group after elimination of intragroup
elements.
24
III The European Framework
3. Content of supplementary Supervision

• Capital adequacy
• The four methods developed by the Joint Forum in
  1999 can be used

• accounting consolidation method,
• deduction aggregation method,
• book value/requirement deduction method,
• combination of 2, or all, of methods above.
• The choice of the method is validated by the lead
  coodinator.

25
III The European Framework
3. Content of supplementary Supervision

1. Risk concentration

• There is a group-wide measure of concentration
  risks
• It comprises all risks, namely credit,
  counterparty, investment, underwriting, market
  risk, etc.
• It is a qualitive supervision, but discretion
  for quantitative limits,
• The coordinator role consists in
• setting limits, according to the risk profile of
  the group,
• measuring contagion risk/conflicts of
  interests/arbitrage, etc.
• determining risk categories requiring reporting.

26
III The European Framework
3. Content of supplementary Supervision
c) Intra Group transactions

• Concept of  important Intra Group Transactions
  - IGTs
• (gt 5 of minimum capital requirements)
• Periodic notification of the important IGTs to
  the coordinator
• Qualitive supervision of the IGTs, but country
  discretion for quantitative limits
• Coordinator role, similar to his role in risk
  concentration monitoring.

27
III The European Framework
3. Content of supplementary Supervision

1. Internal control and risk management requirements

• Sound management processes (adoption and
  periodic assessment by the top management of the
  Groups strategies, policies and risk policy)
• Capital adequacy policy, appropriate to match the
  conglomerates risk profile and strategy
• Internal risk measurement and management
  processes commensurate with the conglomerates
  risks
• Sound internal control mechanisms and accounting
  principles.

28
III The European Framework
4. Means of supplementary Supervision EU
Financial conglomerates

• Access to information,
• Cooperation and exchange of information,
• - Areas of information exchanges are mainly
  groups structures, strategy, acquisitions,
  restructuring, CAD, IGTs, large exposures,
  profitability, shareholders, management, internal
  control systems, materially adverse developments,
  regulatory measures, etc.
• - Essential information must be shared relevant
  information may be shared.
• Verification of information,
• Enforcement.

29
III The European Framework
4. Means of supplementary Supervision
Entities established outside the EU

• notion of equivalent supervision, and
• cooperation agreements

30
III The European Framework
4. Means of supplementary Supervision Groups
with a Third Country Parent

• What needs to be determined? Whether
   appropriate and equivalent  supervisory is in
  place
• When and by whom? The request is made at the
  initiative of the parent or the regulated entity
  or the coordinator
• Who determines the possible equivalence? The
  coordinating supervisor decides with the advice
  of other relevant supervisors, and taking into
  account the general guidance issued by the
  Financial Conglomerates Committee in July 2004
  regarding the equivalence of supervision in
  Switzerland and the USA
• What if no equivalence? In this case, the
  Directive is applied by analogy to the EU parts
  of group and appropriate methods are used to
  capture and measure at least  the sub-groups
  risks  (e.g. require a sub-holding company).
• .

31
Contact details ChairmanJosé María
RoldánEmail josemaria.roldan_at_c-ebs.orgTel.
44 20 7382 1770 Vice ChairDanièle NouyEmail
daniele.nouy_at_banque-france.frTel. 33 1 4292
7501 Secretary GeneralAndrea EnriaEmail
andrea.enria_at_c-ebs.orgTel. 44 20 7382 1750