Solvency II News July 2012

Solvency ii Association
1200 G Street NW Suite 800 Washington, DC 20005-6705 USA Tel: 202-449-9750 www.solvency-ii-association.com
Dear member, Today we will start from the Solvency I I Equivalence developments
Solvency I I Equivalence Transitionals measure

Short introduction of the concept and to the technical work currently undertaken by E IOPA
1. Introduction
1.This note aims to provide some additional information as to the concept of Solvency I I Equivalence Transitional measures (proposed under the current draft Omnibus I I Directive) as well as to the work currently being undertaken by EIOPA in respect to the Commission request for technical input of February 20121. 2.The Commission has developed a transitional regime for Solvency I I equivalence for third countries which either have a risk based regime similar to Solvency I I or are willing and committed to move towards such a risk based regime over a predefined period (5 years in initial Commission proposal). 3.The transitional measures recognise both that it will not be possible to undertake full equivalence assessments in respect of all pertinent third countries prior to the implementation of Solvency I I , and that there are a number of third countries where their solvency and/ or prudential regimes are not currently able to satisfy the equivalence criteria in full,
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but will be in a position to do so once planned changes to the regime have been made. The transitional measures would allow undertakings in or connected to these third countries to obtain the benefits of a positive equivalence finding on a temporary basis during the transitional period. 4.Inclusion in the transitional regime would be subject to a Commission Decision. This will most likely be taken in mid2013 under the working assumption that the Solvency I I regime will be applied by EU undertakings from 1 January 2014.
The criteria envisaged for eligibility for the transitional regime are still subject to ongoing political discussion (negotiations on the Omnibus I I Directive in the Council of Ministers and the European Parliament).
Commissions request for EIOPAs input

5.In respect of the third countries that have indicated to the Commission that they are interested in being covered by the transitional provisions, the Commission has requested that EIOPA carry out an analysis of the following during 2012: - Whether persons working for, or on behalf of, the supervisory authorities are bound by obligations of professional secrecy. Professional secrecy equivalence is a prerequisite to inclusion in a transitional regime. - The main areas where the equivalence criteria would currently not be met. 6.In its letter to E IOPA, the Commission has noted that the same level of detail as would be required for a full equivalence assessment is not
required for the purpose of identifying the main areas where the equivalence criteria may not currently be met. With the exception of the professional secrecy provisions, what the Commission has requested is a gap analysis. However, this analysis clearly needs to be based on information covering the same ground as would be covered in a full equivalence assessment. Participating third countries have therefore been invited to provide information by way of completing the questionnaire annexed to this note, which closely reflects that used in the earlier equivalence assessments undertaken by CEIOPS/EIOPA.
Participating third countries and next steps:

7.To date, the following third countries that have expressed an interest in being covered by the transitional provisions have received the EIOPA requests for information for the Solvency I I gap analysis: _ Australia _ Chile _ China _ H ong Kong _ I srael _ Mexico _ Singapore _ South Africa 8.EIOPA will base its advice to the Commission largely on the responses to the questionnaire provided by these participating third countries. 9.However, following adoption of the Omnibus I I Directive (political agreement among colegislators) E IOPA expects to launch a Call for evidence procedure inviting any interested parties to provide their input
regarding practical experience/ direct knowledge of these third countries supervisory systems.
2.Basic principles underlying E IOPA technical contribution to the Commission decisions on equivalence transitionals Positive Equivalence of third country professional secrecy is a determinative element for a third country to be included in the equivalence transitional regime.
1.Professional secrecy is the basis for all supervisory cooperation among EU and third country supervisors. EIOPA will aim to ensure that appropriate professional secrecy and confidentiality requirements are in place. 2.A full equivalence assessment of the third country professional secrecy regime will be undertaken using the principle, objective as well as the indicators CEIOPS (EIOPA predecessor) proposed in its final 2010 Level 2 Advice to the Commission. 3.When pursuing the assessment of the overarching principle of professional secrecy, the principle of proportionality will not apply in relation to professional secrecy.
Technical input to the Commission regarding identification of regulatory & supervisory gaps by reference to Solvency I I framework is NOT an equivalence assessment.
4 . E IOPA will NOT seek to establish whether the country supervisory system provides for a similar level of policyholder/beneficiary protection as under Solvency I I to be considered equivalent. EIOPA will conduct a gap analysis through which it will seek to identify the areas where the third country does not meet the current criteria for
equivalence which will be embedded in the criteria to be set out in the Level 2 implementing measures. 2.5. The gap analysis will be conducted using the indicators of equivalence previously identified by CEIOPS and taken over by EIOPA i.e. those factors which EIOPA considers provide guidance in determining whether the relevant principles and objectives are achieved.
Proportionality principle.
6.Proper consideration should be given to the adequacy of third country practice in applying the proportionality principle, where this is relevant. As such, a proportionality principle in the application of regulatory provisions in third country jurisdictions (contingent upon the nature, scale and complexity of the risks inherent in the business) should not in itself be seen as an indicator of regulatory/supervisory gaps. The gap analysis will be made in respect of the regime in existence and applied by a third country supervisory authority at the time of the assessment. Nevertheless, relevant planned regulatory developments will also be taken into account in E IOPA Advice to the Commission. 7.Plans and ongoing initiatives for changing the national insurance supervisory regime in the third country should be taken into account at the time of the gap analysis although they will not automatically lead to assessors concluding as to the absence of a gap in the third country supervisory/ regulatory framework. Such initiatives should be taken into account to the extent they are relevant and clearly identified as ongoing work when providing the technical gapanalysis to the Commission. 8.As EIOPA expects that a full equivalence assessment will be performed during the transitional period.
The currently planned or ongoing developments taken into account for the purpose of performing the gap analysis will be revisited at the time of the full equivalence assessment.
3. Main operational aspects of gap analysis process

1 . E IOPA work is of technical nature only. The European Commission retains full decision making powers as to the third countries to be included in the list of beneficiaries of an equivalence transitional regime. The Commission also retains full responsibility as to the contents of any future convergence plans that may be agreed with a third country as part of the process to be accepted in the transitional regime. 2 . E IOPA considers that the active cooperation of the third country supervisor is essential for a proper analysis to be undertaken. EIOPA will not engage in any SII gap analysis in the absence of confirmation of willingness to participate from the third country supervisory authority. The confirmation of the third country willingness to engage is provided by the Commission. 3 . E IOPA will post a call for evidence on its website following OMD I I approval (i.e. agreement of the criteria for a third country to be included in the list of beneficiaries from an equivalence transitional regime). 4.The call for evidence will allow any interested parties an opportunity, early in the process, to bring to E IOPAs attention any factors that they think may be relevant to the gap analysis or the professional secrecy equivalence assessment.
5 . I nformation provided under a call for evidence will be considered by EIOPA but will not be published. Neither will E IOPA respond to the points made. 6 . E IOPA assessment teams will expertise, knowledge and supervisory experience in the following areas: _ Legal expertise _ Financial requirements expertise (pillar I issues) including actuarial expertise _ Expertise in supervisory review, governance and reporting (pillar I I & I I I issues) _ Group supervision expertise for assessments in relation to Articles 227 and 260. 7.The minimum number of assessors per team should be no less than 3, including a E IOPA Staff representative who can also cover one of the above areas. 8 . E IOPA has invited third country supervisory authorities to complete the annexed questionnaire relevant to the Articles of the Solvency I I Directive under which an assessment is to be undertaken. These questionnaires are be based on the criteria set out in the Level 2 implementing measures and encapsulate the indicators that EIOPA considers provide guidance in determining whether the criteria are met. 9.Where necessary , E IOPA will request additional evidence from the respective third country supervisory authority. 10.While the responses of the third country supervisory authority to the questionnaires issued by E IOPA will form the basis of the analysis, EIOPA will not be restricted to considering only this material.
3.11. E IOPA may also consider other relevant information available, where appropriate, such as any assessment carried out by the I MF or World Bank, or whether the third country is party to the I AIS Multilateral Memorandum of Understanding. Such information will only be used as supporting information for the gap analysis.
QUESTION N AIRE FOR EQUI VALENCE GAP ANALYSIS I N RELATION TO ART. 172, 227 AND 260 OF SOLVENCY I I DIRECTIVE (2009/ 138/ EC) Principle 1. Powers and responsibilities of third country supervisory authorities
Objective The supervisory authorities of the third country have the necessary means, and the relevant expertise, capacity, and mandate to achieve the main objective of supervision, namely the protection of policyholders and beneficiaries regardless of their nationality or place of residence. In particular, the supervisory authorities in that third country shall have the necessary capacities, including financial and human resources. The supervisory authorities of the third country duly consider the potential impact of their decisions on the stability of financial systems globally, particularly during emergency situations and take into account the potential procyclical effects of their actions where exceptional movements in the financial markets occur.
Reinsurance specificities:
The supervisory authorities of the third country are empowered by law or regulation to effectively supervise domestic insurance or reinsurance undertakings carrying out reinsurance activities and to undertake a
range of actions, including the ability to impose sanctions or take enforcement action in relation to the domestic insurance or reinsurance undertakings carrying out reinsurance activities that it supervises.
Group supervision specificities:

The supervisory authorities of the third country shall be empowered by law or regulation to supervise insurance and reinsurance undertakings which are part of a group. The supervision of insurance and reinsurance undertakings which are part of a group shall be carried out effectively and the supervisory authorities of the third country shall be empowered by law or regulation to undertake a range of actions, including the ability to impose sanctions or to take enforcement action in relation to the group that it supervises. The supervisory authorities of insurance and reinsurance undertakings which are part of a group shall be able to assess the risk profile and solvency and financial position of that group as well as its business strategy. Third country provisions and arrangements should allow efficient and effective supervision through cooperation and exchange of information among supervisors of the group.
1.Please provide a comprehensive presentation of your supervisory authority, including details as to:
- A legal basis specifying supervisory responsibilities and enforcement powers; - Freedom from undue political, governmental and industry interference in the performance of supervisory responsibilities; - Transparency of supervisory processes/ procedures; - Adequate financial and nonfinancial (e.g. sufficient numbers of
appropriately skilled staff) resources; - Appropriate protection from being liable for actions taken in good faith. 2.Please provide details as to supervisory powers available to the authority in respect of undertakings in difficulties (solo) / ultimate parent undertakings in difficulties (groups), which may include: - Prohibition of disposal of assets; - A recovery plan, finance scheme; - Reestablishment of the level of own funds, reduction of risk profile; - Downward revaluations; - Preventing the conclusion of new contracts; - Withdrawal of authorisation; - Measures relating to directors, managers, controllers and other relevant persons. 3.Please offer a detailed overview of the enforcement actions available to the authority including as to the supervisory authoritys ability to cooperate with other authorities/ bodies in respect of enforcement action. 4.Please provide information on your authoritys powers to take preventative and corrective measures to ensure that insurance and reinsurance undertakings comply with the applicable laws, regulations and administrative provisions including details as to the authoritys: - Ability to ensure compliance on a continuous basis with laws, regulations and administrative provisions (including through onsite
inspections) including measures to prevent/ penalise further infringements; -Ability to communicate concerns, including those relating to the undertakings/ groups financial position; -Ability to oblige the (re)insurer to respond to concerns raised by the supervisor; - Ability to obtain all information necessary to conduct the supervision of the undertaking / group. 5.Please indicate whether in the exercise of your general duties, you are duly considering the potential impact of your decisions on the stability of financial systems globally, particularly during emergency situations, on the basis of the information available at the time. - Please provide any examples of actions recently undertaken in this respect; -Please provide details as to regulatory requirements as to information sharing in crisis/ normal situation with foreign supervisors. - In the context of group supervision, please provide details as to regulatory requirements as to information sharing in crisis/normal situations which may include: Ability/ Willingness to submit information on intragroup transactions; Exchange of prior information on decisions that could affect the solvency of the entities belonging to an EEA Member State; Ability/ Willingness to allow the transfer of cash;
Ability/ Willingness to support restrictions on free assets for supervised entities.

6.Please indicate whether the you are taking into account the potential procyclical effects of your actions where exceptional movements in the financial markets occur
- Please provide any examples of actions recently undertaken in this respect.

7.In the context of group supervision, please explain your supervisory powers/arrangements/ requirements for cooperation with other countries. Please indicate whether: - Under your national provisions, you may act as group supervisor for the entirety of groups domiciled in your jurisdiction. - Where you are the group supervisor, do you act as the point of contact for key questions at group level and take responsibility for: The coordination and dissemination of information; Review of the groups financial position; Planning and coordination of supervisory actions in respect of the group as a whole; Establishment of a framework for crisis management; The assessment of the application for a group internal model if relevant and take its decision in consultation with other supervisory authorities concerned. - As group supervisor do you have the prerogative to consult and involve in advance the relevant supervisory authorities concerned in case you intend to carry out an inspection in an (re)insurance undertaking situated in the EEA.
- Do you have provisions in place for the establishment of cooperation arrangements, which allow that: A college of supervisors or similar cooperation arrangements can be established composing a minimum of all relevant authorities for the group supervision under the following circumstances: Relevance of the group to overall financial stability; Relevance of the group in specific insurance market; Similarity of supervisory practices; The nature and complexity of the business undertaken by the group; In case a College of supervisors or similar cooperation arrangements are established, the functioning and organisation of these mechanisms is based on written arrangements, including provisions on obligation to cooperate /exchange of information and decision making processes (aimed at consensus); Please indicate whether and, should it be the case, provide details as to the existence of a mechanism for dispute solving mechanism in case of disagreement with other relevant supervisory authorities
Principle 2 Professional secrecy, exchange of information and promotion of supervisory convergence

Objective The supervisory authorities of the third country and supervisory authorities of Member States involved in the supervision of domestic insurance and reinsurance undertakings shall cooperate and, where relevant, ensure the effective exchange of information. The supervisory authorities of the third country shall provide that all persons who are working or who have worked for the supervisory authorities, as well as auditors and experts acting on behalf of those authorities, are bound by obligations of professional secrecy.
The above mentioned obligations of professional secrecy shall extend to

information received from the supervisory authorities of Member States. 8.Please describe the applicable regime with regard to the professional secrecy obligations the authority must observe (incl. the existence and extent of these obligations) including: - Confidential information identification; - Legal duty to protect confidential information; - Applicable to all relevant individuals (i.e. all those who work, have worked or act(ed) on behalf of the supervisory authority); - Ongoing obligation (applicable whilst working/acting on behalf of supervisory authority and on continuous basis thereafter); - Disclosure of confidential information in restricted and clearly defined circumstances as well as subject to conditions of professional secrecy Use of confidential information only in the course of supervisory duties: compliance monitoring (including monitoring of technical provisions, solvency margins, administrative /accounting procedures and internal controls), imposition of penalties, court proceedings/ appeals; -Consent of Competent Authority where the confidential information originates from another competent authority prior agreement to the disclosure, disclosure is made in accordance with any specified conditions, including those relating to the purpose of the disclosure and use of the information.
- Ability to enter into cooperation agreements (subject to guarantees of professional secrecy. 9.Please describe national applicable legal provisions in case of breach of the obligation of professional secrecy like for example the provisions in national law in respect of the breach of professional secrecy (for example offences, penalties, enforcement).
10.Please describe the exceptions allowed by the applicable regime with regard to the professional secrecy obligations the authority must observe including:
- Express agreement to disclose/ use; - Summary/ aggregate disclosure (individual undertaking not identifiable); - Civil/ criminal proceedings (where the undertaking has been declared bankrupt or is being compulsorily wound up information must not concern third parties involved in rescue attempts ). 11.Please describe the applicable provisions regarding the existence and extent of provisions with regard to your ability to exchange information with: - Supervisory authorities including in relation to authorisation and suitability assessments covering individuals as well as communication of concerns regarding financial soundness of supervised undertakings/ groups; - Other authorities/ bodies/persons/institutions responsible for, or having oversight of: supervision of financial organisations/markets, liquidation/ bankruptcy proceedings,
carrying out statutory audits of accounts, detection/ investigation of breaches of company law, - Central banks; - Government administrations responsible for financial legislation (for reasons of prudential control); - Other authorities/ bodies/persons/institutions (please indicate).
Principle 3 Taking up of business

Objective
The taking up of the business of reinsurance in the third country shall be subject to prior authorisation.
Authorisation for the taking up of business shall be conditional on the undertaking meeting a clear, objective and publicly available set of written standards on a continuous basis. 12.Please provide details as to existence and content of standards in respect of the Legal Entity: - Legal form; - Head office of the undertaking to be situated in the same country as its registered office; - Articles of Association. 13.Please provide details as to existence and content of standards in respect to the undertakings operations: -Limitation to reinsurance and related operations for pure reinsurance undertakings which may include, for example, a holding company function;
- Limitation to the business of insurance and operations arising directly therefrom for insurance undertakings; - Scheme of operations (including, for the first three years, a forecast balance sheet, estimates regarding but not limited to: future Solvency Capital Requirements, Minimum Capital Requirements, the financial resources intended to cover technical provisions and capital requirements); - Financial resources covering set up costs; - Basic own fund items that constitute the absolute floor of the minimum capital requirements;
- Compliance with the system of governance referred to under Principle 4.

14.Please provide details as to existence and content of standards in respect to the undertakings obligation to provide information on Shareholders/Members: - Identity of shareholders/ members with qualifying holdings; - Amount of holdings; and
- Assessment of reputation and financial soundness of the owner and acquirer.

15.Please provide details as to existence and content of standards in respect to close links: - Identification of close links (i.e. a situation in which two or more natural or legal persons are linked by control or participation, or are permanently linked to one and the same person by a control relationship);
- Monitoring of close links to ensure they do not prevent the effective exercise of supervisory powers over the authorised undertaking. 16.Please provide details as to existence and content of standards in respect of refusal/withdrawal of authorisation: - legally possible; - possible due to qualifications of shareholders/ members; and - where close links prevent effective supervision.
Principle 4 System of Governance; Supervisory Review and Public Disclosure

Objective The solvency/prudential regime of the third country shall require domestic insurance and reinsurance undertakings carrying out reinsurance activities to have in place an effective system of governance which provides for sound and prudent management of the business, and require groups to have in place such asystem at the level of the group. That system shall at least include an adequate transparent organisational structure with a clear allocation and appropriate segregation of responsibilities, requirements for ensuring that persons managing the undertaking are fit and proper and effective processes to ensure the timely transmission of information both within the undertaking or group and to the relevant supervisory authorities. The solvency/prudential regime of the third country shall require domestic insurance and reinsurance undertakings carrying out reinsurance activities to have in place an effective risk management system comprising the strategies, policies, processes and internal and supervisory reporting procedures necessary to identify, measure, monitor, manage and report, on a continuous basis and at an individual and an aggregated level, the risks to which the undertaking is or could
be exposed, and their interdependencies, as well as an effective internal control system. It shall require groups to have in place such a system at the level of the group. The solvency/prudential regime of the third country shall require domestic insurance and reinsurance undertakings carrying out reinsurance activities to establish and maintain riskmanagement, compliance, internal audit and actuarial functions. Groups shall be required to establish and maintain these functions at group level.
The solvency/prudential regime of the third country shall require groups and domestic insurance and reinsurance undertakings carrying out reinsurance activities to disclose publicly, on at least an annual basis, a report on their solvency and financial condition.
Group supervision specificities:

The prudential regime of the third country shall require the group to have sound reporting and accounting procedures to monitor and manage its intragroup transactions and risk concentrations and to report at least annually significant risk concentration at the level of the group and significant intragroup transactions. 17. Please provide an overview of the governance including risk management general requirements and supervisory powers applicable in your regime, including information on the existence of: - Effective system of governance (including but not limited to transparent organisational structure with a clear allocation and appropriate segregation of responsibilities, effective system for timely transmission of information);
- Requirements relevant to the fitness (for example appropriate professional qualification, knowledge and experience) and propriety (for example good repute and integrity) of management and key function holders; - Effective and well integrated risk management system aimed at identifying, measuring, monitoring, managing and reporting (on a continuous basis) the risks to which the undertaking is or could be exposed (on an individual and aggregated level, interdependencies), and the amount of own funds necessary to cover those risks (comparable to an own risk and solvency assessment; - Objective and independent internal audit function with a direct reporting lineto the administrative, management or supervisory body; - Effective internal control mechanisms (for art. 172 including those appliedto ensure that data received from cedants are reliable and timely); - Sound written administrative/ accounting procedures; - Contingency plans. 18.Please indicate whether and under which conditions is an actuarial function required by your system including whether there is a clear condition of knowledge of actuarial and financial mathematics appropriate to the nature, scale andcomplexity of the risk inherent in the (re)insurance business. 19.Please indicate whether your supervisory system requires continuous supervision of outsourced functions or activities (in order to ensure that meeting of obligations shall not be affected). In your reply please also provide information on the existence/ extent of provisions in relation to outsourcing including as to the requirement for a notification to the supervisory authority prior to outsourcing of critical or important functions or activities as well as any other material subsequent developments.
20.Please indicate whether your supervisory system requires that undertakings have a Compliance Function in place to provide the administrative, management or supervisory body advice on compliance with law, regulations and administrativeprovisions including an assessment of the possible impact of any changes in the legal environment and the identification and assessment of compliance risks. 21.Please provide details as to governance requirements applicable in order to ensure identification of deteriorating financial conditions and remediation of deteriorating with appropriate monitoring tools in place. 22.Please provide details as to the existence and extent of the auditors' duty to report: - Breach of laws, regulations, administrative provisions; - Issues which may affect the continuous functioning of the undertaking; - Refusal (or reservations) in respect of certification of accounts; - Noncompliance with Solvency and Minimum Capital Requirements. 23.Please provide a comprehensive overview of requirements for the public disclosure of report(s) on solvency and financial conditions at least on an annual basis with adescription of: - The business and performance; - System of governance; - Risk exposure, concentration, mitigation and sensitivity; - Assets; - Technical provisions, other liabilities;
- Capital management; - Significant intragroup transactions and significant risk concentrations, in the case of groups. 24.Please describe the type and frequency of accounting, prudential, statisticalinformation obtainable by the supervisory authority: - Annual Report on the solvency and financial condition of the undertaking; - Annual accounts (covering all operations, financial situation and solvency);
- Returns/statistical documents;
- Information regarding contracts held with intermediaries, in the case of reinsurance undertakings (art. 172)
Principle no. 5 Changes in business, management or qualifying holdings

Objective The solvency/prudential regime of the third country shall require that proposed changes to the business or management of domestic insurance or reinsurance undertakings carrying out reinsurance activities or of groups, or toqualifying holdings in such undertakings and groups are consistent with maintainingthe sound and prudent management of the domestic insurance or reinsurance undertaking or group. 25.Please provide information on the existence/ extent of provisions and supervisorypowers in respect of acquisitions, including as to: - Notification of intention to hold or increase directly or indirectly a qualifying holding;
- Right of supervisory authority to oppose proposed acquisition as well asability to suspend voting rights and/ or ability to annul casted votes; - Existence of thresholds prompting notification; - Possibility for assessment of acquisition by financial undertakings to besubject to prior consultation. 26.Please provide information on the existence/ extent of provisions and supervisory powers in relation to disposals, including as to: - Notification of intention to dispose directly/indirectly of a qualifying holding;
- Thresholds prompting notification.

27.Please provide information on the existence/ extent of provisions and supervisory powers regarding the information obtainable from an undertaking, including as to: -Thresholds prompting notification of acquisitions/ disposals; -Regular notification (e.g. annual) of qualifying holdings, including size.
28.Please provide information on the existence/ extent of provisions and supervisory powers in relation to the requirements for ongoing assessment, approval and disclosure of relevant information, including information in respect of:
- Portfolio transfers or transfer of individual contracts (e.g. in the context of reinsurance contracts); - Changes to management; and - Scheme of operation.
29. Please provide details as to existence and content of standards and supervisory powers in respect to the undertakings obligation to provide information on assessment of reputation and financial soundness of the new owner / acquirer.
Principle no. 6 Solvency Assessment

Objective The solvency/prudential regime of the third country shall require domestic insurance and reinsurance undertakings and groups to hold adequate financial resources. The assessment of the financial position of domestic insurance and reinsurance undertakings and groups in the third country shall rely on sound economic principles and solvency requirements shall be based on an economic valuation of all assets and liabilities. The solvency/prudential regime of the third country shall require domestic insurance and reinsurance undertakings and groups to establish technical provisions with respect to all of their insurance and reinsurance obligations towards policyholders and beneficiaries of insurance and reinsurance contracts. The solvency/prudential regime of the third country shall require that assets held to cover technical provisions are invested in the best interests of all policyholders and beneficiaries taking into account any disclosed policy objective and that domestic insurance and reinsurance undertakings and groups only invest in assets and instruments whose risks the undertaking concerned can properly identify, measure, monitor, manage, control and report. The solvency/prudential regime of the third country shall require domestic insurance and reinsurance undertakings and groups to meet capital requirements that are set at a level which ensures that in the event of significant losses policyholders and beneficiaries are adequately
protected and continue to receive payments as they fall due to a level of confidence at least equivalent to that achieved by Article 101 of Directive 2009/ 138/ EC.
Those capital requirements shall be risk based with the objective of capturing quantifiable risks.
Where a significant risk is not quantifiable and cannot be captured in the capital requirements, then that risk shall be addressed through another supervisory mechanism. The solvency regime of the third country calculation of capital requirements shall ensure accurate and timely intervention by supervisory authorities of the third country in the event that those capital requirements are not complied with. The solvency regime of the third country shall require domestic insurance and reinsurance undertakings and those which are part of a group to maintain a minimum level of capital, noncompliance with which shall trigger immediate and ultimate supervisory intervention. The solvency regime of the third country shall require domestic insurance and reinsurance undertakings carrying out reinsurance activities to meet the capital requirements referred to in paragraphs 5 and 6 above with own funds that are of a sufficient quality and which are able to absorb significant losses. Own fund items considered by the supervisory authorities to be of the highest quality shall absorb losses both in a going concern and in case of a winding up.
For group supervision assessments:

The calculation of group solvency in the third country's prudential regime shall produce a result that is at least equivalent to the result
achieved by either one of the calculation methods set out in Articles 230 and 233 of Directive 2009/ 138/ EC. The calculation shall ensure that there is no double use of own funds to meet the group capital requirement and that the intragroup creation of capital through reciprocal financing is eliminated. 30.Please provide information on the existence, content and extent of provisions in respect of financial supervision, including as to: - Verification of state of solvency and financial condition of undertaking / of the group; - Verification of establishment and ability to request increase of technical provisions and covering assets; - Obligation of undertaking to submit financial reporting to supervisor. 31.Please describe provisions as to rules for valuation of assets and liabilities, and indicate whether the following are applicable: - The valuation of assets and liabilities is based on an economic valuation of the whole balance sheet; - Assets and liabilities are valued at the amount for which they could be exchanged between knowledgeable willing parties in an arms length transaction; - Valuation standards for supervisory purposes is consistent with international accounting standards, to the extent possible. 32.Please provide details as to the legal and supervisory regime applicable in relation to technical provisions (TP) and indicate whether and/ or how:
- TP are established in respect of all (re)insurance obligations and aim to capture all expected risks related to (re)insurance obligations of the undertaking;
- TP are calculated in a prudent, reliable and objective manner;

- The level of TP is the amount a third country (re)insurance undertaking would have to pay if it transferred or settled its contractual rights and obligations immediately to another undertaking/ knowledgeable willing party in an arms length transaction; - The valuation of TP is market consistent and makes use, to the extent possible, of and is consistent with information provided by financial markets and generally available information on underwriting risks; - A segmentation of the (re)insurance obligations into appropriate risk groups and as a minimum by lines of business is out in order to achieve an accurate valuation of reinsurance obligations; - Processes and procedures exist to ensure the appropriateness, completeness and accuracy of the data used in the calculation of TP. - The supervisor is able to require the undertaking to raise the amount of technical provisions if it does not comply with the requirements. 33. Please provide details as to the regime applicable in relation to own funds including, where applicable, as to: - Own funds are classified in accordance with their ability to absorb losses in the case of windingup and on a going concern basis; - The highest quality capital is available to absorb losses in a going concern and in case of a winding up, with additional requirements of sufficient duration of the own fund item, absence of incentives to
redeem, absence of mandatory servicing costs and absence of encumbrances; - A distinction is made between own funds on the balance sheet and off balance sheet items (for example guarantees); - According to their classification, own funds are eligible to cover partially or fully (for the best quality own funds) the capital requirements; - Quantitative limits apply to the own funds to ensure the quality of own funds covering the capital requirements. In the absence of quantitative limits other supervisory requirements should ensure the high quality of own funds. 34.Please describe the applicable regulatory and supervisory regime in relation to investments providing details supporting that: - Undertakings are only allowed to invest in assets and instruments where the risks can be properly identified, measured, monitored, managed, controlled and reported and appropriately taken into account in their solvency needs; - Assets held to cover TP are invested prudently in the best interest of all policyholders and beneficiaries; - All assets are invested in such a manner as to ensure the security, quality, liquidity, availability and profitability of the portfolio as a whole; - Prudent levels of investments in assets not admitted to trading are required; - Investment in derivative instruments are possible insofar as they contribute to a reduction of risks or facilitate an efficient portfolio management;
- There is avoidance of excessive reliance on any one particular asset, issuer or accumulations of risk; no excessive risk concentration. 35. Please provide details as to the legal and supervisory regime applicable in relation to capital requirements and indicate whether and/ or how: - Capital requirements are be risk based and aim at measuring all quantifiable unexpected risks of the undertaking. Please cover the following points: Where a significant risk is not captured in the capital requirements, please provide details as to the mechanism applied to guarantee that capital requirements adequately reflect such risk; How the capital requirements reflect a level of own funds that would enable the undertaking to absorb significant losses and that gives reasonable assurance to policyholders and beneficiaries that payments will be made as they fall due; What is the calibration target for the capital requirements? Do the requirements enable the undertaking at a minimum to withstand a 1 in 200 ruin scenario over a one year period or ensure that policyholders and beneficiaries receive at least the same level of protection;
The calculation of capital requirements shall ensure an accurate and timely intervention by supervisory authorities of the third country;
Obligation on undertakings to communicate concerns relating to their financial position; Obligation on undertaking to respond to concerns raised; The supervisory authority has powers to take the necessary and appropriate actions against the undertaking to restore compliance with that requirement;
Appropriate standards are in place where capital requirements take into account the effect of risk mitigation techniques. - There is a minimum level under which capital requirements should not fall which equates to a minimum level of policyholder protection which triggers immediate and ultimate supervisory intervention action. - Solo and group capital requirements are calculated at least annually and monitored on an ongoing basis. 36.If your regime provides for the use of internal models, please describe the applicable provisions regarding specificities of assessment of internal models in the context of assessing capital requirements, including information relating to the following areas: - Where the (re)insurance undertaking uses a full or a partial internal model to calculate its capital requirements, the resulting capital requirements provide a level of policyholder protection that is at least comparable to the level that would be required under local rules if no internal model is used (i.e. it adequately models the risks the undertaking is or could be exposed to and provide capital requirements with the same confidence level as the standard approach);
- The regime has a process for the approval of internal models which includes a requirement for prior approval of the internal model before the undertaking is permitted to use the model to determine its regulatory capital requirements;
- The applicable regime includes the following requirements for an internal model to be used to calculate regulatory capital: A prerequisite for an adequate risk management system; The internal model is widely used in and plays an important role in the undertakings system of governance (use test);
Statistical quality standards; Validation standards; Documentation standards; Calibration standards; Profit and loss attribution. - Where a (re)insurance undertaking uses a partial internal model to calculate its capital requirements, the scope of the partial internal model is clearly defined and justified to avoid the "cherry picking" of risks. Please provide any supporting information to demonstrate that there is no ambiguity as to which risks, assets and/ or liabilities are included or excluded from the scope of the partial internal model. 37.Please provide details as to the legal & supervisory regime applicable in relation to group capital requirements and indicate whether and/ or how: - Appropriate standards are in place where capital requirements take into account the effect of risk mitigation techniques and diversification effects at group level;
- In order to reflect the total risks that the group may face, the group solvency capital requirement also reflects the risks that arise at the level of the group and that are specific to the group;
- The calculation methods used for determining the group capital requirement. 38.Please provide details as to the regime applicable in relation to group own funds including, where applicable, as to provisions requiring that: - Double gearing and the intragroup creation of capital through reciprocal financing is eliminated;
- The result of the assessment of fungibility / transferability issues (e.g. restricted assets) is communicated by the group supervisor; - Solo deficits are fully taken into account at group level unless the group can prove that its responsibility is limited to its proportional share of the capital; - The calculation of the group solvency shall take account of the proportional share held by the participating undertaking in its related undertakings. However, where the related undertaking is a subsidiary undertaking and does not have sufficient eligible own funds to cover its Solvency Capital Requirement, the total solvency deficit of the subsidiary shall be taken into account.
Principle 8 Parent undertakings outside the Community: group supervision

Objective The supervisory authorities of the third country shall have a legal or regulatory framework for determining which undertakings fall under the scope ofsupervision at group level. The scope of supervision at group level shall at least include all undertakings over which a participating undertaking, as defined by Article 212 of Directive 2009/138/EC, exercises dominant or significant influence. The scope may exclude undertakings where this would be inappropriate to the objectives of group supervision. 39. Please provide information on whether the scope of group supervision covers all parts of the group particularly for entities for which
there is a dominant or significant influence are included in the scope of group supervision. The scope may exclude undertakings where their inclusion would be inappropriate to the objectives of group supervision (i.e. the undertaking which should be included is of negligible interest with respect to the objectives of group supervision or the inclusion of the undertaking would be inappropriate or misleading with respect to the objectives of the group supervision). 40.Please indicate your approach, as group supervisor, to informing other supervisory authorities concerned where you have decided that an entity within the group should be excluded from group supervision.
In communicating with the other supervisory authorities in such cases do you include the reasons for this decision?
41.Please provide any other relevant information on how your regulatory framework provides for a single identified group supervisor responsible for coordination and exercising group supervision.
Financial Stability Report 2012 First half year report Introduction

EIOPAs Financial Stability Committee (FSC) has updated its report on financial stability in relation to the insurance and occupational pension fund sectors in the EU/EEA. The current report covers developments in financial markets, the macroeconomic environment, and the insurance, reinsurance and occupational pension fund sectors as of 4 May 2012 unless otherwise indicated.
Summary of main issues and conclusions INSURANCE SECTOR

Lately, the relatively positive development of insurers experienced in recent years, has started to reverse. This has shown in solvency ratios as well as profitability and to an extent also premium growth. Though the solvency situation of insurers is only reflected on a Solvency I basis1 in this report right now, the development of key value drivers (e.g. low yield environment in a number of currency zones in Europe) indicates that the situation also puts significant pressure on market values.
Nevertheless, Solvency I ratios for insurers are still at a comfortable level with ~200% at the end of 2011. Following up on last reports risk perception, E IOPA has analysed the sectors resilience to a possible longer lasting low interest rate environment as well. Although the sector overall seems to be capable of coping with these challenges for some time, EIOPA continues to monitor the situation closely. However, if accompanied by other potential threats materialising, the situation might look different, e.g. in case of renewed turmoil due to the failure of governments to stabilise fiscal situations, a strong weighing of these developments on economic growth, or a disruptive unwinding of currency risk (e.g. as a consequence of developments in Greece). While first order effects of such an event on the European insurance sector as a whole seem limited (according to EIOPA analysis conducted), local insurers are likely to suffer and second order effects might also hit other European insurers, though mainly through the potentially triggered disruption of financial markets (e.g. sovereigns, banks and equities).
REINSURANCE SECTOR
In 2011, a large number of very severe natural catastrophes occurred, making 2011 the costliest year ever for the reinsurance sector. The natural catastrophe losses exceeded by far the heavy losses of the previous record year 2005 (with hurricanes Katrina, Rita, Wilma). At the same time, the financial crisis worsened, with interest rate levels generally remaining low.
As a consequence the reinsurance undertakings were confronted with huge challenges regarding both the liability side and the asset side of the balance sheet.
However, at the beginning of 2011 the overall reinsurance industry was very well capitalised.
As a consequence the reinsurers dealt well with the challenging environment; the capital reduction was only very modest. Several years of relatively benign payouts as well as the recovery of the financial markets had led to reinsurance capacities substantially in excess of demand.
Altogether, the international reinsurance market remained relatively stable in 2011 and saw only modest price increases at the beginning of 2012.
Raising prices largely could not yet be seen in spite of the many natural catastrophes in 2011. The renewals at the beginning of 2012 as well as at April 1 led to some marked increases in reinsurance prices in the regions and segments affected by losses.
But overall the rates have gone up only modestly, last but not least due to the extensive absence of major loss events in Europe and North America.
Furthermore, there is an increased capital flow into the reinsurance market. In the background of the financial crisis investors are searching for relatively safe investments, exerting a moderating effect on the rates.
OCCUPATIONAL PENSION FUNDS SECTOR

The members and beneficiaries of Institutions for Occupational Retirement Provisions (IORPs) are currently concentrated mainly in a few Member States, but continue to grow in importance across Europe; in some Member States reforms are in place to foster this growth in the future. A trend is observed towards defined contribution schemes, which leave sponsors less vulnerable to market downturns as risks are borne mainly by members and beneficiaries. Data for 2011 (provided by supervisors on a best effort basis) document a grave evolution in the funding positions of IORPs, especially for the larger defined benefit (DB) systems such as UK and NL, where levels in 2011 seem to have declined below 100%. The low yield environment in both countries is a key driver behind this development, as it forces the market value of liabilities up. At the same time both systems also result in low expected future asset returns given the dominance of debt investments for most occupational pensions in most countries. Supervisors have taken actions to address these low funding levels. In NL funds are obliged to participate in a recovery programme as their coverage ratio (assets divided by technical provisions) drops below the required level (on average 120%).
The UK pensions regulator is also running recovery programmes and has published a statement in April setting out expectations of trustees of DB IORPs starting valuations under the current conditions.
Other recent trends include an increase in sovereign debt exposures of IORPs in 2011 with respect to 2010.
At least in high yield countries this is focussing on shorter maturities. Given current turbulent market conditions, a number of regulators have emphasised the increasing importance of proper governance processes and increasing reporting requirements, also including regular scenario analyses and stress tests.
Recent developments FINAN CIAL MARKET DEVELOPMENTS

The macroeconomic environment is still challenging in many European countries and thus a main source of concern for financial stability. Unease over government debt levels remains and political uncertainty continues to influence markets also after the relatively strong policy responses at the European level. Overall, the political and economic climate continues to weigh on growth prospects in Europe, although there are regional differences. Figure 1 shows the evolution of two leading European business cycle indicators for the economic cycles six months ahead. The OECD index shows a somewhat declining trend in macroeconomic output, although possibly at a slower pace than in previous months. The ZEW Eurozone indicator had improved at the beginning of 2012 after having reached levels comparable with those observed during the financial crisis in 2008. The latest figure, however, indicates that the sentiment is again deteriorating slightly.
Note: The figure shows leading indicators for the economic cycle six months ahead. Two indicators are depicted. One derives from the ZEW (Zentrum fr Europische Wirtschaftsforschung) Eurozone expectation of economic growth and the other from OECD. The former is plotted in blue on the left hand axis and the latter is plotted in green on the right hand axis. The OECD updated its methodology for the calculation of the indicator in April 2012 to use GDP as a reference series. Several European countries are facing continued economic downturn. Figure 2 shows the development in GDP in several large European countries.
Only in a few countries is the GDP back to pre crisis levels. In several countries, GDP seems to be sloping downwards. Combined with deleveraging by the banking sector in Europe and the fiscal consolidation path followed by major governments, growth prospects for several countries seem dim, at least in the short term. The fact that fiscal consolidation and bank deleveraging is occurring in many countries at the same time increases the disruptive potential of the situation. At the same time, there is little evidence of inflationary tendencies which might have been expected given the debates at the political level on growth oriented instruments and global fiscal expansionary policies.
Figure 3 shows that overall inflation expectations are well anchored at around 2% at a five year horizon.
Note: The figure shows the evolution of the rate of the 5 year EUR inflation swap. It is noted that the swap rate is not adjusted for any inflation or other risk premia. Combined with high levels of Government debt following the banking crisis which started in 2008, this situation has led European government bond yields to diverge further. Government bond yields are high compared to the last few years for many European countries and several currently show an increasing trend.
LEGISLATIVE AND REGULATORY DEVELOPMENTS

A number of legislative and regulatory developments have been reported by 29 Members and Observers on the basis of an E IOPA survey on national regulatory reforms which have been adopted in the second half of 2011 and the first part of 2012. The volatility in the capital market and the turbulence experienced in the Eurozone sovereign debt market are perceived as the major thrust of the regulatory and legislative changes reported by most of the responding countries. As a reaction to the impact of sovereign risk on the solvency position of the insurance undertakings, in several countries changes were made in the valuation approach to sovereign bonds (DE, DK, GR, IT). Supervisory engagement also included increasing the required frequency of reporting of sovereign, banking and other asset class exposures by insurance undertakings and groups (IE, LU, SI). To deeply explore potential risk concentration areas and market vulnerabilities ad hoc risk analyses, legislative amendments and reporting requests have been made (BE, FR, IT, PL). The composition of the asset portfolios held by insurance undertakings and the asset allocation policies are closely monitored in many territories (BE, DE, EE, FR, GR, I E, IT, PL, RO) as well as the liquidity position (BE, CY, PT, PL, RO) as a consequence of higher lapse rates. Likewise in house Stress Test exercises were widely performed, or are planned to be conducted in 2012, to assess the insurers ability to absorb additional shocks as well as the impacts of relatively large movements in risk factors using new stress test calculations, methodologies or additional adverse financial contexts (EE, FR, FI, LU, NO, PL, CZ).
Low yield valuation exercises are also considered to be a key instrument to be further used to investigate financial weaknesses of the domestic market players.
In this context, and in preparation of 2012 European stress testing, several countries have already launched or are planning to conduct a QIS5bis exercise over the current year.
Following up on the regular and ad hoc monitoring of the solvency and capital positions of undertakings, more than half of the responding countries reported the need to adopt additional supervisory measures to prevent or solve solvency strains. In few countries a need was seen to put in place targeted actions or to request ad hoc data (EE, MT, SE) on the basis of concern over the high risk profile of individual companies. This has broadly led to a review of the annual, quarterly or monthly reporting packages (LU, LI, SE) which in some cases have also been amended or newly implemented to allow an impact assessment of the new prudential requirements to be adopted under the Solvency I I framework. Action plans to gradually implement the new prudential requirements have already been initiated in the observed period (second half 2011 first half 2012) and will be carried out over the year 2012 (DE, LI, MT, FR). These mainly consist in exercises for evaluating the preparedness and affectedness of the industry by SII requirements, supported in some countries by dedicated meetings and by on site visits carried out as part of the I nternal Model pre application process and of the Solvency I I implementation process. Similar programs, started before the observed period, are ongoing and broadly performed in many other European jurisdictions.
Developments in the European insurance sector INSURANCE SECTOR DEVELOPMENTS

Overall, the reported data from a sample of large European insurers indicates a slight worsening in profitability and solvency levels while new business is quite sluggish for a significant number of reporting groups. Life insurance premiums have increased by only 3% on average though more than half of the participating groups reported declining premiums. While in traditional life insurance, with a guarantee component, premiums declined by around 10% on average, unit linked life insurance recorded higher premiums (+3%). In non life business, premiums decreased on average by 2% while more than half of the sample experienced higher premiums. The highest increases in premiums have been seen in marine / aviation / transport (+24%), while in credit / suretyship premiums shrank by 17%.
Source: EIOPA, based on worldwide consolidated financial information received from a sample of 24 large European insurance groups from AT, CH, DE, ES, FR, IT, NL, SE and UK (22 groups for 2011 data).
Source: EIOPA, based on worldwide consolidated financial information received from a sample of 24 large European insurance groups from AT, CH, DE, ES, FR, IT, NL, SE and UK (22 groups for 2011 data). Overall profits of surveyed groups decreased from 2010 to 2011 when considering the median group, profits were some 17% lower. Return on equity also decreased (from 9.6% to 7.8% for the median group) though the dispersion especially on the lower end of the distribution was significantly lower in 2011 than in 2010.
Source: EIOPA, based on worldwide consolidated financial information received from a sample of 28 large European insurance groups from AT, CH, DE, ES, FR, IT, NL, SE and UK (25 groups for 2011 data). Though 2011 was characterised by a large number of unusually costly natural catastrophes, profitability of the large non life insurance groups did not deteriorate: Net claims incurred grew less than net premiums so combined ratios were quite stable. Overall, it declined from 99% to 97%. Also this trend was observed for a majority of surveyed groups.
Source: EIOPA, based on worldwide consolidated financial information received from a sample of 22 large European insurance groups from AT, CH, DE, ES, FR, IT, NL, SE and UK (18 groups for 2011 data).
LOCAL MARKET DEVELOPMENTS

In addition to the quantitative answers based on the fast track reporting summarised above, members have provided qualitative assessments of market conditions, key aspects of the life and non life insurance sectors, and the main risks and challenges as they are observed in local markets. In EIOPAs view the insurance sector across Member States appears to be generally resilient. In spite of adverse market conditions and sluggish economy, life and non life companies are sufficiently capitalised in terms of solvency ratios following the current regime. A large group of Members reported that solvency ratios in their national markets suffered end 2011 from decreases in market valuation and
sovereign debt crisis, however, some insurers have already recapitalised and others announce to do it during the year 2012. Overall, in the majority of the Member States (DE, DK, ES, FR, I T, UK) a stabilisation in the upcoming 6 to 12 months is expected. In a significant number of Member States a decline in gross premiums in the life sector has been observed recently, primarily due to the sluggish economic activity in some countries. Continued high unemployment also makes it difficult financially for many individuals to purchase new products. In addition, in some Member States the demand for classical life insurance products decreased slightly compared to last year which may be somehow related to the trend in many Member States to marketing towards unit linked or zero guarantee products. While a few Member States report slight improvements in financial results of life and non life companies, in most Member States, insurers were affected by adverse market conditions, low interest rates and by the sovereign debt crisis. Hence, lower returns on assets due to volatile financial markets, low interest rates, the sovereign debt crisis and the macroeconomic downturn, are highlighted as the main causes for the mixed financial results of the European life and non life sectors. In particular, the currently available information pointed out that financial market developments during the second half of 2011 contributed to a deterioration of the solvency situation of the insurers in Europe, however, the sectors are reported to remain well capitalised. A number of key aspects and developments in the European life and non life insurance sectors have been reported by Members.
As life insurers examine how to reduce the capital strains caused by guaranteed products, the prolonged low interest rate environment will depress the yields for new cash flow and maturing bonds.
Therefore there is an increased trend in many Member States (DE, FI, NO, SE, UK) towards marketing unit linked or zero guarantee products.
A particular issue pertains to the lapse rates which deteriorate in some of the Member States (AT, BE, FR, I T) which may be somehow related to weak macroeconomic environment. In particular in some Member States were observed higher lapse rates during the last quarter of 2011 but latest information available point out to a decrease (FR) or a stabilisation in 2012 (AT, BE, IT, SE). In terms of assets held by insurance companies, in a few Member States, insurers determined concentration limits for asset management, reducing exposures to or even banning euro peripheral sovereign. Furthermore, in the majority of Member States most insurers wrote down the value of Greek government bonds in the second quarter. In a large group of Member States there has also been an allocation from peripheral low graded government bonds to higher graded government bonds, equity and high graded non financial corporate bonds (DE, FR, UK, FI, NO). Moreover, in a few Member States it is expected that insurers shorten maturities, hold cash and favour liquid assets (FR, I T).
Risk and Challenges

The overarching and somewhat interconnected risk themes, which have been on the economic agenda for some time now, remain mainly unchanged: (i) sovereign risk;
(ii)the low yield environment, and the risk of not meeting issued interest rate guarantees; and (iii) the search for yield and the additional risk assumed in this process. Emerging themes may well follow on the back of these three well known risk factors. The list could contain events such as further developments in the sovereign bond markets in Europe, renewed strains on the banking sector, further deterioration of the US economy and fiscal budget, imbalances and further uneven growth rates within the euro area economies and following political and macroeconomic risks.
SUPERVISORY RISK ASSESSMENT FOR TH E INSURANCE SECTOR

As regards the risk themes highlighted by Members, some of the risk factors which are affected more for adverse financial markets conditions and a weaker economic environment are seen now to be more relevant. The risks expected to increase: sovereign, property and credit to corporates and households emerge simultaneously in a sluggish economic environment such as Europe experienced in the past months.
Moreover, in an environment where government yields are located at low levels, interest rate guarantees become hard to fulfil.
Furthermore, as a result of a weak economic recovery, the remaining economy and industrial enterprises face difficulties, and the average credit rating of governments and industrial corporations would therefore deteriorate. Hence, investment opportunities in lower rated investment vehicles, such as, for example, sub investment grade bonds, increase in supply, making it relatively easier for insurance companies to engage in such investments.
As highlighted by several Members, it is important to be vigilant and to contain and monitor these risks described above. Otherwise, it can be envisaged that weaker capitalised insurance companies could suffer unsustainable losses from their investment activities. Indeed, macroeconomic conditions indicate that 2012 will likely be another year in Europe of low GDP growth, low interest rates and moderate equity market performance. Even if the economic recovery continues, insurers may find that the assets underpinning their balance sheets have decreased in value.
EIOPA Members and Observers have been asked to assess risks and challenges according to the probability of a materialisation and the impact on the national insurance markets.
While for the Autumn 2011 E IOPA Financial Stability Report a more comprehensive list of 45 risks and challenges is used as the basis for the risk assessment, many of them being of a structural nature, the list used in the this Spring Report is primarily focussed on market and credit risks. Based on the responses from 29 Member States4, the following risks and challenges are classified as the most imminent, ranked by the product of the scores for probability and potential impact. Sovereign risk, equity risk, low interest rates as well as credit risk of banks are the risks with highest overall rankings. Especially the first of these items is considered to have an increased probability of materialisation and also the impact of such a scenario is expected to be significant.
Over the last six months eight of the 10 risks mentioned above have increased according to the feedback of national supervisors. The highest increases are reported with regard to equity risk, property risk and liquidity risk. On the contrary, natural catastrophes and currency risk are considered to be stabilised compared with data from six months ago. For the next six months three risks are expected to increase further, due to turbulences in the financial markets and as a consequence of a sluggish economy, e.g. credit risk on sovereigns, property risk and credit risk to corporates and households. Conversely, interest rate risk related to a prolonged period of low interest rates is expected to decrease slightly.
Developments in the European reinsurance sector MAJOR LOSS EVENTS I N 2011 AND AT THE BEGINNING OF 2012
The year 2011 has set new records. At about USD 380bn, global economic losses far surpassed 2005, the previous record year with losses of USD 220bn and make 2011 a year of unprecedented losses. Original insured losses totalled USD 105bn, slightly more than 2005s USD 101bn (in original values). The most destructive loss event of the year 2011 was the devastating earthquake of 1 1 March in Tohoku, Japan, which alone (including the tsunami and without considering the consequences of the nuclear accident) accounted for overall losses of USD 210bn and insured losses of about USD 35bn - 40bn. It was the costliest natural catastrophe of all times and the strongest earthquake (magnitude of 9.0) ever recorded in Japan.
The earthquake was also the most severe natural catastrophe in 2011 relating to fatalities: 15,840 people were killed, roughly more than the half of all people who have been victims of natural catastrophes in 2011.
However, the figure does not include the countless people who died as a result of the famine following the worst drought in decades on the Horn of Africa, which was the greatest humanitarian catastrophe of the year 2011. The second most expensive natural catastrophe in 2011 for the insurance industry was again a very severe earthquake. On 22 February, N ew Zealands second largest town, Christchurch, was partly destroyed by an earthquake with a magnitude of 6.3, which caused
insured losses of about USD 13bn and overall losses of roughly USD 16bn.
These two large earthquakes were responsible for making geophysical events the dominant loss drivers in 2011. Nearly two thirds of economic losses and about half the insured losses stemmed from geophysical events. The long term average contribution of geophysical events has been just 22% of the economic losses and only 10% of the insured losses. So 2011 was exceptional not only due to its extraordinarily high losses, but also because of significant deviations of the distribution of the losses to the different perils. Since the hurricane season was relatively harmless the storm related insured losses reached only 37% of all insured losses in 2011 compared with 76% in the long term average. Again, untypically, more than 50% of all insured storm losses stemmed from devastating thunderstorms and tornado outbreaks in the USA which accounted for an absolute record of insured losses of about USD 26bn. A further record in 2011 represents the flooding in Thailand.
With overall losses of about USD 40bn and insured losses of about USD 10bn the flooding in Thailand was not only by far the countrys most expensive catastrophe to date, but also the worlds most expensive flood disaster. A prominent role played the increased importance of Thailand regarding the global manufacturing supply chains. A large number of key component manufacturers were affected by the flooding, leading to production delays and disruptions at client businesses. As a consequence insured losses caused by production disruptions soared up. So, despite the dominant geophysical events in 2011, the weather related events in total were also very severe, leading to the second highest values recorded since 1980 in terms of overall and insured losses (in 2011 currency units). Even without the earthquakes, 2011 would have been an extreme natural catastrophe year. Moreover, the distribution of insured losses between the continents in 2011 was also exceptional. Asia accounted for 44% of all insured losses, whereas North America and Europe together accounted for fewer than 40% in 2011 contrary to the long term average of more than 85% of all insured losses. The absence of major loss events in the Western developed countries with a high insurance density left the insured losses in relation to the overall losses at a low level and is one major reason why overall the rates only increased relatively modest in spite of the heavy losses in 2011. By contrast, loss activity during the first three months of 2012 has been relatively light.
Insured losses during the quarter are expected to be less than USD 5bn, significantly lower than losses of over USD 50bn in the first three months of 2011. The sinking of the cruise ship Costa Concordia, regional tornado outbreaks in the US and earthquakes in Mexico and Chile were the most significant losses that occurred in the first quarter of 2012. Despite the heavy losses of 2011, the reinsurance market continues to function normally and has sufficient capital. At the end of 2011, the reinsurance capacity was only three percent under the level of 2010. The renewals in January and April reveal that sufficient capacity was available in the market in spite of the heavy losses and the challenging macroeconomic environment (particular low investment yields and increased investment volatility). Several years of relatively benign payouts as well as the recovery of financial markets had led to reinsurance capacities substantially over the demand, which depressed the prices.Consequently the rates did not rise largely, which is very different from other post loss markets. There are, of course, some marked increases in reinsurance prices in the regions and segments affected by losses, especially regarding the Asia Pacific region. But overall the rates have gone up only modestly, last but not least due to the extensive absence of major loss events in Europe and North America. Particularly the demand for reinsurance in the US, where reinsurance demand far exceeds that of any other region, continues to be very sensitive to price.
The 2011 hurricane season was relatively harmless. The model version changes (RMS v.1 1) were often already reflected in underwriting processes to varying degrees based on previous loss experience with the result of a less increased demand for reinsurance than expected earlier.
Annex 1: Country abbreviations

AT Austria BE Belgium BG Bulgaria CY Cyprus CZ Czech Republic DE Germany DK Denmark EE Estonia ES Spain FI Finland FR France GR Greece HU Hungary IE Ireland IS I celand IT I taly LI Liechtenstein LT Lithuania LU Luxembourg LV Latvia MT Malta NL Netherlands NO Norway PL Poland PT Portugal RO Romania SE Sweden
SI Slovenia SK Slovakia UK United Kingdom CH Switzerland
The translation (Japanese to English) is ready! Insurance I nspection Manual (Inspection Manual for Insurance Companies) Points of Attention for Inspections with Use of This Manual
(1)This inspection manual shall apply to all insurance companies, including the overseas offices of Japanese insurance companies (overseas branches, locally incorporated entities, representative offices, etc. provided however, that the determination of whether to include these offices in the inspection subject to this manual shall be judged in view of applicable laws and regulations, including the local regulatory framework), as well as Japanese branches of foreign insurance companies, etc. and specified corporations. (2)When the insurance company is a company with a committee system, inspections shall be conducted from the viewpoint of whether the Board of Directors, committees (such as the nomination, compensation, and audit committees), executive officers, and other corporate structures exercise their empowered authority, etc., paying attention to the following points:
- 1) The authority to execute business is bestowed on executive officers, and in principle, directors do not have the authority to execute business.
- 2) The Board of Directors may delegate, by resolution, the authority to make business decisions to executive officers.
- 3) The purpose of the Board of Directors is to supervise the execution of the respective duties performed by directors and executive officers.
- 4) Auditing authority is bestowed on the audit committee, and not on individual audit committee members. (Audit committee members appointed by the audit committee may exercise the authority of the audit committee.)
(3)In the case where an executive director (non-director) assumes the roles and responsibilities that would normally be assumed by a director in charge of a specific business operation, it is necessary to conduct a comprehensive review as to whether the Board of Directors has assigned the officer authority similar in effect to that which would be granted to a director in charge, whether the focus of the responsibility is made clear, and whether the Board of Directors sufficiently monitors the execution of the relevant business operation. Based on the findings thereof, the inspector should determine whether the executive officer is performing the roles and responsibilities required for a director in charge, as specified in the checklists of this manual. (4)Furthermore, when due to certain special reasons, it is necessary to conduct an inspection of subsidiaries, etc., of insurance companies or parties conducting business on their behalf, examinations as may be required shall be conducted in accordance with the applicable sections of this manual. (5)Unless specified otherwise, items expressed in the question form such as does the company or is the company refer to requirements that must be met by insurance companies. Meanwhile, items preceded by It is desirable refer to best practices recommended for insurance companies, unless specified otherwise.
With regard to items accompanied by for example, insurance companies are not required to fully comply letter-by-letter with the criteria and requirements specified therein.
They are merely examples of items that may be useful for checking whether insurance companies are meeting certain criteria and requirements, in a manner befitting the scale and nature of their business.
(6)The following are definitions and uses of some of the key terms in this manual - 1) I tems that are defined as roles of the Board of Directors are items for which the Board of Directors itself needs to determine substantial matters related thereto. However, this shall not preclude another deliberative body, division or department from discussing draft proposals for decision. - 2) The Board of Directors or organization equivalent to the Board of Directors includes, in addition to the Board of Directors, other entities that decide matters concerning corporate management, with the participation of senior managers such as a council of managing directors and a corporate management council (hereinafter referred to as the Council of Managing Directors, etc.). It is desirable that decisions concerning items specified as the prerogatives of the Board of Directors or organization equivalent to the Board of Directors be made by the Board of Directors itself. In the case where the decision - making authority is delegated to the Council of Managing Directors, etc., it is necessary to make sure that the delegation has been made in a clear manner, that a follow-up review is provided for through the compilation of the minutes of meetings of the Council of Managing Directors, etc., and that a sufficient check-and-balance system is ensured, through arrangements such as requiring reports to be made to the Board of
Directors, and allowing corporate auditors to attend meetings of the Council of Managing Directors, etc. - 3) The business locations refers to organizations, other than the head office, which includes branches, regional offices, business line headquarters, business offices, overseas branches, and overseas corporations. The term business locations, etc. refers to business locations, and also includes service centers (including loss investigation operations), overseas representative offices and other locations that are not engaged in sales activities, and business locations other than the head office.
- 4) The manager refers to persons in senior managerial positions in management divisions (including directors).
Furthermore, the term also refers to the head of a business location, or senior managers thereof (including directors) with levels of responsibility equivalent to or higher than the head of a business location. - 5) The employees, etc. refers to employees, sales representatives, and insurance agents of insurance companies.
- 6) The insurance sales representatives refers to sales representatives and insurance agents, but does not include insurance brokers.
- 7) The policyholders refers to persons who are parties to insurance contracts with insurance companies. - 8) The policyholders, etc. refers to policyholders, insured persons, and beneficiaries.
- 9) Internal rules are rules that specify arrangements on an insurance companys business in accordance with its corporate management policy, etc. that are applicable within the company.
It should be noted that internal rules do not necessarily have to specify detailed procedures.
- 10) The marketing and sales division refers to a division, department, or business location engaged in sales business. For example, a division involved directly or indirectly in sales or engaged in sales promotion planning is a marketing and sales division. - 1 1) The legal checks, etc., which includes a compliance check, means, for example, a validation of the consistency and compatibility of internal rules and the legality of transactions and business operations by personnel in charge of legal affairs, a division in charge thereof, personnel in charge of compliance, the compliance control division, and in-house or outside lawyers and other experts. - 12) Monitoring refers to not only surveillance but also implementation of specific pre-emptive measures such as issuing warnings. - 13) The risk profile of a financial institution refers to the sum of features of various risks to which the institution is exposed.
Checklist for Business Management (Governance) (for Basic Elements)

Checkpoints
- In order to protect customers by ensuring the sound and appropriate management of business and fairness of insurance solicitation of an insurance company, under appropriate governance, thorough implementation of legal compliance, proper insurance solicitation and customer protection, and accurate management of various risks across all businesses of the insurance company are needed.
-In order to enable an insurance company to conduct business management (governance) effectively, officers and employees, as well as organizations within the company must perform their respective roles and responsibilities. To be more specific, directors and other executives are responsible for nurturing work ethics and cultivating a company-wide culture that attaches importance to internal control. The representative directors, non-representative directors and corporate auditors must understand their own roles in the various processes of internal control and fully involve themselves in the processes. Also, it is important that the Board of Directors and the Board of Auditors function effectively and that the functions of a check-and- balance system among divisions and departments, and the functions of internal audits by the I nternal Audit Division are executed appropriately. -The inspector should determine whether the insurance companys business management (governance) system is functioning effectively throughout the institution and whether the management is performing its roles and responsibilities appropriately by way of reviewing, with the use of the check items listed in this checklist, the effectiveness of the functions of five basic elements, namely a system of (1)Business management (governance) by the representative directors, non-representative directors and the Board of Directors,
(2) Internal audits,

(3) Audits by corporate auditors, (4) External audits, and (5) Checking by actuaries. - If the insurance companys management fails to recognize weaknesses or problems recognized by the inspector, it is also necessary to explore,
in particular, the possibility that the I nternal Control System is not functioning effectively, and review the findings thereof through dialogue.
-The inspector should review the status of improvements with regard to the major issues pointed out on the occasion of the last inspection and determine whether or not effective improvement measures have been developed and implemented.
Checklist for Legal Compliance

Checkpoints
-The development and establishment of a legal compliance system is one of the most important tasks for an insurance company in order to secure the sound and appropriate management of its business. Therefore, the companys management is charged with and responsible for taking the initiative in developing and establishing the legal compliance system that covers the companys entire business by deciding a basic policy on legal compliance and developing an organizational framework, etc..
-The inspector should determine whether the legal compliance system is functioning effectively and whether the roles and responsibilities of the insurance companys Board of Directors are being appropriately performed by way of reviewing, with the use of check items listed in Chapter I., whether the management is appropriately implementing
(1) Policy development, (2)Development of internal rules and organizational frameworks and (3) Assessment and improvement activities. - If any problem is recognized as a result of reviews conducted with the use of the check items listed in Chapter I I and later in this checklist, it is necessary to exhaustively examine which of the elements listed in Chapter I are absent or insufficient, thus causing the said problem, and
review findings thereof through dialogue between the inspector and the insurance company.
-If the companys management fails to recognize weaknesses or problems recognized by the inspector, it is also necessary to explore in particular the possibility that the I nternal Control System is not functioning effectively and review findings thereof through dialogue. -The inspector should review the status of improvements with regard to the issues pointed out on the occasion of the last inspection that are not minor and determine whether or not effective improvement measures have been developed and implemented. To read more http:/ / www.fsa.go.jp/ en/ refer/manual/ hoken_e/ h-all.pdf
Interview with Gabriel Bernardino, Chairman of EIOPA, conducted by Silke Wettach, WirtschaftsWoche (Germany)
Mr Bernardino, how much does EIOPA currently know about occupational pensions in the EU?
Bernardino: We currently have very little data from pension funds at the European level. We d on t h ave a comm on lan guage and national regimes considerably vary from each other, which makes it even more difficult to have comparable data for different countries. We cannot easily assess the sustainability of the funds and the soundness of their promises. A common and transparent framework that ensures comparable data would be extremely useful in this case.
So how are you going to proceed with it?

Bernardino: I f we had comparable data we could conduct stress tests the way we already do for insurers. We have no scheduled date, but this is in our plans in the near future.
What do you expect from the IORPs stress test?After the stress tests in the banking sector the picture was insufficient.
Bernardino: European pension funds manage in total 3 trillion EUR in assets.
They are represented in assets everywhere which makes them relevant for the economy and for the stability of our financial system. That is why EIOPA proposes to conduct annual stress tests for the big pension funds at the European level. At the same time supervisory authorities should perform stress tests at the national level. Smaller IORPs can be tested on a less frequent basis. What we want to know while conducting stress tests is where the future vulnerabilities are? But here we are talking about a very long term perspective.
With the banking stress tests there were a lot of national reflections. Nobody wanted to see national champions failing. Will the situation in occupational pensions be different?
Bernardino: We have now a very sensitive discussion on the pensions side and it was expected. The truth must finally be put on the table.
And how exactly does the truth look like?

Bernardino: Occupational pensions are now under a great pressure. Everywhere be it Germany, the Netherlands or the UK population and labour force are contracting. At the same time stock markets become very volatile and have a tendency to go down. The long term interest rates are also decreasing. All this threatens those pension promises that were made in the past.
But if we deny the reality, we will not take any action. And I am afraid that on the occupational pensions if we dont act, we might be heading towards an inter-generational conflict, when the pensions of future generations might be significantly reduced.
What are policy holders going to face?

Bernardino: I t is quite simple: if I make a promise to pay based on a certain assumption and this assumption changes, then either I can pay less or I request higher contribution. In the Netherlands we already witness the consequences: occupational pension funds cut their payments because market interest rates are lower than it was originally anticipated.
Are the Netherlands smarter than the others?

Bernardino: Some countries are more transparent. And this is exactly what we require from others when we suggest a holistic balance sheet or an extended solvency balance sheet. Each employee will exactly know the risks he bears and which payments he will get. So such a reality+driven check+up would be beneficial for everybody.
Perhaps some funds are absolutely not interested that their true condition comes to light?
Bernardino: Some funds discount long term liabilities with too high interest rates. If you use more prudent and real discount rates they will report huge underfunding. And of course companies do not want that it comes out, but it is not a secret.
How good are the funds managers?

Bernardino: The quality varies and in any case it must be improved. The current low interest rates make I ORPs search for interesting investments. And this makes it very important for fund managers not just to outsource asset management. Those who, however, instruct a third party to invest in derivatives or structured financial instruments, should at least have a thorough understanding of the possible consequences.
The industry expects that the EU is going to set up the same capital requirement for the IORPs as for the insurers. Is that correct?
Bernardino: We do not want just to copy the requirements for insurers. However, lets take a situation when a company has a pension plan and transfers the risk to the I ORP like it used to do with an insurance company. In this situation why cant the same regulation be applied to the I ORP?. But this should not be the case if pension funds act as investment vehicles and their risk is taken by the company or a protection fund.
Some German critics fear that the Commissions plans could destroy the German system. Do you understand their fears?
Bernardino: I t is not our intention to destroy any kind of systems and our goal is not to design a perfect regulation, which makes occupational pensions so expensive that nobody can afford them. But the worst scenario would be if those pension promises on which everybody counted, fail. This is why we must act. Ultimately, it is like the debt crisis: it emerged not because people know little about economics, but because they were denying the reality. And this is always expensive.
Overview of Progress in the Implementation of the G20 Recommendations for Strengthening Financial Stability
Report of the Financial Stability Board to G20 Leaders, 19 June 2012
Introduction
Since the onset of the global financial crisis, the G20 has established core elements of a new global financial regulatory framework that will make the financial system more resilient and better able to serve the needs of the real economy. National authorities and international bodies, with the Financial Stability Board (FSB) as a central locus of coordination, have further advanced this financial reform programme, based on clear principles and timetables for implementation. The FSB coordinates and closely monitors the national implementation of agreed G20 and FSB financial reforms and is responsible for reporting on it to the G20. The FSB set up in October 2011 a Coordination Framework for Implementation Monitoring (CFIM), in collaboration with international standard-setting bodies (SSBs), to intensify its monitoring and public reporting on implementation, focusing in particular on priority reform areas. This report details the progress made in global policy development and in implementation of global policy reforms since the G20 Cannes Summit in November 2011. A central piece of the international policy reforms is stronger minimum standards for bank capital and liquidity through implementation of Basel I I , I I .5 and I I I requirements.
As of end-May 2012: - 20 of 27 member jurisdictions of the Basel Committee on Banking Supervision (BCBS) had implemented the Basel I I.5 rules to strengthen capital charges for banks trading books and complex securitisations, which were due to come into force from end-2011. Six member countries have not issued final regulations in this area. - 20 of 27 BCBS member jurisdictions have issued draft or final Basel I I I regulations, implementation deadline for which is 1 January 2013. Seven member jurisdictions have yet to do so, but the majority of these believe they can issue final regulations by the implementation deadline. Another central reform objective is ending too big to fail through strengthened resolution regimes and resolution planning for global systemically important banks (G-SIBs): - Encouraging progress has been made by major jurisdictions, including the US, UK and EU, to put in place or propose legislation to establish effective resolution regimes; - However, although cross-border crisis management groups (CMGs) have been established for 24 of the 29 G-SIBs, much further work is needed to develop resolution strategies and plans, and the crossborder co-operation agreements needed to ensure the resolvability of these G-SIBs. With regard to reforms to over-the-counter (OTC) derivatives markets, all jurisdictions and markets need to aggressively push ahead to achieve full implementation of market changes by end-2012 to meet the G20 commitments in as many reform areas as possible: - Good progress has been made by those jurisdictions with the largest OTC derivatives markets, including the United States (US), European Union (EU) and Japan, in advancing national legislation
and regulation and practical implementation of reforms to market infrastructures; - SSBs have also made significant progress in developing the international policies that are key to advancing OTC derivatives reform implementation across jurisdictions. All jurisdictions now have sufficient information about international standards and policies to put in place the needed domestic legislation and regulation. With regard to reform of compensation structures at financial institutions: - Almost all FSB member jurisdictions have now implemented the FSB Principles and Standards for sound compensation practices in regulation or supervisory guidance. Since Cannes, jurisdictions that showed significant gaps have progressed. However, sustained supervisory and regulatory attention will be needed to achieve lasting improvements in financial firms compensation structures and practices. Since the Cannes Summit, the FSB and its members have made good progress in policy development in areas where G20 objectives have been agreed, including developing proposals for public consultation on extending the framework for systemically important financial institutions (SIFIs) to cover global insurers and domestic banks, measures to address the regulation and oversight of shadow banking, and the development of a governance framework for a global Legal Entity Identifier (LEI) system. An important goal of the monitoring process is to highlight, for corrective action, areas where there are risks that policy objectives will not be met, or where implementation is not meeting the agreed timelines.
Among these areas: - Although CMGs have been established, much further work on resolution plans and on cross-border co-operation is needed to improve resolvability. Progress is being made in national legislative reforms to establish more effective resolution regimes. The standards set out in the FSBs November 2011 Key Attributes of Effective Resolution Regimes provide international standards in this area, and the detailed assessment methodology being developed will provide further guidance. - Many jurisdictions still need to address weaknesses in their supervisors mandates, to ensure sufficient independence to act, appropriate resources, and a full suite of powers to proactively identify and address risks. The Basel Core Principles are being strengthened in this area, with a consultative paper having been issued last December. The following sections describe in greater detail the progress made by the FSB and its members to promote financial stability and strengthen the resilience of the global financial system, including through surveys conducted by the FSBs Implementation Monitoring Network (IM N).
2. Building resilient financial institutions 2.1 I mplementation of Basel I I / I I .5 /I I I

The G20 Leaders, at the Cannes Summit, reaffirmed their commitment to improve banks' resilience to financial and economic shocks, and called on jurisdictions to meet their commitment to implement fully and consistently the Basel I I / I I .5 /I I I requirements. The Basel I I I framework seeks to strengthen the resilience of the banking system through prudential measures that will enhance the
quality of capital; increase the level of capital; promote the build-up of capital buffers to mitigate pro-cyclicality; supplement the risk-based capital requirements with a leverage ratio; and introduce a set of global liquidity standards. Together with the Basel I I and Basel I I .5 frameworks, Basel I I I will improve the banking sectors ability to absorb shocks arising from financial and economic stress, whatever the source, thus reducing the risk of spillover from the financial sector to the real economy. The BCBS with the endorsement from GHOS, meanwhile launched in January 2012 a comprehensive process to monitor its members implementation of Basel I I / I I .5 /I I I. The process consists of three levels of review: (i)Level 1: ensuring the timely adoption of Basel I I / I I .5 /I I I; (ii)Level 2: ensuring consistency of domestic regulations with Basel I I / I I .5 /I I I; and (iii)Level 3: ensuring consistency of outcomes (initially, this assessment of implementation at the bank level will focus on risk-weighted assets). The three-level monitoring framework will promote timely and consistent implementation of Basel I I / I I.5 /I I I and also provide inputs to the FSBs reporting to the G20 Leaders on implementation of priority reforms. On the timely adoption of Basel I I / I I .5 /II I (Level 1), the BCBS published in October 2011, April 2012 and June 2012 reports that detailed the progress BCBS members have made in implementing Basel I I / I I .5 /I I I. As of end-May 2012, 21 of 27 BCBS member jurisdictions have implemented Basel I I , which was due to come into force from end-2006. In addition, Indonesia and Russia have implemented Basel I I s Pillar 1 (minimum capital requirements). Argentina, China, Turkey and the US are in the process of implementing Basel I I .
With regard to Basel I I.5, as of end-May 2012, 20 BCBS member jurisdictions had implemented those rules, which were due to come into force from end-2011. Argentina, I ndonesia, Mexico, Russia, Turkey and the US had not issued final regulations. The US authorities approved final rules covering the market risk elements of Basel I I .5 in early June 2012. Saudi Arabia has issued final regulations but these have not yet come into force. Among the 29 G-SIBs identified in N ovember 20114, nine are headquartered in jurisdictions that have not yet fully implemented Basel I I or Basel I I .5. Draft Basel I I I regulations had not been issued by seven BCBS member jurisdictions as of end-May 2012: Argentina, H ong Kong, I ndonesia, Korea, Russia, Turkey and the US. The US authorities however have since then published the draft Basel I I I rules. The majority of these countries believe they can issue final regulations by the implementation deadline of 1 January 2013.
However, for the others, depending on their domestic rule-making process, meeting the deadline could pose a significant challenge.
In addition to monitoring the timely adoption of Basel I I I rules, the BCBS has established a process to review the content of the new national rules for the implementation of Basel I I I. This second level of review is meant to ensure that the national adaptations of Basel I I I are consistent with the minimum Basel I I I standards. The BCBS has initiated peer reviews of the domestic regulations of the EU, Japan and the US to assess their consistency with the globally agreed standards. The findings of these reviews are preliminary since the analysis is not yet completed and the formulation of national standards is still ongoing.
Nevertheless, there is a possibility that national and regional implementation will be weaker than the globally agreed standards in some key areas. A third level of review by the BCBS examines whether there are unjustifiable inconsistencies in risk measurement approaches across banks and jurisdictions, and the implications these might have for the calculation of regulatory capital. This review will initially focus on banks risk-weighting practices in the banking and trading books, and includes the use of test portfolio exercises, horizontal reviews of practices across banks and jurisdictions, and joint on-site visits to large, internationally active banks. The BCBS intends to develop an updated progress report by the time of the G20 Finance Ministers and Central Bank Governors meeting in November 2012 that includes: (i)An update on its members domestic rule-making; (ii)The final outcome of the regulatory consistency assessment of the EU, Japan and the US; and (iii)Preliminary findings from its deeper analysis of banks risk measurement approaches and regulatory capital calculations. A review of the consistency of Singapores regulations with the international standards (i.e. a Level 2 review) will commence later in 2012, with reviews of China and Switzerland to follow in 2013.
This schedule ensures that all countries that are home to G-SIBs will have been reviewed before the middle of 2013. Reviews of Australia, Brazil and Canada will take place during the second half of 2013.
The BCBS is collaborating with the I nternational Monetary Fund (IM F) and World Bank to ensure that its schedule is complementary and nonduplicative to the Financial Sector Assessment Program (FSAP) review process.
2.2 Liquidity standards under Basel I I I

A key component of the Basel I I I framework is the introduction of global liquidity standards.
During the financial crisis, the banking system experienced severe stress because many banks did not manage their liquidity in a prudent manner. Basel I I I s Liquidity Coverage Ratio (LCR), is designed to promote short-term resilience by ensuring a bank holds adequate highly liquid assets to survive significant stress lasting for one month. The other standard, the Net Stable Funding Ratio (N SFR), is intended to promote a sustainable maturity structure of assets and liabilities and thereby avoid significant maturity mismatches over longer-term horizons. To better understand the potential effect of these standards, the Basel Committee on Banking Supervision (BCBS) agreed to put in place rigorous reporting processes to monitor the LCR and N SFR during an observation period that began in 2011.
The BCBS oversight body, the Group of Central Bank Governors and Heads of Supervision (GHOS), requested in January 2012 that the LCR rules text be clarified so that the 100% threshold would be a minimum requirement in normal times and banks would be expected to use their pool of liquid assets during the stress period, thereby temporarily falling below the minimum requirement.
The GHOS also asked the BCBS to finalise and publish recommendations by the end of 2012 to address specific concerns regarding the pool of high-quality liquid assets as well as some adjustments to the calibration of net cash outflows so as to reflect the actual experience during the crisis. The BCBS is working towards finalising the LCR by the end of 2012, with a view to implementing it in January 2015. The N SFR will be implemented in January 2018.
2.3 Quantitative impact assessment of Basel I I I

Apart from monitoring the timely and consistent implementation of Basel I I / I I .5 /I I I across member jurisdictions, the BCBS is conducting a semiannual monitoring exercise to assess the impact of Basel I I I on a representative sample of institutions in each member jurisdiction.
According to the most recent results (as of 30 June 2011), if changes to the definition of capital and risk-weighted assets were applied without considering the transitional arrangements, the average common equity Tier 1 capital ratio (CET1) of Group 1 banks would have been 7.1%, higher than the Basel I I I minimum requirement of 4.5%. For the other banks (Group 2 banks), the average CET1 ratio stood at 8.3%. The BCBS has also estimated that the sum of profits after taxes and prior to distributions during the second half of 2010 and the first half of 2011 would cover about 70% of the capital that the Group 1 banks need to raise over the coming six-year implementation horizon to satisfy the 7% target for CET1 and the surcharge for G-SIBs. Meanwhile, for the smaller Group 2 banks, the capital shortfall to be met over the same horizon is much less than these banks profits. There is considerable variation across individual banks, so it is difficult to draw firm conclusions from the BCBS estimates. However, the averages may suggest that a proportion of the industry has the capacity to meet the new capital targets through earnings retention and reduced distributions over the transition period. On the other hand, the estimated impact of the Basel I I I liquidity standards by the BCBS seems to suggest the need for banks to further adjust their liquidity positions during the observation period, for example, through lengthening the term of their funding or restructuring business models which are most vulnerable to liquidity risk in periods of stress. Assuming banks were to make no changes to their liquidity risk profile or funding structure, as of June 2011, the weighted average Liquidity Coverage Ratio (LCR) for Group 1 banks would have been 90% while the weighted average LCR for Group 2 banks was 83%. The weighted average Net Stable Funding Ratio (NSFR) was 94% for both Group 1 and Group 2 banks. Banks have until 2015 to meet the LCR standard and until 2018 to meet the NSFR standard.
The BCBS is currently investigating the case for modifying a few key aspects of the LCR but will not materially change the framework's underlying approach. The BCBS will finalise and subsequently publish its recommendations in these areas by the end of 2012.
2.4 Strengthening risk management

Risk management functions are the first line of defence in enhancing the resilience of financial institutions. In this regard, the FSB, SSBs and national authorities are making continuous efforts to strengthen risk management practices through increased supervisory expectations, enhancements of risk disclosures (market discipline), and additional guidance for national authorities and financial institutions.
Across the FSB member jurisdictions, supervisory expectations for risk governance have increased, particularly for SIFIs, as this was an area that exhibited significant weaknesses in many financial institutions during the global financial crisis.
To take stock of changes underway in risk governance practices, the FSB launched a thematic review on risk governance in March 2012. The peer review will also assess progress in addressing the weaknesses in risk governance identified during the crisis at both national authorities and at firms.
The inclusion of a firm-level survey in the peer review reinforces the message that a firms board and senior management are responsible for managing its risk, while supervisors are responsible for assessing whether a firms risk governance framework and processes are adequate, appropriate and effective for managing the firms risk profiles.
The peer review report will be published in the first half of 2013. In addition, the FSB hosted a roundtable on risk disclosures by financial institutions in December 2011 to encourage the private sector to jointly take forward development of principles and of leading practice disclosures that will be relevant and informative given current market conditions and risks.
Given the importance to market confidence of useful disclosure by financial institutions of their risk exposures and risk management practices, the FSB facilitated the formation of a private-sector Enhanced Disclosure Task Force (EDTF) in May 2012. The primary objectives of the EDTF are to: (i)Develop principles for enhanced disclosures, based on current market conditions and risks, including ways to enhance the comparability of disclosures; and (ii)To identify leading practice risk disclosures. The recommendations of the EDTF are expected to be reported to the FSB and published in October 2012. The BCBS issued in May 2012 a consultative document that set out a revised market risk framework and proposed a number of specific measures to improve trading book capital requirements. These proposals are aimed at fundamentally strengthening capital standards for market risk, an area where weaknesses became apparent during the crisis. The key elements of the proposals include: a more objective boundary between the trading book and banking book that materially reduces the scope for regulatory arbitrage; and the introduction of the expected shortfall as a risk measure that better captures tail risk compared to value-at-risk. The BCBS also issued a consultative paper on The I nternal Audit Function in Banks in December 2011, which provides guidance to help assess the effectiveness of a bank's internal audit function. This is a revision of the BCBS 2001 document I nternal Audit in Banks and Supervisors Relationship with Auditors. The proposed guidance reflects developments in supervisory and banking practices and incorporates lessons drawn from the financial crisis. To strengthen liquidity risk management practices of collective investment schemes (CIS), the I nternational Organisation of Securities Commissions (IOSCO) published in April 2012 a consultation report
entitled Principles of Liquidity Risk Management for Collective Investment Schemes. These Principles are intended to be used by both the industry and regulators in assessing the quality of regulation and industry practices relating to liquidity risk management for CIS. The fundamental requirement is to ensure that the degree of liquidity managed by an open-ended CIS enables it to meet redemption obligations and other liabilities. The consultation report describes how compliance with this requirement can be achieved. IOSCO also published in January 2012 Principles on Suspensions of Redemptions in Collective I nvestment Schemes, a report that provides a common approach and standards for use in an exceptional case where CIS face serious liquidity problems. National authorities have also been making efforts to strengthen the risk management practices of financial institutions in their jurisdictions. In particular, many jurisdictions are enhancing their liquidity risk management and stress testing practices in line with the Basel I I I rules and BCBS guidelines, such as: - In Canada, OSFI s final Liquidity Guideline (B-6) which is in line with BCBS requirements has been in force since February 2012.
Financial institutions implementation of the B-6 guideline will be reviewed during Q2 2012 through a cross-system benchmarking review /self-assessment.
Financial institutions also periodically submit liquidity data related to BCBS liquidity standards. - In H ong Kong, the supervisory guideline on stress testing has been revised to incorporate the BCBS' guidance and the recommendations from other international organisations to address deficiencies in this area that were revealed by the global financial crisis.
The revised guideline was issued on 9 May 2012.14
Ending Too-Big-To-Fail
The G20 is determined to make sure that no financial institution is too big to fail and that taxpayers do not bear the costs of resolution of any institution that does fail (and cannot be put into insolvency for reasons of systemic stability).
To this end, the G20 Leaders endorsed at the Cannes Summit the FSBs comprehensive policy framework, comprising a new international standard for resolution regimes, more intensive and effective supervision, and requirements for cross-border cooperation and recovery and resolution planning as well as, from 2016, additional loss absorbency for those banks determined as global systemically important financial institutions (G-SIFIs or G-SIBs).
3.1 Improving the capacity to resolve firms in crisis

The FSB Key Attributes of Effective Resolution Regimes for Financial Institutions (the Key Attributes) form an international standard that sets out the essential elements that all resolution regimes should have to ensure that national authorities can resolve financial institutions in an orderly manner that does not expose taxpayers to the risk of loss. FSB members have committed to an ambitious schedule for bringing their resolution regimes in line with this new standard and for implementing a range of G-SIFI specific requirements, including (i)The establishment of Crisis Management Groups, (ii)The elaboration of recovery and resolution plans (RRPs), (iii)The conduct of resolvability assessments, (iv)The adoption of institution-specific cross-border cooperation agreements (COAGs); and (v)The establishment of cooperation arrangements with the relevant jurisdictions that are hosts to systemic operations of a G-SIFI but are not represented on its CMG.
The progress made to date on implementing the G-SIFI framework includes the following key elements:
(i) Effective resolution regimes

A self-assessment by FSB members indicated that national resolution regimes are not fully consistent with the Key Attributes in many FSB member jurisdictions. However, reforms are underway to align the regimes more closely with the Key Attributes. For example, the implementation of the Dodd-Frank Act (DFA) in the US, which provides for powers to resolve systemically important financial institutions and requires the preparation of resolution plans, constituted an important step towards implementation of the Key Attributes. Likewise, the European Commission (EC)s adoption of proposed EUwide rules for bank recovery and resolution is critical for advancing consistent reforms across the EU. FSB members have committed to undergo a first thematic peer review of resolution regimes in the second half of 2012 which should provide a fuller picture of the status of national reform and progress in implementing the FSB standard.
(ii) Crisis Management Groups (CMGs)

CMGs have been established for 24 G-SIFIs. Where a CMG is not yet established, substantive action is planned. CMG membership includes the prudential supervisor, central bank and, where it is a separate authority, the resolution authority of the home country; in some, the finance ministry of the home or host jurisdiction participates in a restricted manner. The countries represented in the CMGs are generally the same as those in the G-SIFIs core supervisory college.
Senior level engagement has proved critical for advancing cooperation and resolution planning work within CMGs. A few CMGs have discussed detailed resolution strategies and started to develop operational plans to implement them.
(iii) Recovery and resolution plans (RRPs).

Advancing more detailed CMG work on resolution planning, resolvability assessments and cooperation agreements has proved difficult without a clearly articulated resolution strategy that is, the specification of a high level, strategic approach to how a firm would be resolved.
The FSB has therefore given priority to the development - led by home authorities - of high-level resolution strategies by September 2012. Such strategies include single entry or top down approaches, where a group is resolved through intervention at the level of the holding company; or multiple-entry resolution approaches where separate resolution action may be taken at the level of subsidiaries. The chosen resolution strategies should provide sufficient direction to CMGs for them to undertake more detailed work on the development of cooperation agreements, RRPs and resolvability assessments. For each G-SIFI, home authorities have committed to lead the development within the CMGs of resolution plans that set out in detail how the resolution strategies could be put into operation by the end 2012.
(iv) Resolvability assessments

Resolvability assessments should help identify any remaining barriers to resolution.
They should also inform the development and/ or improvement of the resolution plan. Discussions of resolvability assessments of G-SIFIs are at very early stages, due in part to the fact that resolution strategies need first to be developed before their feasibility and credibility can be assessed. CMGs should conduct resolvability assessments in Q1 2013, after the development of basic resolution strategies for all G-SIFIs.
(v)Institution-specific cooperation agreements

No institution-specific cooperation agreements consistent with the Key Attributes have as yet been agreed or put in place between the members of a CMG, largely because the development of a resolution strategy is seen as a prerequisite to such an agreement and also because differing terms and conditions for information sharing across jurisdictions complicate cross-border cooperation. The FSB has therefore initiated further work to examine how to address existing obstacles to the exchange of information, and to develop minimum common terms and content for information sharing across jurisdictions. These terms and content should be reflected in the cooperation agreements to be put in place for all G-SIFIs in early 2013.
(vi)Coordination with host jurisdictions with systemic G-SIFI operations

Effective cooperation should be established with the relevant host authorities that are not included in the CMGs, but that assess the local operations of a G-SIFI as systemically important to the local financial system.
The FSB is therefore also proposing to develop further guidance for arrangements and procedures for cooperation and information sharing with such host authorities.
The FSB identified several areas where further work is necessary to advance recovery and resolution planning and improve resolvability.
The Key Attributes state the need for the effective segregation of client assets and prompt access to segregated client funds in resolution. Further work will be undertaken on these topics, in coordination with IOSCO and the FSB Shadow Banking work stream. To facilitate assessments by the I MF and World Bank of resolution regimes against the Key Attributes, the FSB is developing a draft assessment methodology with the assistance of a drafting team composed of resolution experts from FSB member jurisdictions, EU institutions, IAIS, CPSS and I OSCO, who have the appropriate sectoral expertise, and from the I MF, the World Bank and I nternational Association of Deposit I nsurers (IADI), who have particular experience in the development and use of assessment methodologies. Given the status of the Key Attributes as umb rella standards for resolution regimes for all types of financial institutions that can potentially be systemically-important in failure, the methodology will incorporate sector-specific considerations. The draft methodology will be submitted to all SSBs in the second half of 2012 to help to determine whether the methodology is suitable for assessing resolution regimes for different types of firms, including FMI s, insurers and securities and investment firms. The questionnaire to be used for the FSBs thematic peer review of resolution regimes will be based on the draft assessment methodology and the findings from that review will be taken into account when the methodology is finalised in 2013.
3.2 Improving the intensity and effectiveness of SIFI supervision

The FSB continued to review progress towards implementation of the 32 recommendations set out in the November 2010 report I ntensity and Effectiveness of SIFI Supervision (SIE recommendations) relating to supervisory mandates, powers, resources and practices for making the supervision of financial institutions more effective. The majority of these recommendations have been implemented or are underway.
The coming year will see a completion of this work, as well as implementation of additional recommendations set out in the 2011 Progress Report on Implementing the Recommendations on Enhanced Supervision.
These include raising supervisory expectations about firms abilities to collect and process data to give an accurate picture of their firm-wide risk exposure, promoting strong risk management, and ensuring that supervisors have adequate resources to supervise SIFIs effectively. While discussions among FSB members on increasing the intensity of supervision are related to all SIFIs, they are generally focused on institutions that are important for the global system (i.e. G-SIFIs). The FSBs agenda for improving the intensity and effectiveness of supervision is focused on four main areas: (i) Holding supervisors to higher standards; (ii) Improving supervisory tools and methods; (iii) Enhancing the effectiveness of supervisory colleges; and ( i v) I mproving firms risk data aggregation capabilities.
A summary of progress in each of these areas is discussed below.
(i) Holding supervisors to higher standards:

At the core of strengthened supervisory frameworks are the minimum standards set out by the BCBS for sound supervisory practices. The BCBS published in December 2011 a consultative document on the enhanced Core Principles for Effective Banking Supervision (BCBS Core Principles). In developing the revised BCBS Core Principles, close attention was given to addressing many of the significant risk management weaknesses and other vulnerabilities highlighted in the last crisis. Final principles are expected to be published in the fall 2012. National authorities will be assessed as part of the IM F-World Bank FSAPs against the enhanced BCBS Core Principles, thus raising the bar for supervisors.
(ii) Improving supervisory tools and methods:

Since the beginning of 2012, the FSB has been working to improve its understanding of risk appetite frameworks, resources needed to intensify SIFI supervision, firms business models, and supervisory methods used to oversee trading operations. Discussions have revealed that (a)Most G-SIFIs have a risk appetite statement but both firms and supervisors have difficulty determining its suitability; (b)While resources at supervisory authorities have increased since the financial crisis, the pace of increase has not been commensurate with higher regulatory and supervisory demands placed on supervisors, such as supervisory colleges and CMGs;
(c)Supervisory approaches to understanding business models vary in part due to resource constraints and lack of expertise; and (d)Supervisors see operational risk as the next big risk which cannot be solved entirely by higher capital. While progress is being made in these areas, more work is needed. The FSB will be developing recommendations on how to ensure supervision of these areas is more intense, more effective and more reliable to promote financial stability.
(iii) Enhancing the effectiveness of supervisory colleges:

As recommended by the SIE report, the BCBS and I AIS are studying how to improve the operations of supervisory colleges in order to ensure a more rigorous and coordinated assessment of the risks facing the GSIFIs. In the second half of 2012, the FSB will also be discussing the means to enhance the effectiveness of supervisory colleges, in particular for GSIFIs.
( i v ) I mproving firms risk data aggregation capabilities:

The BCBS is acting on the SIE recommendation to develop supervisory expectations for firms risk data aggregation capabilities.
A paper setting out principles for effective risk data aggregation and risk reporting is under development. The principles will be finalised by the end of the year and G-SIBs are expected to implement these principles by the beginning of 2016, which is the start of the phase-in period for the added loss absorbency requirements for G-SIBs.
Supervisors will start discussing implementation with senior management of these firms from early 2013 and ensure that the G-SIBs develop strategies to meet the principles by early 2016.
3.3 Extending the SIFI framework

After the comprehensive framework for addressing the too-big-to-fail problem was agreed at the Cannes Summit, the G20 Leaders asked the FSB in consultation with the BCBS, to extend expeditiously the G-SIFI framework to D-SIBs. The I AIS was asked with the development of an assessment methodology for the identification of global systemically important insurers (G-SIIs) and to continue its work on a common framework for the supervision of internationally active insurance groups (ComFrame). The G20 Leaders also called on the FSB to prepare methodologies to identify global systemically-important non-bank financial entities (nonbank G-SIFIs) by end-2012 in consultation with I OSCO.
3.3.1 Domestic systemically important banks

The FSB, in consultation with the BCBS, submitted to the G20 Finance Ministers and Central Bank Governors in April 2012 a progress report on the modalities to extend the G-SIFI framework to D-SIBs. The G-SIB framework assesses the externalities from a global perspective (i.e., where distress or failure would disrupt the global financial system), making no distinctions about impacts on individual jurisdictions. The policy framework envisaged for D-SIBs would take the perspective of individual jurisdictions. That is, it addresses the impact of failure associated with the local presence of a bank - whether a national or an internationally-active bank in a given jurisdiction. The D-SIB framework being considered would be based on assessments by local authorities, who are best placed to identify the banks which are systemically-important relative to the domestic economy.
An important aspect of a D-SIB framework relates to its compatibility with the G-SIB framework, to ensure that adequate and consistent incentive structures are in place at the domestic as well as at the international level. The principles for D-SIBs being considered therefore seek to establish a minimum framework that would ensure compatibility with the G-SIB framework, address the cross border externalities that the failure of a DSIB may nonetheless pose, and preserve a level playing field within and across jurisdictions.
The principles would include guidelines for national authorities to assess the systemic importance of banks in a domestic context.
The BCBS is developing a set of principles as a common framework for D-SIBs, including on the issues of compatibility with the G-SIB framework, home-host coordination, and the instruments and composition of additional loss absorbency for D-SIBs. The FSB and BCBS will submit the outcome of this work to the G20 Finance Ministers and Central Governors meeting in N ovember 2012.
3.3.2 Systemically important insurers

The I AIS has made progress in developing a proposed assessment methodology for identifying G-SIIs.
A consultation paper was issued in May 2012 on the proposed I AIS assessment methodology for identifying G-SIIs. The paper included some initial thoughts on the policy measures that should apply to G-SIIs and further development of potential policy measures is underway. Potential measures include enhanced supervision, improved resolvability, structural measures, higher loss absorbency and restrictions on certain activities. A consultation paper on proposed policy measures will be issued in September 2012. The I AIS will deliver to the G20 in April 2013 a consolidated paper on the assessment methodology and the policy measures.
At that time, the FSB and national authorities, in consultation with the IAIS, will determine the initial cohort of G-SIIs. Meanwhile, I AIS work on developing a common framework for internationally active insurance groups (ComFrame) is progressing and its development phase is expected to be completed in 2013.
3.3.3 Systemically important non-bank financial entities23

In response to the request of the G20 Leaders, the FSB, in consultation with I OSCO, is preparing methodologies for identifying non-bank GSIFIs whose distress or disorderly failure would cause significant disruption to the wider financial system and economic activity at the global level. This is in line with the methodologies developed for identifying G-SIBs and also with that of G-SIIs issued for consultation by the I AIS in May. In developing the methodologies, the FSB will focus on detailed design issues such as the scope of application, applicability of materiality criteria, modus operandi and data availability. At the national level, meanwhile, the US Financial Stability Oversight Council (FSOC) published in April 2012 the final rule and the interpretive guidance regarding the process and criteria to be used for designating non-bank financial institutions for consolidated supervision by the Federal Reserve System and enhanced prudential standards as their material financial distress or the nature, scope, size, scale, concentration, interconnectedness, or mix of its activities could pose a threat to the US financial stability. Based on the published rule, the FSOC could make the first of these designations during 2012.
Strengthening the oversight and regulation of shadow banking

At the Cannes Summit, the G20 Leaders agreed to strengthen the oversight and regulation of the shadow banking system, and endorsed the FSBs initial recommendations with a work plan to further develop them in 2012.
At the request of the G20, a progress report on shadow banking was submitted to the G20 Finance Ministers and Central Bank Governors in April 2012. The shadow banking system which can be broadly described as credit intermediation involving entities and activities outside the regular banking system has become an integral part of the modern financial system that has an important role in supporting the real economy. However, the shadow banking system can also pose risks to the financial system, on its own and through its links with the regular banking system. The FSB issued initial recommendations in its October 2011 report Shadow Banking: Strengthening Oversight and Regulation to address potential risks in the shadow banking system.
It has adopted a two-pronged approach.

First, the FSB will enhance the monitoring framework through continuing its annual monitoring exercise to assess global trends and risks, with more jurisdictions participating in the exercise. Second, the FSB will develop recommendations to strengthen the regulation of the shadow banking system, where necessary, to mitigate the potential systemic risks with specific focus on the five areas explained in section 4.2. An initial integrated set of policy recommendations will be developed by the end of 2012. A properly structured and regulated shadow banking sector can make the financial system more robust, efficient and diversified; hence, the reforms in this area will seek to mitigate systemic risks while preserving the scope for realising those benefits.
4.1 Strengthening oversight of the shadow banking system

The FSB has set out recommendations for effective monitoring of shadow banking in its October 2011 Report and also committed to
conduct annual monitoring exercises to assess global trends and risks in the shadow banking system. The global monitoring exercise conducted in 2011 covered eleven FSB member jurisdictions and the euro area. The coverage of the 2012 monitoring exercise will be extended to cover the remaining FSB jurisdictions. The annual monitoring exercise is expected to facilitate the national authorities assessment of shadow banking risks based on the FSB recommendations, and the sharing of experiences among authorities in order to highlight trends in shadow banking that are of relevance to the stability of the global financial system. In addition to participation in the FSB annual monitoring exercise, a few jurisdictions have also taken steps to enhance the monitoring of shadow banking in their jurisdictions. For example: - In Australia, the Reserve Bank of Australia (RBA) will provide an annual update on the shadow banking system to the Council of Financial Regulators (CFR). This should identify any emerging risks, which may lead to changes to regulatory arrangements if that is warranted. - In Canada, the Office of the Superintendent of Financial Institutions (OSFI) has initiated work to examine Canadian banks interactions with shadow banking entities, in the context of the Canadian marketplace. The Bank of Canada is also expanding the resources devoted to assessing risks and vulnerabilities in the financial system, including the shadow banking system. It is developing a shadow banking monitoring framework in coordination with other federal and provincial authorities, focusing
on the channels through which shocks can be propagated through the financial system. - The European Central Bank (ECB) has proposed the creation of an EU Central Database on Euro Repos as a joint effort by public authorities and the financial industry. This is to address the lack of granular data on the repo market in the euro area, with the aim to allow better monitoring from a financial stability perspective. - In the US, FSOC provides US regulators with a surveillance mechanism and allows for a flexible approach to address potential risks in the shadow banking system. Under the Dodd-Frank Act (DFA), FSOC has the discretion to subject any non-bank financial company to a detailed review if the company could pose a threat to US financial stability. That company would then be subject to heightened prudential standards. The DFA requires that FSOCs Annual Report address significant financial market and regulatory developments, along with an assessment of developments on the stability of the financial system; potential emerging threats to financial stability; and, recommendations to enhance the integrity, efficiency, competitiveness. As a result of DFA, the SEC expanded its regulatory scope and is now collecting additional information through Form PF on hedge funds and private equity funds that have at least $150m in assets under management to better monitor their activities.
4.2 Strengthening regulation of the shadow banking system

Based on the initial recommendations and work plans set out in the October 2011 Report, five workstreams have been launched to advance the work to develop proposed policy recommendations.
(i) Banks interactions with shadow banking entities:

With the objective of mitigating the spill-over effects between the regular banking system and the shadow banking system, the BCBS will propose, where needed, to regulate banks interactions with shadow banking entities by July 2012. It is currently reviewing the consolidation rules for prudential purposes; limits on the size and nature of a banks exposures to shadow banking entities; risk-based capital requirements for banks exposures to shadow banking entities; and the treatment of reputational risk and implicit support.
(ii) Money market funds (MMFs):

IOSCO was tasked to develop by the autumn 2012 policy recommendations to reduce the susceptibility of MMFs to runs.
IOSCO published in April 2012 a consultation report that provides an analysis of the systemic importance of MMFs and their key vulnerabilities, including their susceptibility to runs, and sets out possible policy options to reinforce the soundness of MMFs and to address the identified systemic vulnerabilities. The possible policy options include: a mandatory move from constant to variable net asset value (NAV); enhancement of MMF valuation and pricing framework; enhancement of liquidity risk management; and reduction in the importance of ratings in the MMF industry. These options are not mutually exclusive and some may be considered in combination. I OSCO envisages using the outcomes of the
consultation to narrow down the policy options into policy recommendations.
(iii) Other shadow banking entities:

An FSB workstream is developing policy recommendations by September 2012, where appropriate, on the regulation of shadow banking entities other than MMFs to mitigate their systemic risks. The Workstream has completed a categorisation and data collection exercise for a wide range of non-bank financial institutions (or Other Financial Intermediaries (OFI s)). After casting the net wide through this exercise, the Workstream is adopting a two-step prioritisation process to narrow the scope to certain types of entities that may need policy responses. The first step is to develop a list of entity types (filtered list) for closer scrutiny based on national experience (i.e. authorities judgements) and size; the second step entails the detailed assessment of the shadow banking risk factors (e.g. maturity transformation, liquidity transformation and leverage) with respect to each entity type in the filtered list. The Workstream plans to analyse the filtered entities by looking at their economic functions rather than legal names or forms. In this way, the Workstream aims to develop potential policy recommendations that can be applied across jurisdictions to all entities that have the same economic function, while taking account of the heterogeneity of economic functions carried out by different entities within the same sector.
(iv) Securitisation:
To assess and align the incentives associated with securitisation to prevent it creating excessive leverage in the financial system, I OSCO, in coordination with the BCBS, is examining the
(i)Retention requirements and (ii)Measures that are aimed at enhancing transparency and standardisation related to securitisation. As the first phase of its work, the European Commission (EC) and the US Securities and Exchange Commission (SEC) staff have completed a comparison of securitisation rules in the EU and US. Building on this work, I OSCO has conducted an analysis of global regulatory and industry initiatives on risk retention, transparency and standardisation, as well as the identification and assessment of material differences in regulatory/ industry approaches and their impact. Draft policy recommendations are set out in a consultation report published in June 2012.29 Based on the comments received on the consultation report, IOSCO will publish the final report in late 2012.
(v) Securities lending and repos:

An FSB workstream is examining the regulation of secured financing contracts such as repos, and securities lending from a financial stability perspective, by the end of 2012. The Workstream published in April 2012 its interim report which covers an overview of the securities lending and repo markets; key drivers of the securities lending and repo markets; its location within the shadow banking system; overview of existing regulatory framework; and financial stability issues. The financial stability issues identified by the Workstream include (i)Lack of transparency, (ii)Pro-cyclicality of system leverage and interconnectedness through valuation, haircuts and collateral re-use, (iii) Other issues associated with re-use of collaterals, (iv) Potential risks arising from fire-sale of collateral assets,
(v) Potential risks arising from securities lending activities, (vi) Shadow banking through cash collateral reinvestment, and (vii) Insufficient rigour in collateral management and valuation. Based on its mapping of the markets and identification of financial stability issues, the Workstream will develop policy recommendations as necessary by the end of 2012. In addition to the policy-making work at the FSB-level, some national and regional authorities have embarked on initiatives to address potential risks arising from the shadow banking system in their respective jurisdictions. For example: - In Australia, the Australian Securities and I nvestments Commission (ASIC) will be producing an internal report by 30 June 2012 on MMFs. Any further work in thissector will be informed by the internal report and its conclusions regarding whether or not appropriate regulation is in place. - I n the EU, the EC issued in March 2012 a Green Paper on Shadow Banking that draws from the FSBs October 2011 report. The paper takes stock of current developments and presents on-going reflections on the subject to gather views from the stakeholders, in order to enable the EC to actively respond and contribute to the global debate. - In the US, authorities have taken many steps to address potential systemic risks to financial stability emanating from the shadow banking system. In addition to the establishment of FSOC and its authority to designate a non-bank financial firm for prudential supervision, the US has taken policy measures that seek to address risks posed by money market funds, private investment funds, securitisation activities and the tri-party repo market.
For example, the SEC adopted new rules in February 2010 to increase the resilience of MMFs to economic stresses, and reduce the risks of runs by tightening maturity and credit quality standards and imposing new liquidity requirements. The new rules include provisions to: improve liquidity, credit quality and disclosure, and require periodic stress tests. The DFA imposes new requirements relating to asset-backed securities, including those for risk retention, disclosure, and conflict of interest.
Creating continuous core markets - OTC derivatives reforms

In September 2009 in Pittsburgh, the G20 Leaders agreed that all standardised OTC derivative contracts should be traded on exchanges or electronic trading platforms, where appropriate, and cleared through central counterparties (CCPs) by end-2012 at the latest; OTC derivative contracts should be reported to trade repositories (TRs); and noncentrally cleared contracts should be subject to higher capital requirements.
The FSB published a report, Implementing OTC Derivatives Markets Reforms, in October 2010 that set out 21 recommendations to address practical issues in implementing the G20 Leaders commitments.
The FSBs OTC Derivatives Working Group has been monitoring the implementation of the OTC derivatives markets reforms, with reports to the FSB every six months. In October 2011, the FSB published its second progress report on the implementation of OTC derivatives reform, cautioning that, with only just over one year until the end-2012 deadline for implementing the G20 commitments, few FSB members had the legislation or regulations in place to provide the framework for operationalising the commitments. Since then, as noted in the FSBs third progress report published in June 2012, encouraging further progress has been made in setting international standards, the advancement of national legislation and
regulation by a number of jurisdictions and practical implementation of reforms to market infrastructures and activities. The report concludes that all jurisdictions and markets need to aggressively push ahead to achieve full implementation of market changes by end-2012 to meet the G20 commitments in as many reform areas as possible. Jurisdictions have sufficient information about international standards and policies to put in place the needed legislation and regulation. They should do so promptly, and in a form flexible enough to respond to cross-border consistency and other issues that may arise. Broadly speaking, the jurisdictions currently with the largest markets in OTC derivatives the EU, Japan and the US are the most advanced in structuring their legislative and regulatory frameworks.
They expect to have regulatory frameworks in place by end-2012 and practical implementation within their markets is well underway.
Other jurisdictions are generally less advanced although, as the third progress report indicates, progress has been made by many of them, particularly with respect to central clearing and reporting to TRs. The development of implementing regulations to require exchange or electronic platform trading, where appropriate, is generally less advanced. National implementation of capital requirements for exposures to CCPs and margining requirements for non-centrally cleared contracts is awaiting international principles that are currently under development. One reason for the slower timetables in some jurisdictions has been that authorities had been waiting for the key elements of the regulatory frameworks in the EU, Japan and the US to be finalised before putting their own legislation in place, in an effort to be consistent with these frameworks. Additionally, some jurisdictions have sought greater certainty about the application of international principles and safeguards to cross-border financial market infrastructure, including CCPs and TRs, so as to make
an informed decision about the appropriate form of market infrastructure for their jurisdiction. Since the October 201 1 progress report, SSBs have made significant progress in developing international policies, notably: - CPSS and I OSCO issued the Principles for FMIs (PFMIs) in April 2012. These principles, which harmonise, strengthen and replace the previously separate sets of principles for different types of FM Is, are an important milestone in the global development of a sound basis for central clearing of all standardised OTC derivatives. - IOSCO published its Report on Requirements for Mandatory Clearing in February 2012, providing important guidance for jurisdictions on the process for setting the scope of central clearing requirements. - CPSS and I OSCO published in January 2012 a Report on OTC derivatives data reporting and aggregation requirements, recommending that TRs implement measures to provide authorities with effective and practical access. - IOSCO published its Final Report on I nternational Standards for Derivatives Market I ntermediary Regulation in June 2012, which recommends high-level international standards for the regulation of market participants that are in the business of dealing, making a market or intermediating transactions in OTC derivatives. Additionally, the Committee on the Global Financial System (CGFS) published in N ovember 2011 a report The macrofinancial implications of alternative configurations for access to central counterparties in OTC derivatives markets that analyses the implications for financial stability of the alternative arrangements for access to CCPs (such as through large global or smaller regional or domestic CCPs) and assesses the potential trade-offs involved.
IOSCO published in January 2012 additional analysis of the characteristics of different types of organised trading platforms, following on from its February 2011 report. International workstreams are also progressing rapidly to develop frameworks for a global LEI (see section 7.1); guidance on resolution of CCPs (see section 3.1); capital adequacy rules for exposures to CCPs; international standards on margin requirements for non-centrally cleared derivatives; and work on regulatory access to data from TRs. In January 2012, the FSB identified four safeguards for a resilient and efficient environment for central clearing, on which substantial progress should be made by mid-2012 to support national authorities in deciding whether to rely on domestic or global clearing infrastructure to meet the G20 commitment to centrally clear all standardised OTC derivatives.
Substantial progress has now been made, through SSB workstreams and otherwise, to provide these safeguards and thus allow authorities to make their decisions.
The safeguards, and the steps taken to achieve them, are: (i)Fair and open access by market participants to CCPs, based on transparent and objective criteria (addressed within the PFMIs); (ii)Cooperative oversight arrangements between all relevant authorities, both domestically and internationally and on either a bilateral or multilateral basis, that result in robust and consistently applied regulation and oversight of global CCPs (addressed as a minimum standard through the responsibilities for authorities set out in the PFMIs and in practice through individual cooperative agreements in place or in development for CCPs); (iii)Resolution and recovery regimes that ensure the core functions of CCPs are maintained during times of crisis and that consider the interests of all jurisdictions where the CCP is systemically important (CPSS and I OSCO plan to issue in July a consultation paper on the application of the Key Attributes of Effective Resolution Regimes to CCPs and other FMIs); and (iv)Appropriate liquidity arrangements for CCPs in the currencies in which they clear (addressed within the PFMIs and through conclusions
of the Economic Consultative Committee of the Bank for I nternational Settlements (BIS)). The FSB, through its OTC Derivatives Working Group, seeks to identify any overlaps, gaps or conflicts in national frameworks or implementation that might compromise the achievement of the G20 commitments, particularly where there may be a risk that such issues will not be satisfactorily resolved through existing bilateral or multilateral channels. Additionally, the FSB has established the OTC Derivatives Coordination Group, comprising the chairs of the BCBS, CGFS, CPSS, I OSCO and the FSB, to discuss on a regular basis the coordination of international workstreams on OTC derivatives reforms. The progress achieved to date is contributing to the broader G20 goals of improving transparency, mitigating systemic risk and protecting against market abuse. This is an important part of FSBs broader efforts to end too big to fail and to support continuouslyopen markets. To assist in doing so, the FSB will seek to further improve data and other survey information on the extent to which OTC derivatives are in practice standardised, centrally cleared, traded on organised platforms and reported to TRs. For the next progress report, the FSB intends to put additional focus on the readiness of infrastructures to provide central clearing, platform trading and reporting of OTC derivatives, the practical ability of industry to meet the requirements and the remaining steps for the industry to take. At the Cannes Summit, the G20 Leaders requested I OSCO to assess the functioning of credit default swaps (CDS) markets and the role of those markets in price formation of underlying assets. In response to the G20 request, I OSCO has prepared a report that analyses the CDS markets as a whole, including both corporate and sovereign CDS markets (prioritising sovereign CDS markets) and encompasses:
- An examination of existing research on the functioning of CDS markets, notably information about the trading, pricing and clearing of CDS; - The nature of the CDS markets, e.g. type or level of volatility and liquidity and the links to the cost of funding; and - Recent experience with the functioning of the CDS markets, e.g. the effect of a 50% write down on Greek debt triggering or not triggering a default for CDS purposes.
Creating continuous core markets Strengthening and converging accounting standards

At the Cannes Summit, G20 Leaders reaffirmed their objective to achieve a single set of high quality global accounting standards and meet the objectives set at the London summit in April 2009, notably as regards the improvement of standards for the valuation of financial instruments.
They called on the I nternational Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB) to complete their convergence project and requested a progress report at the G20 Finance Ministers and Central Bank Governors meeting in April 2012. They also looked forward to the completion of proposals to reform the IASB governance framework. Nearly all FSB member jurisdictions have either adopted I ASB standards (International Financial Reporting Standards - IFRS) or have programmes underway to converge with, or consider adoption of, I FRS by end-2012. The US SEC continues to work toward determining whether to incorporate I FRS into the financial reporting system for US issuers. Foreign private issuers in the US are already allowed to follow I FRS. As requested by the G20 Leaders, a joint update report from the two standard setters was provided to the FSB and to the G20 Finance Ministers and Central Bank Governors in April 2012.
- While important improvements to their standards on financial instruments fair values and off-balance sheet entities were finalised in 2011, the convergence process is taking longer than initially expected in some areas, such as classification, measurement and provisioning. Also, the Boards are not addressing hedge accounting issues jointly. At the Cannes Summit, the FSB encouraged the Boards to redouble their efforts to seek converged standards in these important areas.
- While delays have taken place, the I ASB and FASB are making progress on projects to converge their standards on financial instruments, including a joint expected loss impairment (provisioning) approach and a more converged approach to classification and measurement.
Consistent with earlier FSB recommendations, it will be important that the I ASB and FASB final standard on expected loss impairment result in improved provisioning practices that will incorporate a broader range of available credit information than existing provisioning requirements, so as to recognise credit losses in loan portfolios at an earlier stage. - The IASB and FASB will conduct further public consultations in the second half of 2012, and expect to issue final converged standards in a number of key areas by mid-2013. The two Boards have extended certain project target completion dates in order to allow sufficient time for extensive outreach and public comment on the large number of planned major Exposure Drafts, and for the Boards to reflect that feedback in high-quality final standards. The FSB supports the efforts of the I ASB and FASB to achieve convergence to a globally accepted set of high-quality accounting standards and urges them to issue final converged standards on key projects by their expected timeframe of mid-2013.
The netting/ offsetting of derivative contracts and other financial assets and financial liabilities is another area where the FSB has expressed concerns. In this case, different approaches result in significant differences in total assets and/ or total liabilities in balance sheets of large financial institutions. After considering the comments of stakeholders the Boards decided to maintain their current different offsetting accounting models but to improve and converge related disclosure requirements. After the Cannes Summit the Boards issued in December 201 1 new requirements for common disclosures about gross and net positions for derivatives and other financial instruments. This followed the Boards issuance of a joint proposal in January 2011 on a converged accounting approach to balance sheet netting. However, instead of supporting the joint 2011 proposal, commenters from the US generally supported the current FASB netting rules and those using I FRS generally supported current I ASB rules, with many investors seeking both gross and net information. Derivatives dealer banks, both inside and outside the US, generally wanted the FASB (net) accounting approach in order to avoid a very significant grossing-up of their balance sheets. The FSB noted that differences in the offsetting/ netting accounting standards would adversely affect the efforts to develop an internationally comparable leverage ratio for capital purposes. However, from a bank supervisory perspective, there may be more convergence for the Basel I I I leverage ratio purpose than is first apparent. While the I ASB and FASB have decided to maintain their different accounting rules for netting/ offsetting, the FASB netting approach and the netting approach that will be carried forward to the Basel I I I leverage ratio are similar in their effect because both recognise netting/ offsetting for derivatives based on legally enforceable master netting agreements
without requiring the intent or ability to net in the normal course of business. Following a request at the Cannes Summit, reforms were announced in February 2012 by the I FRS Foundation (IFRSF) Trustees and the I FRSF Monitoring Board to improve the governance of the I ASB. These include internal organisational changes as well as reforms that seek to enhance the involvement of key stakeholders, including those from emerging market economies, and improve the technical dialogue of the I ASB with market regulators, investors and prudential authorities. The internal changes and reforms are being implemented in a manner that will enhance the I ASBs efficiency and effectiveness. The I ASB provided a report on these governance reforms to the G20 Finance Ministers and Central Bank Governors in April 2012.
7. Creating continuous core markets Other market reforms 1. Building a common legal entity identifier
At the Cannes Summit, the G20 Leaders supported the creation of a global LEI which uniquely identifies parties to financial transactions, and called on the FSB to take the lead in helping coordinate work among the regulatory community to prepare recommendations for a governance framework for such a global LEI that is consistent with the public interest.
To meet that request, the FSB has prepared a report (LEI Report) containing recommendations to implement a global LEI system.
The global LEI system would contribute to and facilitate many financial stability objectives, including: improved risk management in firms; better assessment of micro and macro-prudential risks; facilitation of orderly resolution; containing market abuse and curbing financial fraud; and enabling higher quality and accuracy of financial data overall. It would mitigate operational risks within firms by reducing the need for tailored systems to reconcile the identification of entities and to support aggregation of risk positions and financial data, which impose substantial deadweight costs across the economy.
It would also facilitate straight-through-processing. The LEI Report contains 35 recommendations for the development and implementation of the global LEI system.
These recommendations are guided by a set of Global LEI System High Level Principles which set out the objectives that the design of a global LEI system must meet.
The broad goal of the proposals is to put in place a strong global governance framework to protect the public interest, while promoting an open, flexible, and adaptable operational model for the global LEI system. The proposals draw on input and advice from the FSB LEI I ndustry Advisory Panel.
The suggested code and initial reference data are consistent with the standard developed for the LEI by the I nternational Organization for Standardization (ISO) through an industry consensus process (ISO 17442:2012).
A three-tier structure for the global LEI system based on a federated approach is recommended: - The first element is a Regulatory Oversight Committee (ROC). This will carry the ultimate responsibility for the governance of the global LEI system in the public interest. The ROC will be established by endorsement of a proposed global LEI Regulatory Oversight Committee Charter which will set out the governance framework and arrangements. It will comprise authorities that support the High Level Principles and purposes of the LEI, and will have an Executive Committee to steer the work under guidelines to be set out in the Charter. - The second component is a Central Operating Unit (COU) which will form the pivotal operational arm of the global LEI system. Key tasks of the COU will be to implement agreed central operational standards that ensure uniqueness of the LEI and that
deliver a logically centralised database of high quality reference data (such as name and address, and, over time, information on ownership relationships).
In legal form, the COU will be a not-for-profit foundation (or equivalent).

It will be composed of private industry representatives from the various geographic regions and sectors. - The third part of the system will be federated Local Operating Units (LOUs). The LOUs will be the local implementers of the global system.
They will conduct local registration of legal entities and will be responsible for the validation and maintenance of the high quality reference data. Using local systems will facilitate the use of local languages and operational types.
LOUs may also build on local infrastructure such as business registries and numbering agencies. LOUs may be operated either by private or public bodies. They will, however, need to adhere to the agreed global standards to ensure that the system delivers high quality and consistent information. In this context, interim local solutions could be subsequently integrated into the proposed global LEI framework. The FSBs objective is to have a fully functioning self-standing governance and operational framework for the global LEI system by March 2013. The timeline and deliverables in moving towards that objective are as follows:
- Submission of the Global LEI ROC Charter to the FSB in October 2012 or the G20 in N ovember 2012 for endorsement;
- Development of the necessary legal framework for the functioning of the ROC and the COU; and - Development of the legal and technological framework for the proposed global LEI foundation and operational model. An I mplementation Group, comprised of experts from the global regulatory community is being formed to advance this workplan. The Implementation Group will work in close coordination with experts from private industry.
7.2 Reducing reliance on credit ratings and improving oversight of credit rating agencies
In February 2012 the FSB conducted a review of its members compliance with the FSB Principles for Reducing Reliance on Credit Rating Agency (CRA) Ratings.
The aim of these Principles, issued in October 2010, is to reduce mechanistic reliance on CRA ratings that can amplify procyclicality and contribute to systemic disruption through herding behaviour and selloffs of securities when they are abruptly downgraded (cliff effects).
In the period since the FSB Principles were issued, widespread CRA rating downgrades have further underscored the importance of these issues. The FSB Principles encourage banks, institutional investors and other market participants to develop their own internal risk management capabilities to avoid mechanistic reliance on external credit ratings.
CRA ratings should be an input, but no more than that, to the risk assessment process.
Creating the right incentives for market participants to develop their risk management capabilities includes reducing the use (or hard wiring) of CRA ratings in regulatory regimes. The hard wiring of CRA ratings has been wrongly interpreted as providing them with an official seal of approval and has contributed to an undesirable reduction in firms own capacity for credit risk assessment and due diligence. Specifically, the report found that: - A few jurisdictions have passed, or proposed, wide-ranging legislative or regulatory measures to reduce reliance on CRA ratings, but are facing difficulties in detailed implementation. - International standard setters have taken steps to examine the references to CRA ratings in their standards and, in some cases, to discourage undue reliance on CRA ratings within those standards. In a number of cases, study of the issue was either ongoing or was only just getting under way. - The modest progress described in the report was due in part to the challenge of developing alternative risk assessment capabilities and processes. These are essential to permit individual firms and official bodies to reduce their reliance on CRAs while maintaining adequate management of credit risk. When the Principles were written it was recognised that this would take time, and for some market participants the process could take several years. However, the report concluded that the authorities can do more to facilitate this process by identifying the changes in practices that need to be made, sharing experiences and effective practices in developing reforms bearing in mind the need for international
consistency, and establishing timetables and milestones for the transition. The report called for clear milestones to be set out for the transition to a reduced reliance on CRA ratings over the medium term; in many cases those milestones remain to be defined. Among the steps it recommended are: - Further actions by national and regional regulators to encourage the appropriate use of CRA ratings as an input, but no more than that, to the risk assessment process. - Setting standards that actively promote the use of market participants own risk management capabilities rather than reliance on CRA ratings. - SSBs should promote the sharing of successful practices to strengthen credit risk capabilities. - Official sector bodies should publicly explain their approach to credit risk assessment in their market and investment operations and the further steps planned to align their practices with the FSB Principles. - Further comparative analysis of actions to identify hindrances to removing references to CRA ratings in standards, laws and regulations, as well as help re-align national work plans with the FSB Principles. To encourage further progress on the above issues, the FSB will organise a workshop in September 2012 that will bring together SSBs and national experts to review progress and agree on the next steps. The output from the workshop will feed into a further progress report for the G20 Finance Ministers and Central Bank Governors meeting in November.
Other than the efforts to reduce mechanistic reliance on CRA ratings, most FSB members have already put in place requirements for the registration of CRAs. Regulatory action is still in progress in two jurisdictions. - In Mexico, CRAs have been required to be authorised since 1999. I n February 2012, draft regulations were published to enhance the requirements for authorisation, including improvements on structured finance ratings and transparency. - Saudi Arabia is currently developing its CRA Regulations, which will specify the procedures and conditions for obtaining an authorisation. These regulations will be in line with I OSCOs Code of Conduct Fundamentals for Credit Rating Agencies.
A significant proportion of FSB members have also taken actions to improve CRA practices and procedures, such as the adoption of the IOSCO CRA Code, inclusion in relevant rules/regulations of the requirements for assuring the transparency and quality of the rating process, and providing full disclosure of their ratings track record.
7.3 Enhancing market disclosure and functioning

The financial markets are a potential transmission mechanism for systemic crisis, especially when market participants are faced with significant uncertainty, and engage in panic behaviour. In this regard, IOSCO has taken steps to strengthen market disclosure and enhance investor protection. IOSCO published in February 2012 a consultation report Principles for Ongoing Disclosure for Asset-Backed Securitiesthat provides guidance for securities regulators who are developing or reviewing their regulatory regimes for ongoing disclosure for asset-backed securities (ABS) so as to enhance investor protection.
IOSCO issued in March 2012 a consultation report on Principles for the Regulation of Exchange Traded Funds which listed some common principles and guidelines relating to ETFs on investor protection, sound functioning of markets and financial stability. In response to the G20 Leaders request at the Cannes Summit, IOSCO also published in March 2012 a consultation report containing proposals to improve the functioning and oversight of Price Reporting Agencies in the oil markets and has also published its update report to the G20 in June 2012.
In addition, I OSCO published in February 2012 a consultation report on Suitability Requirements with respect to the Distribution of Complex Financial Products, seeking views on common principles relating to suitability and disclosure standards for market intermediaries in relation to the distribution of comp
Enhancing compensation practices

The 2011 FSB peer review on compensation indicated that good progress had been made in implementing the FSB Principles and Standards on Sound Compensation Practices (Principles and Standards, P&S), but that more work was necessary to overcome constraints to full implementation by individual national authorities and to address concerns by firms of an uneven playing field. In response to the G20 Leaders request, the FSB established a Compensation Monitoring Contact Group (CMCG) comprising national experts from member jurisdictions with regulatory or supervisory responsibility on compensation practices. The CMCG is responsible for monitoring and reporting to the FSB on national implementation of the P&S.
The progress report sent separately to G20 Leaders is the first outcome of this monitoring exercise, which is not as deep as a peer review.
The progress report describes the developments in implementing the P&S since the October 2011 thematic peer review.
Almost all FSB member jurisdictions have now completed the implementation of the P&S in their national regulation or supervisory guidance. Those jurisdictions that still showed significant gaps at the time of the 2011 peer review (Argentina, I ndia, Indonesia, Russia, and South Africa) have progressed in their implementation efforts. However, in the case of I ndonesia and Russia, the relevant regulation is currently under review and it has not yet been issued. Moreover, some other jurisdictions (Argentina, Brazil, China, I ndia, and Turkey) have elected not to implement one or more Standards related to the alignment of compensation with risk taking, either because they are not deemed applicable or because of domestic constraints (e.g. labour laws).
All jurisdictions that have not fully implemented the P&S will need to continue their efforts to overcome impediments to full implementation in order to ensure an outcome that is fully consistent with the objectives of the P&S. The reasons for not implementing specific Principles or Standards, as well as the nature of the actions taken to address identified impediments, will be reported to the FSB by the relevant jurisdictions and will be described in the next progress report.
In many jurisdictions supervisory attention continues to increase indeed, a high level of supervisory engagement is reported to contribute to greater attention to compensation issues by firms. Most authorities report that firms in their jurisdiction have made good progress and generally confirm that especially significant firms do not show major implementation gaps, although some challenges remain where more progress is needed, in particular in the area of alignment of compensation with ex-ante risk taking and with ex-post performance and concerning identification of material risk takers. Especially in these areas more supervisory cooperation would be beneficial. The FSB has also established in early 2012 a mechanism for national supervisors from FSB member jurisdictions to bilaterally report, verify
and, if necessary, address specific compensation-related complaints by financial institutions that derive from level playing field concerns. All FSB members have informed the relevant financial institutions operating in their jurisdiction of the main features of the Bilateral Complaint H andling Process (BCHP). Although it is not possible to estimate a priori the volume of complaints that will be received, the process itself is designed to create the right incentives for implementation of the P&S by firms and to dispel their concerns relating to lack of information or adequate processes to address level playing field issues. The findings of the ongoing monitoring confirm that achieving lasting change in behaviour and culture within firms is a long-term challenge requiring a sustained commitment and that additional time is needed for effective and consistent implementation of the P&S to take place. The FSB will continue to monitor and report on progress so as to generate substantive and relevant information that provides further impetus to aligning compensation practices to prudent risk taking behaviour.
Building and implementing macroprudential frameworks and tools

The G20 Leaders stated at the Cannes Summit that We are developing macroprudential policy frameworks and tools to limit the build-up of risks in the financial sector, building on the ongoing work of the FSBBIS-IM F on this subject. While a small number of jurisdictions (e.g. UK, US, EU) have established new institutional structures with macroprudential mandates, many others are implementing enhancements within the existing institutional arrangements. A number of jurisdictions are enhancing their macroprudential frameworks and powers to gather data that are needed for monitoring systemic risk, for example:
- In Switzerland, the Financial Stability Working Group (MoF, SNB, FINMA) published in March 2012 a report on proposals to amendments of regulatory systems. With respect to this, two amendments to the Capital Adequacy Ordinance are planned: the early introduction of a countercyclical capital buffer; and an increase in capital requirements for risky mortgage lending business. Furthermore, a majority of the group has recommended the creation of a right to direct access for the SNB to information on financial market participants which goes beyond its existing entitlement to statistical data.
- In the US, the DFA created the FSOC to provide comprehensive monitoring of risks to financial stability, promote market discipline, and respond to emerging threats.
The FSOCs assessment of threats to the financial system is a collaborative process, driven by review of the best information available and expertise from FSOC members and their agencies and staff. The FSOC has a number of tools to address threats to financial stability, including its authority to designate non-bank financial companies and financial market utilities for enhanced prudential standards and supervision. The FSOC also has the ability to provide for more stringent regulation of a financial activity by issuing recommendations to financial regulatory agencies to apply new or heightened standards and safeguards. In addition, FSOC members have many tools at their disposal to address vulnerabilities and threats, owing to their involvement in supervision and regulation, consumer and investor protection, and market and infrastructure oversight.
- In the EU, the European Systemic Risk Board (ESRB), the macroprudential authority for the EU, published in January 2012 a set of recommendations addressed to the EU Member States on the macroprudential mandate of national authorities.
Under the recommendation, Member States should designate an authority in national legislation to conduct macroprudential policy, taking due consideration of national institutional frameworks.
Further, the ESRB recommended that EU Member States bestow the macroprudential authority with the powers to conduct macroprudential policy on its own initiative or as a follow-up to recommendations or warnings from the ESRB. The national authority should also have full access to all the necessary statistical information and policy instruments. EU Member States are also called upon to confer on the authority the necessary independence for it to fulfil its tasks, to ensure an adequate level of accountability and to reserve the maximum of transparency. The EU Member States are required to communicate their intentions with respect to implementation by June 2012 and to take the necessary actions before 1 July 2013. The BCBS published in May 2012 two working papers arising from its Research Task Force Transmission Channel project that help to build the knowledge base in the area of macroprudential policies.
The first working paper, The policy implications of transmission channels between the financial system and the real economy, analyses the link between the real economy and the financial sector, and channels through which the financial system may transmit instability to the real economy.
The second working paper, Models and tools for macroprudential analysis, focuses on the methodological progress and modelling advancements aimed at improving financial stability monitoring and the identification of systemic risk potential.
The second working paper, in particular, discusses analytical methods used to measure the impact of macro-financial shocks on the real economy; developments in modelling financial sector liquidity risk including the potential for contagion; methods for measuring the potential for systemic risk; and bank behavioural responses to changing central bank and macroprudential policies and macroeconomic conditions.
Strengthening adherence to international financial standards

The FSB, in collaboration with the SSBs, established a framework in October 2011 the CFIM for monitoring and reporting on the implementation of the G20 financial reforms.
The CFIM was subsequently endorsed by the G20 Leaders at the Cannes Summit as a way to intensify our monitoring of financial regulatory reforms, report on our progress and track our deficiencies. The framework highlights priority areas that will undergo more intensive monitoring and detailed reporting via periodic progress reports and peer reviews. It also outlines a process to facilitate ongoing consultation and collaboration between the FSB and the SSBs by clarifying their respective roles in monitoring national implementation efforts. This consultation process is important to ensure that the plans for implementation monitoring are consistent with G20 reporting requirements as described in the CFIM. The FSB has undertaken a number of steps since the adoption of the CFIM in October 201 1 to put it in operation. In priority areas where the policy development work is largely completed, the FSB is working with relevant SSBs to ensure that the scope and approach of implementation monitoring and reporting are sufficiently comprehensive and rigorous to satisfy G20 and FSB information requirements.
This is complemented by the FSBs I MN, which is tasked with collecting information from national authorities and reporting on the implementation of financial reforms in other areas. All implementation progress reports for the priority areas and the completed I M N national/ regional responses on the progress in other areas are available on the FSB website. In addition to periodic progress reports, the FSB monitors the implementation and effectiveness of international financial standards and policies via its peer review programme. Peer reviews are an important institutional mechanism to promote complete and consistent implementation and are a means of fostering a race to the top by FSB member jurisdictions. They provide an opportunity for FSB members to engage in dialogue with their peers and to share lessons and experiences. The FSB completed in December 2011 a review of experience to date with FSB peer reviews. The review identified lessons and recommended certain refinements to the functioning of the programme in order to further enhance its effectiveness and value-added, which have been incorporated in the Handbook for FSB Peer Reviews. Since the Cannes Summit, the FSB has completed a thematic peer review on deposit insurance systems (DISs) using the BCBS-IADI Core Principles for Effective Deposit I nsurance Systems as a benchmark. The review confirmed the importance and necessity of an effective DIS and noted that the crisis resulted in greater convergence in practices across jurisdictions and an emerging consensus about appropriate DIS design features. While the reviewed DISs in FSB member jurisdictions were found to be broadly consistent with thestandard, there remain some areas where there appear to be divergences from (or inconsistencies with) the Core Principles. In some areas, more precise guidance may be needed to achieve effective compliance or to better reflect leading practices.
The report contains a number of recommendations to address these issues. The recommendations of past thematic peer reviews are also leading to concrete follow-up activities by relevant parties. In the case of compensation practices, an ongoing monitoring mechanism has been established by the FSB to follow up on remaining gaps and impediments to full implementation as well as on actions taken in response to the peer reviews recommendations (see section 8). In the case of risk disclosures, an FSB roundtable with relevant market participants was organised in December 2011 and the Enhanced Disclosure Task Force (EDTF) will take forward the work to identify leading practices and develop principles for risk disclosures. In response to the recommendations from the peer review of residential mortgage underwriting practices, the FSB has issued an international principles-based framework for sound underwriting in this area. Finally, in the case of the peer review on deposit insurance systems, the IADI is updating its guidance that pre-dates the financial crisis and developing additional guidance in certain areas covered by the Core Principles. The FSB has also recently completed the country peer reviews of Canada and Switzerland. Three more peer reviews thematic reviews of risk governance and resolution regimes as well as the country review of South Africa will be completed by early 2013. All completed peer review reports are available on the FSB website. FSB members adherence to international standards is essential to reinforce the credibility of the FSBs efforts to strengthen adherence by all countries and jurisdictions. To lead by example, member jurisdictions have agreed to publish information on the commitments they made under the FSB Framework for Strengthening Adherence to I nternational Standards. In March 2010, the FSB launched an initiative to encourage the adherence of all jurisdictions to regulatory and supervisory standards on
international cooperation and information exchange, including by identifying non-cooperative jurisdictions and assisting them to improve their adherence. The initiative responded to a call by the G20 Leaders at their April 2009 Summit for the FSB to develop a toolbox of measures to promote adherence to prudential standards and cooperation. The FSB has prioritised about 60 jurisdictions for evaluation, including all 24 FSB member jurisdictions and non-FSB jurisdictions that rank highly in financial importance. To recognise the progress that jurisdictions have made toward addressing weaknesses in international cooperation and information exchange, and to incentivise improvements by those jurisdictions not cooperating fully, the FSB published on 2 November 2011 information on the jurisdictions evaluated to date. Since then, China and Saudi Arabia have demonstrated, through the results of their I MF-World Bank assessments, sufficiently strong adherence to the relevant standards. The FSB will publish updatedinformation in November 2012 on all jurisdictions that have been evaluated under the initiative.
11. Strengthening FSB governance 1 1.1 Strengthening FSBs capacity, resources and governance
To meet the mandate given by the G20 Leaders at the Cannes Summit to strengthen the FSBs capacity, resources and governance, including its establishment on an enduring organisational footing while preserving its strong and well-functioning links with the BIS, the FSB established a High-Level Working Group on FSB Capacity, Resources and Governance. The FSB has submitted its recommendations along with a revised FSB Charter to the Los Cabos Summit for G20 Leaders endorsement. The main recommendations of the Working Group include: (i) Preserving the FSBs flexible, responsive, member-driven, multiinstitutional and multi-disciplinary character, active involvement of
senior-level officials from finance ministries, central banks and supervisory authorities, and nexus between the political level and regulatory policy making of the SSBs; (ii)Pursuing a gradual approach to the institutionalisation of the FSB by establishing it as an association under the Swiss law to provide it a legal personality, with the functional immunities needed for its effective operation as a policy making body while maintaining strong and wellfunctioning links with the BIS; (iii)Strengthening its continuing role in reducing the likelihood of financial crises through vulnerability assessment, effective and forward looking coordination of international standard setting, reviewing regulatory policies within a macroprudential perspective and comprehensive monitoring of members implementation of international financial standards and agreed G20 and FSB commitments and recommendations; (iv)As needed to regulatory gaps that pose risk to financial stability, developing or coordinating development of standards and principles, in collaboration with the relevant SSBs and other stakeholders, as warranted, in areas which do not fall within the functional domain of another international standard-setting body, or on issues that have cross- sectoral implications, in line with the current practice; and (v)Improving its governance, transparency and accountability arrangements through amendments to its charter, setting up Rules of Procedure and establishing a Standing Committee on Budget and Resources for effective financial governance. The implementation of the recommendations would commence shortly after the G20s endorsement. As part of the ongoing governance reforms, in January 2012, the FSB also reconstituted its Steering Committee to rebalance its composition in terms of institutional and geographic representation.
1 1.2 Increasing outreach through the FSB regional consultative groups
In response to the G20 Leaders call at the Toronto Summit for the FSB to expand and formalise its outreach beyond its membership, the FSB established in 2011 Regional Consultative Groups (RCGs) for the Americas, Asia, the Commonwealth of I ndependent States, Europe, Middle East & North Africa, and Sub-Saharan Africa. The RCGs bring together financial sector authorities from FSB member and non-member jurisdictions to exchange views on vulnerabilities affecting financial systems and on initiatives to promote financial stability.
Membership in the RCGs includes ministries of finance, central banks and supervisory authorities in 65 FSB non-member jurisdictions and their counterparts in FSB member jurisdictions.
All of the RCGs have met at least once and some have set up working groups to study financial stability issues of interest to their respective region. RCGs have presented the output of the working groups to the FSB Plenary as a part of the consultative feedback provided by non-FSB members.
12. Other issues 12.1 Addressing data gaps

In the global financial crisis that began in 2007, the lack of timely, accurate and consistent information on large systemically important banks has proved very costly. The critical initiatives underway to reform and strengthen the financial system all require better data, be it to support more intensive supervision, to identify risk concentrations and the build-up of systemic risk, or to assist authorities in crisis situations. In this regard, the FSB Data Gaps Project aims to provide a consistent framework to pool and share relevant data on the major bilateral linkages between large international financial institutions, and on their common exposures to and funding dependencies on countries, sectors and financial instruments.
As part of a wider initiative to improve data to support financial stability, the FSB was tasked with improving the availability, quality and consistency of data on major global financial institutions and financial inter-linkages. To take this forward, the FSB has set up a working group of experts from national authorities and international institutions, with the mandate to develop proposals for a new common data template for globally systemic institutions. The working group is conducting extensive preparatory work, including a thorough examination of legal issues on the sharing of data and a continued consultation with the industry on the common template. The FSB is taking an incremental approach for the FSB Data Gaps Project with three distinct phases characterised by a progressive increase in the granularity of the data and in the sharing of information. The FSB has approved the implementation of the initial phase of the project (Phase 1) for a start in March 2013. This phase foresees the creation of a central hub to be hosted by the BIS for the storage and management of data collected and the sharing of this information among relevant supervisory authorities. Implementation work for Phase 1 is on track, both on the data side, with the planned finalisation of the Phase 1 template very shortly, and on the governance side, where key principles underpinning exchange of information in Phase 1 have been developed. Regarding the next phases of the project, preparatory work is ongoing on data templates and on the feasibility of wider data sharing. The FSB will decide on the implementation of Phases 2 and 3 after this preparatory work is completed, as there is no automaticity between Phases 1, 2 and 3.
12.2 Identifying unintended consequences of regulatory reforms on EMDEs

In February 2012, the G20 Finance Ministers and Central Bank Governors asked the FSB to coordinate, with the I MF and World Bank, a
study to identify the extent to which the agreed regulatory reforms may have unintended consequences for emerging market and developing economies (EMDEs). The intent of the study is not to re-open recent internationally agreed regulatory reforms but to better understand the possible effects of those reforms in the context of broader post-crisis developments on EMDEs. National authorities from EMDEs that are members of the FSB or of an FSB RCG were surveyed for this purpose, while an FSB Review Group comprising FSB members and co-chairs of RCGs provided guidance on the selection and analysis of the issues included in the study as well as on its main messages. There is widespread support among EMDEs for the objectives of the agreed reforms.
At the same time, there is a broad range of views regarding the extent to which these reforms are having, or expected to have, an impact on their financial systems.
This heterogeneity in perspectives can be attributed to the early stage of implementation of the reforms and to the diversity of EMDE financial systems, which give rise to different considerations and concerns. Those respondents that did identify unintended consequences focused on a few key areas: the Basel I I I capital and liquidity framework; policy measures including resolution frameworks for G-SIFIs; and OTC derivatives reforms. Some respondents also identified other national/ regional regulatory reforms such as higher capital requirements by the European Banking Authority (EBA) for large banks in the EU, and the Volcker Rule in the US as giving rise to spillovers and/ or extraterritorial effects that may lead to unintended consequences. A number of the concerns raised by EMDEs relate to cross-border effects and perceived home bias in the design or implementation of reforms.
Several of the key concerns have also been raised by advanced economies and are being addressed by relevant international bodies during policy development and implementation. The responses reflect some implementation challenges for EMDEs and raise the issue of clearly identifying intended versus unintended consequences. It is too early to assess fully the materiality and persistence of the effects ofregulatory reforms on EMDEs, and it would be useful to continue to monitor the effects of those reforms as well as to share experiences and implementation lessons. The findings also highlight the importance of ongoing dialogue and cooperative relationships among national authorities from EMDEs, SSBs and international financial institutions in order to facilitate the mitigation of unintended consequences from the implementation of agreed reforms in EMDEs.
12.3 Enhancing consumer finance protection

The global financial crisis demonstrated the need to strengthen consumer protection policies and frameworks to ensure that the use (or misuse) of individual financial products do not become a source of financial instability. A significant contributor to that crisis was poorly underwritten residential mortgages, which often represent the largest component of household and consumer debt. In response, a number of FSB members have encouraged prudent underwriting practices to limit the risks that mortgage markets pose to financial stability and to better safeguard consumers and investors. The FSB Principles for Sound Residential Mortgage Underwriting Practices released in April 2012 provide a framework for jurisdictions to set minimum acceptable underwriting standards. After providing sufficient time for implementation, the FSB will conduct a thematic review to assess progress made in implementing the framework. The Principles will assist FSB members in their efforts to improve financial stability and prudential standards.
They also refer to consumer protection issues that contribute to these objectives, but the Principles are not intended to be a statement of consumer protection standards. Jurisdictions will want to adopt the consumer protection standards that are appropriate to them, including the Organisation for Economic Cooperation and Developments (OECD) H igh-level Principles on Financial Consumer Protection which were endorsed by the G20 Leaders at the Cannes Summit. The OECD high-level principles are designed to help its member jurisdictions and other interested economies to enhance financial consumer protection. Several FSB members have already self-assessed their consumer protection frameworks against these high-level principles and found that they are in line with the recommendations (e.g. Australia, Canada, and France). H owever, an even larger number of jurisdictions would like additional information to support their efforts toward implementation, particularly on the following principles: - Disclosure and Transparency (principle 4) - Responsible Business Conduct of Financial Services Providers and Authorised Agents (principle 6)
- Complaints Handling and Redress (principle 9)

The OECD, in collaboration with the FSB and SSBs, have developed an action plan to identify, within 24 months, a set of relevant approaches to support the effective implementation of the high-level principles. To help advance consumer finance protection efforts, the FSB report on consumer finance protection with a particular focus on credit endorsed by G20 Leaders at the Cannes Summitset out three options, including supporting a global platform for consumer protection authorities to exchange views on experiences as well as lessons learnt from the crisis to
help strengthen consumer protection policies across the FSB membership and beyond. In this regard, the importance of the Financial Consumer Protection Network (FinCoNet) as a global network of market conduct financial authorities was recognised by the G20 Finance Ministers and Central Bank Governors in April 2012. FinCoNet is currently refining its mandate to enhance its legitimacy as the international organisation of consumer protection authorities. These efforts will help maintain the momentum toward strengthening consumer finance protection frameworks as several jurisdictions are considering significant changes to their frameworks, including strengthening the institutional arrangements for consumer protection authorities (e.g. China), legislative changes (e.g. Korea) as well as enhancements to existing regulatory frameworks (e.g. Switzerland).
Regulating in a new era of professionalism: what does the FSA want to see from the industry?
14 Jun 2012 Speech by Clive Adamson, Director of Supervision, Conduct Business Unit, FSA to the Marketforce and the I EAs 15th Annual Conference Good morning and thank you to Marketforce and the I nstitute of Economic Affairs for inviting me to speak to you today on Regulating in a new era of professionalism. I will begin by giving you a high level view of the changes taking place in UK regulation, how we expect professionalism to play a part in this, and what this means for you.
UK regulatory changes
The events experienced due to N orthern Rock meant our focus as regulators was focused on ensuring the banking system was stable and prudential regulation appropriate to safeguard the UKs financial stability. The consequence of this, in some cases, was substantially less focus on how firms treated their customers and greater focus on the firms solvency. As time moved on, it was recognised that this approach could not continue in the long term. During the last few months, the FSA began taking steps to separate prudential and conduct regulation in preparation for the creation of the new Financial Conduct Authority and the Prudential Regulatory Authority, in early 2013, and shaping what these two regulators are going to look like.
Internally, the first major milestone was the on April 2011, when we split into two business units the Prudential Business Unit and the Conduct Business Unit. Our second major milestone was April this year when we split banking and insurance supervision into the Prudential and Conduct Units, so that we now essentially operate internally under the FSA umbrella how we will operate when we are legally formed in 2013. Today, I will talk to you from the perspective of the FCA, leaving my colleagues in the PRA to talk from their perspective at other events. The strategic objective of the FCA is to making markets work well. Additionally, it has three operational objectives of ensuring consumer protection, market integrity and competition is in the interests of consumers. Of these, the newest for us in the FCA is the latter. As a primary statutory objective we will be under the obligation to consider the role of competition (or lack of it) as a driver of poor outcomes in markets and work out how address these problems. What we have learnt from the past is that things go wrong when business models are not based on a sound foundation of fair treatment of consumers, and a strong culture that supports this, leading to products being sold that are not suitable for those buying them. Our previous supervisory approach was too focused on disclosure at the point of sale, creating situations where substantial amounts of information were being provided to consumers who not always understood what was being presented to them. This, combined with sales processes that often incentivised staff to sell products that were profitable to the firm rather than suited to the consumer, made it almost inevitable that detriment took place.
It is our intention that the FCA will look and feel different from the FSA.
In brief, we aim to move away from a primarily reactive style to be a judgement based, confident and pre-emptive regulator that acts to ensure consumers get a better deal and markets are fair and orderly. The new supervisory approach will comprise of five main elements: - To be more forward-looking in assessment of potential problems. Looking at how we can tackle issues before they start to go wrong. Increasingly, we will continue to move towards challenging firms about whether their business models deliver good outcomes for consumers and, where we disagree with management, have the confidence in our judgement to require firms to change their business models.
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Intervene earlier when we see problems. The point I want to make here is that the FCA will have greater appetite for earlier intervention, particularly in the product development lifecycle, than the FSA has had. To make it clear, it is not our intention to become a product approval regulator, but we will consider and take action when necessary, when we feel certain products are too risky for their target audiences or sold in the wrong way.
Address the underlying causes of problems that we see, not just the symptoms. It would be relatively easy for us to case individual examples of poor conduct behaviour, but our experience is that these will continue to be manifested unless the underlying causes of these problems are satisfactorily dealt with.
As a result, we will be applying a particular focus to identifying and mitigating the underlying root problems not just patch up the symptoms.
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Secure redress for consumers if failures do occur For example, what we saw with payment protection insurance. We are asking those firms that mistreat their customers to take measures to rectify things.
In practice, this means a combination of appropriate redress for consumers, changes in their systems and controls and ensuring that post-sales processes deliver a fair outcome for their consumers.
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Take meaningful action Against firms that fail to meet our standards, through levels of fines that have a credible deterrence. Where we do not see improvements in firms following our actions, we will consider taking tougher action, including stopping firms taking on new business. Lets take insider dealing as an example increasingly we are using our powers to prohibit individuals from the industry and continuing to focus on senior management responsibility.
How does professionalism fit into this approach?

A key component of the FCAs approach is to continue implementing the work that the FSA has already started around professionalism and provision of advice.
The Retail Distribution Review, which is coming into effect on 31 December this year, is a clear example of action being taken to fulfil one of the FCAs operational objectives consumer protection. It continues to be our view that consumers should have: clarity in the service they receive; a transparent and fair charging system for the advice received; and advice from respected and professional advisors. This is particularly important in the case of long-term savings, for example. The RDR aims to create a resilient, effective, and attractive retail investment market that consumers can have confidence in and trust at a time when they need more help and advice than ever with their retirement and investment planning. Given that long-term savings are long-term commitments, the quality of advice and product suitability is key as often it may take years for signs of detriment to manifest itself. - The Retail Conduct Risk Outlook document, which we published some weeks back, also sets out our views on how professionalism needs to be at the core of advice for long-term savings, including pensions and retirement planning. Practically, this means: - as securing financial wellbeing during retirement is paramount to most pension investors, the quality of advice and product suitability for pension and retirement planning become of significant regulatory concern and interest; - as retirement planning involves complex decisions, it creates the risk that poor advice results in lower retirement income and/ or purchase of products with excessive risks; and
- that the impact of detriment is compounded by limited means to recover from financial loss, especially among vulnerable groups (e.g. the elderly) that have lower earning opportunity or financial flexibility.
So what do we want to see from the industry?

I want to make it clear that our aim is not to take away the consumers responsibility. We want them to make decisions for themselves, but ensure that the decision they make is an informed one. This is where you, the industry, come in. Both the RDR and regulatory reform give us all huge opportunities to do things better. To give consumers more confidence in the advice they are receiving, it is important that advisers look at their customers as unique individuals, consider their personal situations and fully understand their objectives and potential financial needs. Questions that you should be asking yourselves are: - Have you decided if you are going to be independent advisory or restricted? This is possibly one of the most important decisions you need to make. - Is your pricing structure clear? And do you have the systems in place to ensure your clients fully understand how your advice translates into costs to them? - If you are advising on high-risk investments, do the individuals providing that advice have sufficient understanding of the products being offered? - Are you looking at undertaking a wider range of business? If so, have you identified all the risks associated with these products? These are just some of the many questions I hope you are asking yourselves.
For us, advice should be just that, advice not a sales/ product driven process. It should be about: - providing the right product for the right person with the right information; - firms ensuring customer treatment is at the core of their business model; and - firms provide common sense, professional and clear advice to their customers. Professionalism also means that what you do should be properly recognised as a profession by setting minimum standards. This is why it is important that advisers continue to press ahead and achieve appropriate Level 4 RDR qualification and then obtain a Statement of Professional Standing.
I can tell you that 93% of advisers believe they are on track to complete their qualifications on time and 71% of advisers already have appropriate qualifications.
This is very encouraging news and I want to thank you for the tremendous work you are doing to get the required qualifications. Those who are currently appointed representatives should bear in mind that it is their responsibility to ensure they reach the required standards and the responsibility of principal firms to ensure their appointed representatives have the required qualifications.
Conclusions
I hope, however, that I have given you some food for thought. It is clear that firms have made good progress, but we want to see more of you getting the appropriate qualification and making the necessary internal arrangements sooner rather than later.
If you havent done so already, you also need to fully consider whether providing an independent or restricted advice model best suits your client base; and we want to see you start to test and implement suitable adviser charging structures now. I believe the next few months, as we continue to move towards the creation of the FCA and the implementation date for RDR, will be extremely interesting. We will be increasing our communication around what the FCA will be and how it will operate as part of a more transparent approach to both firms and consumers, and welcome opportunities like this to engage with the regulated community and communicate our views on how we can ensure that, together, we continue to put customers at the heart of what we do. Thank you
Addressing Too Big To Fail The Swiss SIFI Policy 1 Background

Two of the Swiss banks are not only systemically important for the Swiss economy, but may also be considered as institutions of considerable importance for financial stability at global level. Although they have significantly reduced their exposures in the aftermath of the crisis, the size of their balance sheets continues to amount to a multiple of the output of the Swiss economy. Both banks are considered as Globally Systemically I mportant Financial Institutions (G-SIFIs) and Too big to Fail. Hence, the issue of Too big to fail (TBTF) is of great relevance for Switzerland. The Swiss Federal Government, the Swiss Financial Market Supervisory Authority FINMA and the Swiss N ational Bank have therefore decided to move rapidly towards measures strengthening the resilience of the Swiss Systemically I mportant Financial Institutions (SIFIs), limiting the economic impact of crisis in the financial system and promoting financial stability.
The starting point of the Swiss initiatives is the work of the commission of experts commissioned by the Swiss Federal Government to develop policy options on how to mitigate risks emerging from TBTF institutions in the Swiss economy. On 4 October 2010, the commission agreed on a proposal for a Swiss SIFI policy framework. What distinguishes the policy proposals is that experts were drawn not only from the relevant authorities and the science community, but also included members from the two Swiss big banks and from the insurance sector. All members of the commission endorsed the results. Currently, FINMA, SNB and the Swiss Federal Department of Finance are working on the practical implementation of these results into Swiss law. The necessary legal changes were sent to Parliament on 20 April 2011. This report describes the Swiss SIFI policy framework based on the proposal of the commission of experts and the dispatch of the Federal Council on strengthening financial sector stability. The Swiss TBTF initiatives are embedded in the global framework, in particular that of the Financial Stability Board and the Basel Committee. A global alignment is paramount given the fact that SIFIs are active at international level and that any substantial regulatory arbitrage may impact financial stability from a domestic and global perspective. However, each country has to consider its own specific situation.
Not only is the failure of a big institution a risk for the Swiss economy: the international exposure of the Swiss financial centre and its companies bears a greater responsibility for global financial stability.
Switzerland has to implement the globally agreed regulations with a Swiss fin ish and to develop and put its initiatives into effect as soon as possible, ahead of those of several peer countries.
2 Defining systemic importance 1. Functional perspective

It is broadly agreed that the systemic importance of a financial institution arises out of the financial functions it provides to the general economy. At the same time, such financial institutions provide a plethora of functions and services which are not systemically important or can be substituted easily and quickly. The proper classification of functions is of vital importance. While the set of systemically important functions should not be too narrow to sufficiently protect the economy from the fallout of a banking crisis, an excessively broad definition complicates crisis management and resolution actions, sets false incentives and reduces pressure to come up with market-based solutions in a crisis scenario. Switzerland aims for a simple, straight-forward yet narrow definition of systemically important functions. According to current discussions, the following functions will presumably fall under this definition: Payment operations; Domestic deposits to ensure access to liquidity for payment transactions; Loans and credit lines to non-financial enterprises; Domestic mortgages with a maturity of less than 1 year.
However, the measures proposed are not limited to the systemically important functions as such, but eventually lead to institutional requirements. When determining capital surcharges, all activities of a SIFI are to be considered, as losses will most probably not be contained in a particular business line, but may impair systemically important functions as well. Also, when assessing the resolvability of a company, it is not only the systemically important activities which are looked at, but rather all functions the company performs, also from a cross-border perspective.
2. Institutional perspective
A company is deemed systemically important if it performs services that are essential to the overall economy and which cannot be substituted by other market participants within a reasonable time frame. The current Swiss initiatives therefore focus on banks. To assess the systemic importance of banks, the evaluation framework has been substantiated to include the following criteria: - Market share in systemically important business activities such as deposits, loans and clearing; - Value of deposits not covered by the deposit insurance regime;
- Relation between the balance sheet size and the gross domestic product;
- Risk profile of the company. Evaluating these criteria naturally leads to designating the two big global Swiss banks, the Credit Suisse Group and UBS, as globally and domestically systemically important. Switzerland has decided to focus its initiatives on these two banks. Once the framework is in place, the initiatives may be extended to include domestic SIFIs.
Given the fact that such D-SIFIs (Domestic Systemically I mportant Financial Institutions) operate in an environment and under conditions which are very different from those of a globally active bank, it is unlikely that a framework adequate for G-SIFIs can be directly adopted for D-SIFIs. However, the rationale ensuring that D-SIFIs can fail without disrupting systemically important functions and without the need for extraordinary public support is the same. Financial infrastructure providers, such as settlement organizations, exchanges and central counterparties, are also systemically important. However, the risks they handle are quite different from those banks are confronted with. The policy framework outlined in this paper is therefore not directly appropriate to deal with infrastructure providers.
3 Policy mix
SIFIs and the financial system as a whole must be capable of surviving crises, even of larger scale, without public support and taxpayers money. The Swiss SIFI policy framework focuses on two major objectives. The first objective, reducing the probability that a TBTF institution fails, is pursued by two key measures: Capital Liquidity The second objective, reducing the potential systemic fallout of a failure of a TBTF institution, is pursued with measures increasing the resolvability of those companies: Organization, and Risk diversification.
The key measures - capital, liquidity, organization and diversification are not isolated, but constitute an integrated policy mix. Capital and liquidity not only help to prevent crises, but also to set aside resources necessary to implement recovery measures or ultimately enable an orderly resolution of the company. Furthermore, the measures are to take effect at all phases. Capital and liquidity measures, which allow for easier restructuring or resolution by the supervisory authority for a bank in distress, provide incentives for the banks management to reduce systemic risk when the company is still a going concern.
Organizational measures, which facilitate recovery and limit the impact of failure, need to be designed, prepared and implemented when there is still enough time for diligent action.
Box 1: Pure size limits regarded as ineffective

The most appropriate way to tackle the TBTF issue would be to prevent institutions from becoming so big that the consequences of a failure would be too dangerous for the economy. Size limits could be expressed by imposing restrictions on the size of the balance sheet (absolute or relative, e.g. as a fraction of the countrys yearly gross domestic product), on the market share or the level of interconnections with other financial institutions or the economy as a whole.
Banks exceeding these limits would be ordered by law to reduce their exposure.
While this concept sounds simple, the effectiveness may not be evident.
From a macroeconomic perspective, the size of a financial system is not only driven by supply. Reducing the exposure of single institutions may not lead to a contraction of the size of the financial system, but rather would cause fragmentation and diversification between many smaller market participants. Such a diversification may help to mitigate risks of isolated issues, but would not be suitable to deal with systemic crises. Business concentrated on a few big companies would migrate to smaller companies, all of them pursuing similar strategies and exposing similar risk behaviour. Crises of a larger scale would cause problems at many of those smaller companies and, at the same time, would render a group of small companies systemic in a herd. Strict limitations on the size of business activities have therefore only a limited potential to reduce the systemic risk, but may heavily complicate any crisis management, as such measures would then have to be applied to several companies at the same time. Of course, economies of scale and other efficiency considerations may also favour larger companies. However, such benefits are hard to quantify and did not play a substantial role in our considerations. As a result, we came to the conclusion that imposing hard size restrictions is not an appropriate approach to strengthen the resilience of the financial system.
4 Capital and liquidity reducing the probability of failure

Higher solvency and liquidity requirements reduce the probability that banks fall below minimum levels of capital and liquidity and therefore reduce the probability of failure. In addition, more solvency and liquidity may significantly facilitate crisis management, resolution or, in a worst case scenario, the liquidation of a company. Finally, as capital and liquidity requirements mostly depend on the volume and risk of a banks business activities, they also create incentives to reduce size and risk. Having a lower probability of failure, more flexibility for crisis management and greater incentives for size and risk reduction is especially important for systemically important institutions.
These companies should therefore be subject to stricter requirements. For some years, large Swiss banks have been subject to a surcharge on top of the regular capital requirements, expressed as a multiple of the Pillar I level. In the wake of the crisis, higher liquidity requirements were quickly imposed. It is now proposed that the existing Pillar I I measures are replaced by a system which allows for improved calibration and to better reflect systemic importance. The new system defines surcharges on the Basel baseline requirements (capital quantity), but also prescribes the capital instruments to be used (capital quality). Both dimensions have to be looked at in parallel. While the proposal significantly raises the minimum capital quantity, it also ensures that there is a safety net to enable recovery and resolution and that this safety net cannot be used, or even depleted, for day-to-day business activities. This allows for restructuring a bank without forcing it into liquidation. That way, the whole company, or at least parts of it, may have a realistic future after a crisis, which is paramount to secure the commitment of investors, clients and counterparties.
4.1 Quantity of capital

Switzerland proposes that the capitalization of systemically important banks should be defined by three components of capital which complement each other, but have distinct objectives.
While the baseline requirements are used as going concern capital, the buffer helps to fend off crises. The surcharge serves as a reserve to restructure or resolve the company.
The calculation of the components and the capital instruments employed are structured in accordance to these purposes.
1.
Basel I I I as a baseline requirement
Just as every banking institution, Swiss SIFIs have to fulfil the baseline capital requirements as defined in the Basel framework and its Swiss domestic implementation.
The baseline requirement amounts to 8% of the companys risk weighted assets (RWA).
The Basel Committee has proposed substantial amendments to its capital accord (Basel I I I ). Switzerland is committed to implement the Basel I I I proposals within the internationally agreed time frame. The revised rules will be applicable to all banks in Switzerland regardless of their systemic relevance. Switzerland implemented ahead of time a subset of the rules, mostly centred around trading book rules (Basel 2.5). All banks concerned are already required to meet these extended rules since 1 January 2011.
2.
Buffer to increase loss absorbency
The last crisis revealed that banks meeting or even exceeding the statutory capital requirements may experience losses at such a scale and
speed that they may significantly fall below the minimum capital levels within a short period of time. Countermeasures implemented by companies, such as fire sales of liquid assets, accelerated these developments, caused contagion to other financial companies and market segments, and could only be impeded by vast interventions undertaken by governments and central banks. Hence, while capital levels as required by Basel I I / I I I and national regimes were never designed to absorb tail risks of large, internationally active institutions, they were too small to prevent a system-wide contagion. By increasing capital requirements for systemically important financial institutions, contagion could be bounded or at least slowed. Switzerland will therefore implement a capital conservation buffer of 8.5% RWA on top of the Basel I I I minimum capital requirements for all banks of 4.5% RWA. This buffer will be limited to systemically important financial institutions, as the contagion potential of smaller or mid-size firms is curtailed. However, as part of the supervisory process, we also will require specific buffers for non-SIFI banks if their size, business activities and risk profile mandate capital resources exceeding the Basel baseline rules. In contrast to the countercyclical buffer discussed by the Basel Committee, neither size nor usage of the Swiss capital conservation buffer is directly dependent on the macroeconomic environment. The banks have to schedule when and how they increase their capital in so-called good times above the requested threshold. However, a bank will be allowed to make use of the buffer in bad times (e.g. when it faces significant losses).
As soon as the profit situation improves, the buffer has to be refilled. The size of the buffer has been calibrated considering the experiences of previous crises and model calculations.
3.
Systemic surcharge
Banks with a higher systemic importance should maintain a higher solvency. Additional solvency gives the banks management, counterparties and regulators alike more time to act, especially to protect the banks systemically important functions. Higher systemic importance often comes with a more complex organizational set-up and multifaceted business activities which in turn lead to more difficult and time-consuming crisis management measures. In addition, linking systemic importance with solvency requirements makes systemic importance expensive and provides for incentives to reduce it. As a third major component, a progressive systemic surcharge consisting of two parts is therefore proposed: Market share-based surcharge taking into account a banks share in the Swiss domestic loan and deposit market; and A size-based surcharge that considers the size of a banks balance sheet. The relationship between market share, size and the resulting surcharge is linear. Given the current situation of the Swiss big banks, both components of the systemic surcharge will result in ***additional capital requirements amounting to 6% of the risk weighted assets* **.
Total capital will demand 19% of RWAs (i.e. 4.5% RWA minimum capital requirements under Basel I I I, the capital conservation buffer of 8.5% RWA, as well as the progressive surcharge of 6% RWA based on current calibration).
Box 2: Capital planning enables banks to fulfil upcoming requirements

As part of the regular supervisory requirements, FINMA expects companies to perform a prospective capital planning. Part of this process is a systematic gap analysis of the institutions current capital situation and future capital needs, taking into account regulatory requirements, the strategy and the risk situation of a company, as well as its projected profitability in the economic cycle. FINMA has been closely following the capital planning process and its implementation of the systemically important banks. Even if the proposed TBTF framework has not yet been enacted, FINMA has already requested these banks to aggressively build up capital in order to fulfil upcoming requirements along a front-loaded transition path.
4.2 Quality of capital 4.2.1 Common equity

The new Basel I I I rules include substantial measures to increase the quality of capital on which the Swiss SIFI framework draws. 4.5% of risk-weighted assets of the baseline requirements and 5.5% of the RWA of the buffer have to be held in common equity. This results in at least 10% of risk-weighted assets to be held in common equity.
4.2.2 Contingent convertible bonds (CoCos)

Contingent convertible bonds (CoCos) are debt obligations that convert or become convertible to equity if a specified event occurs. Once converted, CoCos are fully loss absorbing without triggering the company default. The trigger may be discretionary or well defined upon issuance of the bond. The Swiss SIFI framework proposes CoCos which ***automatically trigger if the common equity tier 1 capital ratio (CET1) of a company falls below predefined levels* **. Since the thresholds are predefined, pricing models for such instruments can be applied accordingly. In order to be accepted under the Swiss SIFI policy, CoCos have to be structured so that they are eligible as a Basel capital instrument. Depending on the actual trigger point, CoCos have different characteristics. CoCos with low triggers (5% CET1) convert to equity just before a comp anys cap ital sit u at ion falls b elow th e min imum requ ireme nt s . The contribution of low-trigger CoCos to the stability of the company is limited, as the capital ratio may exceed the regulatory minimum even in severe crisis situations. However, if the situation deteriorates rapidly, low-trigger CoCos generate capital necessary to implement crisis management measures, may prevent the bank from being put in receivership and, in a worst case scenario, provide funds for an orderly resolution.
Since they trigger just before resolution procedures would have to start, it is ensured that the capital is not used for going concern business activities.
Because the conversion takes place just before resolution or even before liquidation procedures commence, the risk premium of a low-triggering CoCo is rather small.
CoCos with high triggers (7% CET1) convert when the companys capital situation is deteriorating, but the company is still well above the minimum requirements. High-trigger CoCos further improve the loss absorbing capacity of a company. In this way, high-trigger CoCos contribute to the stabilization of a company before harsher restructuring actions are necessary. The conversion also contributes to systemic stability. CoCo holders may even benefit from a subsequent recovery of the company as they participate in the upside potential of equity. However, it is paramount that the companys management is rapidly able to regain the trust of its investors.
The conversion of CoCos may therefore serve as an important wake up call for the management, the companys stakeholders and regulators, and also help to strengthen market transparency.
Of course, the risk premium of high-trigger CoCos is nearer to that of equity and is expected to be substantially higher than the premium of non-convertible debt instruments. The usage of CoCos eligible under the proposed regime is strictly limited.
On top of the Basel and Swiss minimum capital requirement of 4.5% CET1, the Swiss additional capital conservation buffer of 8.5% RWA may consist of CoCos to a maximum of 3% RWA.
These CoCos must have a high trigger, forcing conversion when the companys capital ratio undercuts 7% CET1.
The progressive surcharge of 6% RWA is planned to include only CoCos. As part of the resolution scheme, those CoCos conceptually convert at a capital ratio of 5% CET1. The characteristics of CoCos are crucial to determine the viability of these instruments. This includes considerations on the issuing price, the event triggering conversion, the conversion ratio as well as the legal set-up of the instrument. Instruments with inappropriate terms have the potential to destabilize institutions and markets in a crisis situation, rather than improving resilience. FINMA has therefore decided to follow the issuance of such instruments closely. In order to become recognized under the capital framework, FINMA has to approve the term sheets of the actual issues. Experience has shown that supervisory guidance on this matter facilitates finding an adequate balance between interests of the issuing bank, investors and supervisory objectives.
4.2.3 Write-off bonds

The Swiss policy proposal also includes write-off bonds (bonds with claims waiver).
These are deemed equivalent to CoCos, provided that their terms lead to equivalent positions of counterparties from an economic point of view which also means that the conditions triggering a write-down would be similar to those causing a conversion of CoCos. Write-down bonds would be recognized under the capital requirements framework to the extent that an actual write-down improves the capital ratio of a company. Consequently, in order to be recognized under the capital requirements regime, the terms of such prescriptions would have to be approved by FINMA. The concept of write-off bonds was primarily introduced to open up the possibility of enhancing capitalization by contingent instruments also for firms that are not stock companies and therefore cannot issue shares. This ensured that all firms can benefit from the introduction of contingent instruments into the capital requirements framework.
Box 3: Bail-ins
At international level, the concept of bail-ins has gained significant traction. Under a statutory bail-in regime, certain debt classes would be converted to equity triggered by a discretionary decision of the banks supervisor, while the bank is still a going concern.
The loss absorbing potential of equity would be effectively extended to debt and subsequently to the whole balance sheet without forcing the bank into bankruptcy.
In theory, the concept is elegant: it completely removes the possibility of a TBTF bank failure as it could employ bail-ins to sufficiently generate capital. In practice, however, the concept has several drawbacks.
Substantial parts of a banks debt would not be available for a bail-in. This especially holds true for big retail banks, which to a large extent refinance themselves by deposits (insured or uninsured).
In reality, debt holders would have to know from the beginning that their claims can be bailed in, resulting in an opt-in arrangement, such as the issuance of bail-in able bonds. Also, the concept of bail-ins comes with considerable legal challenges, as the inherent discrimination of certain debtor classes may be difficult to uphold. More convergence on international level in regard to key issues such as the definition of triggers, the point of non-viability as well as a common understanding on debt classes available for bail-in would have the potential to significantly enhance the viability of the bail-in concept in an international context.
Whereas at international level bail-ins seem to trigger only as a last line of defense, i.e. just before the bank stops fulfilling the statutory capital requirements and, in normal circumstances, would have to go into liquidation, the Swiss SIFI framework provides for a significant stake of low trigger CoCos at a level of 5% CET1.
These instruments will be also activated when there is reasonable concern that the bank is heading towards over-indebtedness, facing serious liquidity problems or does not fulfill its refinancing obligations anymore (equivalent with the point of non-viability).
As a result, the probability of a conversion of a bail-in able bond (via administrative write down or debt-to-equity swap) is only slightly higher than that of a normal bond of a bank without any bail-in arrangements.
Hence, the risk premium of a bail-in able bond may be rather small. While this outcome may be welcomed by companies and their shareholders, the incentive to reduce the size and risk of a companys business activities may be too little or non-existent. In addition, because bail-in proceedings are proposed for significant financial institutions only, smaller and mid-size firms may face a competitive disadvantage in favour of big and systemically important companies, effectively amplifying the TBTF issue rather than mitigating it. For all that, Switzerland has decided to include a bail-in mechanism in its Swiss SIFI framework in compliance with the international initiatives (e.g. FSB), but to stay, at the moment, with its definitions of the triggers and point of non-viability.
This decision may be reassessed in face of a possible international consensus and the future availability of a cross-border resolution framework.
4.3 Liquidity
The last financial crisis made it very clear that the existing liquidity requirements had substantial deficiencies. The Swiss regime did not take into account the special situation of large, complex and internationally active banking institutions. Today, the situation has changed. I n Switzerland, FINM A has tightened the liquidity requirements for big banks, applying stress scenarios modelled on the experiences of the recent crisis. The new requirements are already in force and banks are implementing them. The Swiss implementation is largely based on the Basel consultation paper of December 2009 and goes beyond that proposal in certain areas. Compared to the December 2009 proposition, the current Basel initiatives have been diluted. This will result in the Swiss SIFI liquidity regime significantly extending a future international consensus.
5 Improving resolvability reducing the impact of failure

Although the probability of failure of a SIFI is effectively reduced by the capital measures as described above, failure of a SIFI is still possible. Therefore arrangements should be in place whereby, if prevention fails, a SIFI can exit the market in a controlled manner. Contagion or damages to the financial system and the economy as a whole have to be reduced as much as possible. The best measure to reach this would be an internationally harmonized resolution and insolvency regime for SIFIs or banks in general.
However, chances of success in the near future are small. Either way, even such a resolution regime would not solve problems arising out of the interconnectedness of SIFIs and would therefore be only one element on the way to reducing the impact of failure.
5.1 Organizational requirements to support recovery and resolution

The last crisis has shown that the lack of preparedness of the private sector and authorities alike to dissolve SIFIs in crisis scenarios is a main driver of the TBTF issue. Hence, solutions are needed to manage operational and legal complexity of big banks in going concern as well as gone concern scenarios. This involves measures to improve recovery and resolution of a SIFI as well as a sound and effective framework for crisis management. The Swiss TBTF proposal is threefold. First, systemically important banks will be required to demonstrate their resolvability not only with regard to systemically important functions, but globally.
Second, the proposal does not only focus on the resolution phase but also considers effective recovery arrangements as equally important.
It is crucial that companies prepare and implement measures which are able to effectively stabilize banks in a crisis and avoid resolution scenarios to the greatest extent possible. Third, supervisory authorities acquire an explicit role in preparing recovery and resolution as well as its implementation.
If banks fall short of the supervisory requirements and expectations, FINMA has the power to order the implementation of measures improving resolvability.
5.1.1 Preconditions for effective resolution

The effectiveness of resolution procedures is subject to various preconditions which have to be implemented significantly before an actual resolution case has to be solved. First, there must be a viable legal framework for resolution of financial intermediaries in place on national level. Such a regime should not only provide the appropriate tools to authorities, but should also govern responsibilities ideally by designating a single resolution authority and thereby allowing for swift intervention without national coordination issues. Switzerland already has such a regime in place, not only for SIFIs, but for banks in general. Second, there has to be a better understanding of how national resolution regimes interact in a cross-border crisis scenario. While supervisors and resolution authorities may be able to mitigate such issues by entering into formal or informal agreements, they can only do so within their national frameworks. It is therefore important to understand the interplay of national regimes in a cross-border context and to set up appropriate pre- and in-crisis coordination procedures. For its SIFIs, the Swiss authorities have a long-standing tradition of cooperation with key jurisdictions.
These arrangements have recently been formalized within crisis management groups and supervisory colleges. However, actual resolvability is ultimately a characteristic of a single company operating under several defined legal frameworks. Hence and finally, firms have to prepare themselves to allow for their effective resolution in both systemic as well as idiosyncratic crisis scenarios with the ultimate objective being to protect systemically important functions. This involves the organization and legal set-up of the company, its governance and control processes, intra-group interdependencies regarding capital and liquidity as well as, ultimately, their position vis-vis their counterparties.
5.1.2 Preparing for recovery and resolution

The Swiss proposal requires banks to be organized at any time in a way that facilitates resolution in a crisis situation. The ultimate objective is to protect the narrowly defined systemically important functions of a SIFI, not the bank itself. SIFIs are expected to prepare their organizational, operational and structural set-up so that their specific recovery and resolution plan can be executed rapidly and effectively. While the Swiss proposal does not prescribe how to reach these objectives, SIFIs are required to demonstrate their recovery and resolution plans (RRPs) to the regulator in detail. The RRP process places the responsibility to define plans for recovery and resolution on the companies.
Current Swiss resolution framework for banks
Failures of domestic banks in the 1990s demonstrated the ineffectiveness of general bankruptcy procedures and tools to handle bank insolvency cases and eventually led to the development of a specialized resolution regime for banks. Effective since 2004, the regime has been applied successfully in several cases, including those in a cross-border context. FINMA as the sole bank resolution authority:
As a supervisory authority, FINMA has exclusive responsibility for bank bankruptcy and restructuring proceedings.
It has a wide range of tools at its disposal to enable it to take preventive measures when the requirements of prudent practice are not complied with, and to rectify existing irregularities. In the event of persistent capital inadequacy or liquidity problems, FINMA can take measures that may lead to restructuring or bankruptcy proceedings.
The fact that sole responsibility lies with FINMA ensures continuity and rapid action, as it knows the bank concerned and already has comprehensive information about it.
FINMA is also solely responsible for the entire bankruptcy and restructuring proceedings. It appoints and oversees the liquidators or those entrusted with restructuring. If necessary, it can also become involved in the liquidation itself. Early intervention: FINMA can step in as soon as a bank is unable to comply with the capital adequacy requirements for an extended period or experiences
liquidity problems, or if there are other indications of impending insolvency. No formal evidence of over-indebtedness or inability to meet payment obligations is required before restructuring or liquidation proceedings are initiated. Tailor-made solutions: The individual measures can be tailored to the situation at hand, and can be implemented either individually or jointly in restructuring or bankruptcy proceedings. They do not have to be carried out in a particular order. The initiation of restructuring proceedings does not necessarily require a moratorium. As long as the interests of its creditors are safeguarded, the bank can remain in business. Moreover, the measures do not need to be made public unless they directly affect the rights of third parties. Restructuring as an alternative to liquidation: If there is a realistic prospect of success, FINMA can carry out a restructuring plan. Decisions taken in restructuring that fall within the powers of the annual general meeting, such as capital increases, do not require the agreement of the shareholders. The aim of these provisions is to speed up the restructuring proceedings. Only the creditors may reject a restructuring plan, and then only if they represent more than half of the non-privileged claims.
In this case, FINM A will order the banks liquidation (bank bankruptcy).
Recognition of foreign insolvency measures: If a foreign authority takes measures concerning a foreign bank or securities dealer with a branch or assets in Switzerland, FIN MA is responsible for recognising those measures. Once the claims of those creditors whose claims are protected and privileged under Swiss law have been satisfied, the proceeds of the liquidation of assets located in Switzerland are turned over to the foreign proceedings. Equal treatment of Swiss and foreign creditors: All creditors of the bank and of its foreign branches are entitled to participate in the bank bankruptcy proceedings initiated in Switzerland, and are to be accorded the same privileges. They must, however, allow any sums they have received in foreign proceedings against the bank or its assets to be offset against their entitlement in Switzerland.
5.1.3 Evaluating resolvability

FINMA will develop criteria on how to assess the viability of recovery and resolution plans. While the details will be defined by a future revision of the Banking Ordinance, FINM A has already come up with a catalogue of criteria to be implemented with a scorecard approach. This will also enable the construction of a Resolution Effectiveness Test (RET) as an objective and transparent benchmark.
The assessment of a companys resolvability will drive two supervisory decisions: First, the Swiss framework will define a minimum standard every Swiss SIFI has to fulfil. If a company falls short of these expectations, FINMA will have the power to intervene and order the implementation of measures which will bring the company on par with the minimum requirements. Second, if banks demonstrates that they have significantly increased their resolvability in excess of the minimum requirements, they may be eligible for a capital rebate on the systemic surcharge.
Such a rebate would be subject to strict conditions.

Banks would have to prove that they have implemented comprehensive and effective measures to facilitate resolvability and to limit the impact of failure for all of their business activities at a domestic and international level. Specifically, limiting the impact on systemically important functions alone would not qualify for a rebate. A SIFIs RRP may favour systemically important functions and discriminate other SIFI stakeholders in Switzerland and abroad. This is deemed acceptable to protect the overall economy. However, the RRP plan is not isolated, but has to be seen within the context of the significantly extended capital requirements. These reduce the probability of failure and, therefore, shrink the potential of discrimination. Also, equal treatment and adequate capitalization in a global perspective, i.e. of all parts of a company even in a resolution scenario, will be considered as an element of the resolution effectiveness
assessment.
Box 5: Bank levies and resolution funds deemed ineffective

For implementation of the emergency plan in crisis situations, banks can draw on the capital held as a systemic surcharge. Just protecting systemically important functions keeps the capital intensity of a resolution plan reasonably low which in turn allows regulators to require banks to hold the necessary capital on their own in the form of a systemic surcharge. Under this arrangement, system-wide resolution funds are considered neither necessary nor efficient. Having analyzed these ideas, it is believed that in an acceptable time frame funds may never be of a size to cope with systemic crises. Requiring banks to build up capital for contingency measures on their own balance sheet also reduces moral hazard.
5.2 Minimum diversification to reduce concentration risk

Having few big banks may lead to risk concentration and a single point of failure in the financial system, as smaller and mid-size market participants may become dependent on the services of SIFIs and prone to contagion. Hence, diversification improves financial stability and reduces the TBTF issue. Consistent with the new EU-regulation Switzerland will improve the existing regulation of limits on risk concentration between banks by imposing per counterparty limits on interbank exposures whereby the risk weight of exceeding exposures is increased.
However, the new risk concentration limits affect all banks and not merely SIFIs. Further measures are to be developed to reduce interconnectedness. Operational interconnectedness has to be considered as well, as many smaller banks have outsourced operations to SIFIs or access the financial infrastructure through them.
Box 6: No restrictions on business activities

Volcker Rule - like restrictions are not being proposed. Narrowly defined restrictions have the potential to crowd out business activities into other market segments, eventually building up systemically important risks beyond the scope of financial market regulation and supervision. Therefore, having banks conducting such activities in a controlled manner and in observance of appropriate capital requirements is favoured. Companies will be able to continue such operations, provided they are able to fulfil the corresponding capital requirements and that the impact and consequences of such activities are considered in the recovery and resolution planning process.
6 Additional measures 6.1 Leverage ratio

All capital components (baseline requirement, buffer, systemic surcharge) are defined in reference to risk-weighted assets and are therefore directly dependent on the valuation and risk assessment of the exposure.
In order to put a backstop on the expansion of a companys balance sheet and to mitigate deficiencies in the risk assessment models, a risk- neutral measure should supplement the risk-based capital requirements.
Switzerland implemented a leverage ratio as a risk-neutral backstop measure back in 2008.

As part of the SIFI policy, the leverage measure will have to be redefined based on the Basel I I I leverage ratio definition. Independently from challenges resulting from the accounting methodology and the termination of exceptional measures to the national economy, recalibration has to take into account the systemic importance of the banks concerned. The new calibration criteria are supposed to include the size of the bank by imposing progressive requirements.
6.2 Intense supervision and international cooperation

Intense supervision of SIFIs is important in all phases of the economic cycle as is international coordination. The Swiss supervisor has implemented a risk-based approach for deciding on the intensity of supervision. By definition, SIFIs belong to the most intensely supervised companies. Given the international exposure of SIFIs, Switzerland will continue to work closely with host supervisors of those countries where Swiss SIFIs have a substantial market position. This cooperation has already been formally established within supervisory colleges.
In addition to these colleges which deal with day-to-day supervisory issues, crisis management colleges have been created to discuss, improve and assess recovery and resolution preparations of a SIFI in an international scope.
7 Conclusion
The Swiss SIFI policy framework describes a diverse policy mix of preventive and curative measures.
Increased capital requirements strengthen the solvency of SIFIs and their loss-bearing capacity, while at the same time providing incentives to reduce systemic importance.
If prevention fails, capital instruments, which are already available on the banks balance sheet, can be used to restructure the company and to protect a narrow set of systemically important functions. Organizational requirements mitigate the current lack of effective resolution frameworks at least to a certain extent. Completed by improved risk concentration limits and liquidity requirements, the Swiss SIFI proposal reduces contagion risk and improves preparation for effective crisis management. Today, however, financial stability is a global issue which cannot be tackled by one country alone, particularly in the case of globally operating banks. It is therefore essential that the international initiatives continue and eventually come up with an effective framework for SIFIs.
Introduction
Last year, the UK financial services industry faced regulatory change on a sweeping scale. At the national level the last UK government introduced the Financial Services Act 2010, which resulted in a number of changes to our objectives, powers and duties, in particular giving us a new financial stability objective and additional enforcement powers. In June 2010, the current UK coalition government announced that the FSA will be split up. The prudential supervision of banks and insurers will be moved to a new operationally independent subsidiary of the Bank of England: the Prudential Regulation Authority (PRA). The FSA will be renamed the Financial Conduct Authority (FCA) and will focus on consumer protection and markets oversight. The government also established a new committee of the Bank of England with responsibility for delivering financial stability: the Financial Policy Committee (FPC).
The European Union (EU), meanwhile, created three pan-European agencies to address the risk of regulatory arbitrage and improve the quality of national supervision of banks, securities markets and the insurance industry. The EU also created a new advisory body, the European Systemic Risk Board (ESRB), to identify systemic risks and make recommendations for mitigating them. Europes new regulatory architecture became operational in January 2011 and will fundamentally change the way in which national supervisory authorities operate. A significant majority of regulatory requirements will be determined solely at the EU level and national supervisors will play a key role in negotiating and agreeing these, but their role as decision makers will centre on their function as supervisors of firms and markets.
The Financial Services Act 2010

The Financial Services Act 2010 (the Act), which received royal assent on 8 April 2010, resulted in a number of changes:
Consumer protection
The Act removed the FSAs public awareness objective and required us to set up an independent body to take forward consumer education work. The Act also provides for more funding to be made available for consumer education work. The Act gave us additional powers for the FSA to require consumer redress. This allows us to make sure that consumers receive redress in cases involving large-scale consumer mis-selling or other failures.
Financial stability
The Act gave us a new financial stability objective to contribute to protecting and enhancing UK financial stability. We are required to cooperate appropriately with the Treasury, the Bank of England and other relevant bodies in pursuing this objective. The Act requires us to have and keep under review a financial stability strategy. It enables us to gather information from entities, including unregulated entities for financial stability purposes. It also requires us to consider the impact that international events and circumstances could have on financial stability in the UK.
Enhanced powers
The Act extends the scope of our key regulatory powers to make rules and to alter authorised firms regulatory permissions, so we may use the powers in pursuit of any of our regulatory objectives, including the new financial stability objective.
We have new rule-making powers for: Remuneration: we now have the power to specify that remuneration agreements in breach of our rules are void; Recovery and resolution plans; Short selling; and Consumer redress schemes. We have new enforcement powers to:
restrict or suspend the carrying on of regulated activities for up to 12 months; suspend or impose restrictions on an approved person for up to two years; impose a financial penalty at the same time as cancelling a firms permission; penalise any person who performs a controlled function4 without approval; and issue a warning notice against an individual three years from the time we first became aware of the misconduct (increased from two years).
Financial Services Compensation Scheme (FSCS)

The Act contains provisions that will enable the FSCS to act as a single point of contact and to pay redress to consumers where redress is due to them under other schemes, such as schemes established outside the UK.
UK regulatory reform
Over the past nine months, the FSA has begun the process of aligning the organisation to ensure it is ready to cut over to the new regulatory structure. As a result, we incurred approximately 1m of direct costs last financial year: Programme management support 0.33m; Regulatory design 0.10m; I T design 0.33m; and
Other (e.g. H R and other central functions) 0.24m. Shortly after the end of our financial year in April 2011, we replaced our Risk and Supervision business units with two new ones: the Conduct Business Unit, which broadly aligns with the regulatory activities to be undertaken by the FCA, other than enforcement; and the Prudential Business Unit, which broadly aligns with the regulatory activities of the PRA, other than enforcement. Central services will continue for the lifetime of the FSA to be structured on an unitary basis. We are confident that our programme remains on track and further progress will be made during 2011/ 12.
A new European supervisory structure European Supervisory Authorities (ESAs) and the European Systemic Risk Board (ESRB)
The creation of ESRB and the three new ESAs marks a significant change to the way in which financial services regulation will be developed and delivered across Europe. The ESRB will undertake macro-prudential analysis at EU level to identify risks to EU financial stability and will make recommendations to address these risks.
European Supervisory Authorities (ESAs)

The ESAs became operational in January 2011. They are: The European Banking Authority (EBA); The European I nsurance and Occupational Pensions Authority (EIOPA); and The European Securities and Markets Authority (ESMA).
They replace: The Committee of European Banking Supervisors (CEBS);
The Committee of European I nsurance and Occupational Pensions Supervisors (CEIOPS); and
The Committee of European Securities Regulators (CESR). The ESAs are responsible for developing a large proportion of the rules that apply to the financial services sector in the UK. These will be issued as EU regulations, so will be directly applicable across the EU. As well as developing binding rules, the ESAs have powers to: impose a temporary ban on financial activities; investigate alleged breaches of EU rules; take binding decisions in emergencies; arbitrate in disputes between national supervisors;
play a coordinating role within colleges of supervisors;

undertake peer review; directly supervise credit rating agencies (ESMA only); and require information to be passed to them that is necessary for discharging their responsibilities. In 2010/11, we devoted significant resource during the negotiation of the ESA legislation to ensure that the ESA package as a whole secured the key objectives of:
protecting the single market; addressing the risks arising from regulatory arbitrage;
raising standards of supervision among national supervisors; while

retaining responsibility for day-to-day supervision at the national level. Once the ESA legislative package was agreed in the Autumn of 2010, our focus shifted to preparing for the new European order. During 2010/11, we: influenced the ESAs regulatory framework and operating model; adapted our operating model to work effectively with the ESAs; enhanced our secondments strategy and identified training requirements; and developed systems to handle ESA data requests.
Financial stability Introduction

During 2010/ 1 1 the FSAs mandate was significantly extended. From April 2010, we were given a new statutory objective, which made more explicit the responsibilities for promoting financial stability that we had been exercising under the market confidence objective mandated under FSMA. At the same time, our supervisory approach continued to progress toward intensive supervision and proactive challenge, laying the groundwork for the preventative interaction framework that will guide the PRA.
We continued to embed the organisational and cultural change needed to implement intensive supervision, moving our regulatory approach from retrospective intervention to proactive challenge.
Our supervisors made judgements on firms business models; intervening early if they anticipated any risks that might arise from firms business strategies and approaches to funding and capital.
This approach has demanded quality staff, industry knowledge and the will to challenge the industry robustly where potential threats were identified. We contributed significantly to the development of a robust policy reform programme, driven by the initiatives and issues identified in The Turner Review and the wider policy agenda mandated by the EU. And the FSA continued to play a leading role in influencing regulatory reform on the global stage, while ensuring that the UK arrangements on, for example, key issues of capital and liquidity were consistent with the direction of international standards. This section describes the work we accomplished in these areas, under these headings: The Financial Services Act our new financial stability objective; FSA supervision a major intensification of approach; Progress on reforming the international and European regulatory framework policy and practice; and Specific measures to strengthen firms resilience. We also include the principal metrics we use to assess our supervisory effectiveness in relation to our financial stability objective and to gauge financial stability generally.
These are:
Supervisory effectiveness
Chart 1: Supervisory issues closed
Chart 2: Firm feedback on the quality of FSA supervisory risk assessments
Measures of financial stability

Chart 3: Cost of credit Chart 4: FSA firm cancellations Chart 5: Major UK banks CDS spreads, five-year senior debt
A central tool in supervision is identifying the risk mitigation actions firms must take. Looking at the quantity identified and speed which with these are closed gives a perspective on the intensity and effectiveness of our supervision. The number of issues closed in Q4 2010 /1 1 is 439 (from 303 in Q3 2010/1 1); this represents 17% (12% in Q3 2010/11) of the population of open issues. This shows an absolute and proportional increase in the number of issues closed than previously reported. The proportion of high-risk issues closed was slightly higher than other issues at 18%, reflecting us prioritising issues with the most risk. Also, about 40% of the issues (recorded and closed) were in respect of high-impact firms, reflecting the enhanced focus of our risk assessment and mitigation work on these firms.
From our regulated firms perspective, the quality of our risk assessment in the last six months has reduced slightly from 5.2 down to 4.9, with the
most significant reductions in our Major Retail Groups Division and Retail Division. Risk mitigation is scored more positively at 5.3, but again this represents a fall against the 5.6 recorded for the six months to June. However, scores remain positive in the context of a 1-7 scoring system, where 4 is neutral. The deterioration may have been driven by the amount and pace of regulatory change, which has continued to put pressure on both sides of the firm-supervisory relationship.
The current cost of interbank borrowing (measured by the Libor-OIS spread) in a context and relative to the extremes of 2008 is not excessive.
However, spreads have recently entered a slightly more volatile period, driven by movement in the OIS swap rate. In part, this reflects uncertainty about the short-term outlook for the bank rate, amid persistent above target inflation and variable information about the performance of the economy.
This chart shows the number of authorised firms this year that have cancelled their authorisation with the FSA. Not all cancellations are necessarily failures and not all failures are regulatory failures.
Nevertheless, this chart gives some indication of the level of distress in the system. During 2010/ 1 1, there was a significant reduction in the cancellation rate among significant impact firms.
UK banks credit default swaps (CDS) spreads are a measure of how investors perceive the default risk posed by these firms. UK banks CDS spreads rose in November, as the I rish sovereign crisis pushed up CDS spreads for Eurozone sovereigns. Spreads for some of the banks fell back after the EU and I MF bailout was announced. HSBC and Standard Chartered have seen swap rates rise in early 2011 due to concerns in the aftermath of the Japanese earthquake.
Nevertheless, using absolute CDS as an indicator, they remain the banks with the lowest perceived credit risk, driven in part by their strength in emerging market economies.
Solvency I I
As we said in our Business Plan for 2010/1 1, Solvency I I is a fundamental change of the prudential regime for the European insurance industry. It aims to establish a revised set of EU-wide risk management standards and capital requirements that will replace and harmonise the current arrangements. Policy in this area continues to be developed in Europe. There have been delays to the timeline that have affected our own consultation and shortened the window for implementation. As a result, we are looking for ways to manage this uncertainty. At the same time, we have continued to contribute to the development of the Directive, such as through our involvement in the work of European Insurance and Occupational Pensions Authority (EIOPA). We continue to lead some of the working groups, and Hector Sants was appointed to the EIOPA Management Board in January 2011.
Our work with the UK industry

We have maintained close contact with the UK insurance industry on both policy and implementation issues. We continued in 2010 to engage with firms to understand how the developing requirements affect them and inform our contributions to EIOPA.
We also had ongoing discussions with firms about how prepared they are for the new regime. The fifth quantitative impact study (QIS5) helped us increase our dialogue with firms on both fronts. We gave briefings and ran workshops to educate firms about the importance of taking part in QIS5. We encouraged firms of all sizes and types to participate in the exercise to provide a robust evidence base to inform the ongoing development of the Solvency I I landscape. During the exercise, we answered over 600 queries, and the UK report to EIOPA was compiled with submissions from 267 solo firms and 35 groups, representing over 70% of the market. We also had discussions with firms about the practical implications for them and we will continue to do so in the run up to implementation. We have continued to make progress with the internal model approval process (IM AP). We published an update in April 2010 setting out the pre-application process for firms, and the findings of the thematic review in February 2011. At the end of March 2011, started the next phase of IM AP as we endeavour to give as many firms as possible a decision on their model for day one. We further detailed our approach at our Solvency I I Conference in April 2011 more information about this is available on the dedicated Solvency I I pages of the FSA website. As stated above, we had started to prepare our consultations; however, the publication of the Omnibus I I proposals to amend the Solvency I I
Directive to bring it in line with the new European regulatory structure and allow for transitional provisions has meant that our consultation timetable has been affected.
Our consultation process will relate to the transposition of the level 1 text of the Directive and consequential changes to the Handbook.
We expect to publish the first Consultation Paper later this year. We will review the European policy timelines regularly, and publish our own consultation timeline on our website in due course. Internally, we developed and delivered technical training for supervisors and other specialists working on Solvency I I. At the end of March, we had trained over 450 people. To deliver Solvency I I we have increased our resources significantly, with recruitment ongoing to provide the skills and processes to support and deliver the implementation of the Directive. Most recently, we shared our current thinking on the policy issues and implementation approach, with approximately 550 people from the UK insurance industry at our Solvency I I Conference on 18 April 2011. We outlined our two-tier approach to the way we would allocate resources to firms in the pre-application phase of IM AP. We discussed the main policy uncertainties, which we also set out in the accompanying conference document Delivering Solvency I I, April 2011. We outlined the key dates, including our assumptions that full implementation will be on 1 January 2013, and that we would be open to receive applications on the provisions of the Directive that require our approval.
We underlined the importance of the UK industrys continued involvement in developing the approach to implementation in Europe and the UK.
We will do this through a number of different fora, including the existing Insurance Standing Group and its sub-groups, which has over 100 people registered to receive information.
We will also create new ones as needed. We published an overall update on Solvency I I in June 2010 on all pillars of the Directive to inform and motivate firms to take action as needed. We have tailored our information for smaller insurers through our events and our website, including things for firms to consider when creating their implementation plans. We also gave briefings to market analysts and ratings agencies (February 2011), and to non-executive directors of insurance and reinsurance firms (January and April 2011) as part of our educational programme. 2011/ 12 is critical in our preparations for implementing Solvency I I , in Europe and the UK. We are confident that our implementation approach will help us deliver our Solvency I I programme and carry out our obligations fully.
Interview with Gabriel Bernardino, Chairman of EIOPA, conducted by Jan Wagner, Versicherungsmagazin (Germany)
The EUs new regulatory regime for insurers, known as Solvency I I, will take effect from 2014. Although hailed by EU regulators as an innovation, the regime has come under sharp criticism from smaller insurers, including several in Germany. They complain that the scheme favors bigger insurers who have the resources to easily adjust to the new regime. Wrong says Gabriel Bernardino, who as chairman of the EU insurance and pension regulator EIOPA will be Solvency I I s chief enforcer. Versicherungsmagazin spoke to him at length.
Why is Solvency I I needed? Has not Solvency I ensured for a well (functioning insurance industry? I know of no cases in Germany where the insured lost their money when an insurer went under.
The idea was never that Solvency I I would fix the market because Solvency I failed, or because insurers needed more capital. The idea was rather a move toward a risk_based system. The problem is that there is misallocation of capital among companies.
Some have more capital than they need, and some have less. This has negative consequences for protection and pricing.
To illustrate this, let us take two insurance firms with the same liabilities but two different investment strategies. One is based on shares and the other is based on bonds. From a market perspective, you would conclude that the firm with a share driven strategy would need to hold more capital than the one with a bond driven one. But the current regime doesnt require this! The risks on the asset side are not taken into account, and thats what Solvency I I aims to resolve.
Are European insurers prepared for the transition to Solvency II?

When Solvency I I begins in 2014, there will be no Big Bang. Thats because some of its elements are already in the system. In Germany for example, incentives for better risk management and governance are embedded in MaRisk, which is already in force. The objective is not to force insurers to have more capital. I t is rather to have capital better aligned with the risks. You will have companies that have more capital than they need under a risk based system and others that do have less than they need. For those who have less, its fair to ask them to raise more capital. But even in the latter situation, Solvency I I is accommodating. You dont need to apply it immediately from 2014, so you have time to raise the capital you need.
Another example is the life business where a transition period applies to

calculations of the liabilities according to Solvency I I .
Isnt it true though that big listed insurers have an advantage over mutuals, as they will be able to raise the capital they need under Solvency I I more easily?
If you look at mutuals around Europe, they collectively have much more capital than public companies. I therefore dont think Solvency I I will be a big burden for them. Moreover: If they can demonstrate to the regulator that they effectively manage the risks on their investments, they may deviate from the standard model with its set of risk charges and use an internal one which is more flexible.
So smaller insurers have nothing to fear from Solvency I I ?

I m not saying that the introduction of Solvency I I will have no effect on the market. Something like this always does. One possible consequence of Solvency I I is that there will be some concentration in certain markets. But were seeing this already!
Some insurers complain that Solvency I I will compel them to invest in safe, but low yielding instruments like bonds, as they carry no risk charge.
Clearly thats not what we have seen and thats not what we will see. The US asset manager Black Rock did a survey some months ago in which it asked European insurers what asset classes they would target even under Solvency I I.
They replied that they would invest more in alternative investments like hedge funds, venture capital and project finance. And why? In a low interest rate environment insurers have to find ways of boosting returns.
No one is saying that with Solvency I I you have to invest more in this or that asset class.
Were merely saying that if you have more risk, you should have more capital.
Given the European debt crisis, does it still make sense to require no risk charge for sovereign bonds. Greek bonds can hardly be considered safe instruments
Although there is a zero risk charge for sovereign bonds, Solvency I I deals with the specificity of the various asset classes in that market valuations are used.
This is different than in the banking sector. If sovereign debt in the portfolios of insurers were to be assessed under Solvency I I , it would need to be rated according to the risk that the markets perceive nowadays. And that perception has definitely changed with the debt crisis, no question. So if say German Bunds decrease in value, this is immediately reflected on the portfolios of the insurers, and this is the figure you take into account in order to calculate the difference between your assets and liabilities.
If therefore an insurer has a 100 percent solvency requirement, but the markets penalize some bonds on the portfolio, then the assets diminish value and your solvency diminishes.
So you see, Solvency I I does take the risk associated with sovereign bonds into account.
For assets which are more volatile like shares and real estate, a further risk charge applies.
Will the reporting requirements under Solvency I I be a burden for smaller insurers?
The requirements are harmonized around Europe, so this makes things easier for cross border companies. But this is also good for medium sized ones with business in two or three countries. Having one system of reporting provides a huge cost benefit for all insurers doing cross border business. The idea is to bring more commonality to supervision. Secondly, weve got the principle of proportionality applied to the ultimate extent. There will be of course more complexity for those insurers who are invested in say structured products or use derivatives. But if you dont invest in these kinds of instruments your reporting will be less complex. There will be annual reporting, which is more comprehensive, as well as quarterly reporting on the most important elements.
But for smaller companies whose risk profile doesnt really change, the regulators have the option of waiving the quarterly reporting requirement.
Will Solvency I I be applied to pension funds?

As I have always said, this is not a copy_paste exercise. There are elements of Solvency I I that make lots of sense for pension funds, such as governance, transparency and risk management. These are known as the second and third pillars of Solvency I I. In terms of the capital requirements, or the first pillar of the regime, we concluded that there is great diversity among pension plans in Europe. There are plans that are basically insurance type contracts, and in those you should have a regime like Solvency I I. But there are also employer sponsored plans where the risk is not transferred to the insured. This is a different type of system than the insurance type, and it makes little sense to apply exactly the same capital requirements.
Hearing on the ESRB before the Committee on Economic and Monetary Affairs of the European Parliament
Introductory statement by Mario Draghi, Chair of the ESRB Brussels, 31 May 2012 Dear Madam Chair, Dear Honourable Members,
I am very pleased to appear before this Committee today to present the first annual report on the activities of the European Systemic Risk Board (ESRB) of which you have all received a copy and which is being published as I speak.
In my remarks today , I will refrain from repeating the content of the report and will instead focus on three key areas of the ESRBs work over the past year, which will also keep us busy for the foreseeable future. These are: i)The assessment of systemic risks; ii)The establishment of a sound macro-prudential framework in the EU; and iii)Medium-term structural developments in the EU financial system. I will then be at your disposal for questions.
1. Assessment of systemic risks in the EU financial system

It is less than a year since the ESRB cautioned that the risks to the EU financial system had become systemic.
After a period of stabilisation on the back of actions by central banks and other institutions earlier this year, more recently there have been renewed bouts of volatility and uncertainty, although not at the same levels reached in November 2011. Fundamental challenges persist. I n my view, these include: i)Limiting contagion between Member States across the EU; and ii)Promoting a macroeconomic strategy that, together with fiscal consolidation, supports growth and furthers the competiveness adjustments needed to tackle the economic imbalances within the EU. Addressing these challenges in a decisive and sustainable manner is a prerequisite for the success of measures to ensure a more resilient financial system capable of supplying, on a sustainable basis, the financial services necessary to support economic activity. From a macro-prudential point of view, such measures include: i)Implementing credible mechanisms for the recapitalisation and restructuring of banks, where needed; and ii)Improving banking supervision and resolution at the European level. In the past, the ESRB has underlined the need for all national and European authorities to act, and to do so in unison, with speed, ambition and a total commitment to safeguard financial stability. Today, I reiterate this call, while acknowledging the efforts undertaken so far. Within the broader economic and financial context, the financial system continues to face the challenge of adjustment in order to address imbalances accumulated in the past.
For banks, progress has already been made on some fronts, but more is needed. For other financial sectors, it is important that international and EU reforms, designed to improve their resilience, are fully implemented and adhered to an issue that I will return to later. The ESRB is concerned with two aspects of banks adjustment. First, it should be carried out in an orderly way to support economic growth to the full extent necessary, without exacerbating market fragility and the positions of others in the financial system. Second, the degree of adjustment planned by the EU banking sector over the coming years must be sufficient to restore confidence in the strength of banks balance sheets. With regard to the first point, official data and surveys from many countries across the EU indicate some overall stabilisation in financial conditions in the early part of this year. However, the recent turbulence highlights the uncertainty surrounding the outlook for these financial conditions, given their link to the soundness of EU banks balance sheets and, in turn, the direct or indirect connections between those balance sheets and sovereign vulnerabilities. Concerning the second point, close monitoring and a systemic assessment of the feasibility and nature of the adjustment by banks, as well as within the financial system more broadly, is crucial. In this regard, the ESRB has called upon its partners within the European System of Financial Supervision supervisory authorities at the national and EU level to regularly collect detailed, ex ante information from banks and other key players in the system, and report it to the ESRB. The General Board will review the latest developments and their implications at its meeting in June.
2. A sound macro-prudential framework for the EU

Let me now turn to the work undertaken to establish a framework capable of addressing the deficiencies of the pre-crisis framework in preventing and mitigating systemic risks in the EU. While the launch of the ESRB was a first, and necessary, step in this respect, it is vital to develop a sound and comprehensive macroprudential framework for both the EU as a whole and the individual Member States. As indicated in the Annual Report, this has been one of the ESRBs priorities since its inception. First, in order to create a solid foundation for pre-emptive action against systemic risks, it is essential to develop macro-prudential mandates and tools. In its recommendation published in January, the ESRB highlighted the need for well-defined macro-prudential mandates for national authorities to act either on their own initiative, or in response to the ESRBs advice. In accordance with the ESRBs duty to follow up on its recommendations, the first reports from the Member States outlining their progress thus far are expected by the end of June under the ESRBs comply or explain mechanism. A key lesson from the past is that financial or systemic stability mandates must be accompanied by the means to act. Macro-prudential authorities will need to be equipped with effective policy tools to respond, in a pre-emptive way, to the complex and everchanging variety of systemic risks. The ESRB is currently working on identifying the minimum set of tools necessary for conducting macro-prudential policies throughout the EU.
Second, it is crucial to ensure that macro-prudential issues are taken into consideration when developing EU legislation for the financial sector, given the impact that such regulations could have on incentives within the financial system.
In this regard, I would like to touch on a number of important pieces of EU legislation that the ESRB has been following: i)A draft directive and regulation on capital requirements for credit institutions (the CRD/ CRR);
ii)The proposal for a regulation on OTC derivatives, central counterparties and trade repositories (E M IR ); and
iii)The part of the proposal for the Omnibus I I directive that concerns the regulation of the insurance sector. With regard to the CRD/ CRR, I very much welcome the recent progress made by this Committee, as well as by the EU Council, on advancing the proposals put forth by the Commission less than a year ago.
Your work together with the Council provides a promising basis for the establishment of important macro-prudential instruments for addressing systemic risks in the banking sector.
To assist you, and the Council, in your work on the CRD/ CRR, the ESRB wrote to you in March outlining a number of macro-prudential principles. I urge you to consider these principles in order to ensure that macroprudential authorities, at both the EU and national level, are fully equipped with a flexible set of policy tools and sufficient scope to act early and effectively to prevent the build-up of systemic risks in the future.
Obviously, discretion to pursue macro-prudential policies requires efficient coordination as a safeguard against potential negative externalities or unintended consequences.
The ESRB is ready to play a central role in this respect, and work is under way to establish a general framework for the coordination of national macro-prudential policies by the ESRB, where such policies give rise to material spillovers across borders.
The agreement on EM IR was also an important step forward in implementing lessons from the crisis, and it includes a number of useful elements to safeguard financial stability in the EU. The ESRB has started preparations for performing the tasks assigned to it under EM IR. From a macro-prudential perspective, however, I should point out that, in the view of the ESRB, EM IR does not address the issues raised by the possible pro-cyclical effects of either easing or tightening of collateral eligibility and of requirements for transactions subject to central counterparty clearing. In accordance with its responsibilities, the ESRB continues to examine whether and how collateral requirements could be applied as a macroprudential tool at a later stage.
The new regulatory framework for insurance activities is currently being finalised.
Some important aspects of this framework such as those related to the treatment of long-term guarantees are being discussed over the next few days as part of the Omnibus I I trialogue discussions, in which this Committee is actively involved. The ESRB is aware that several of the issues at stake are potentially relevant from a macro-prudential point of view.
In particular, the new regulatory framework (Solvency I I ) may amplify the procyclicality of insurers balance sheets and, in particular, capital levels.
This has been recognised by the legislator, which is designing several policy instruments (including some of a macro-prudential nature) to mitigate procyclicality and other factors.
It is crucial that such instruments are designed to deliver a clear and credible objective and that their interaction is duly considered to ensure that the use of these instruments has the intended effect.
3. Structural developments in the EU financial system

Finally, I would like to highlight some medium-term, structural developments that the ESRB is currently looking at, with a view to gaining a better understanding of their implications for systemic risk and to identifying appropriate policy responses for delivering a more resilient financial system.
The ESRB is devoting particular attention to structural aspects of both the traditional banking sector and the shadow banking sector. Before commenting on developments in these sectors, I would like to briefly say a few words on the whole financial system, which is currently undergoing a regulatory reform in all its segments. An important goal of such reforms is to ensure a sustainable supply of financial services from the system to the rest of the economy. In Europe, the financial sector has traditionally been centred around banks. However, some activities may shift to other maybe less regulated parts of the system in the years to come, perhaps as a direct consequence of the current crisis or as a result of the overhaul of standards for regulated activities and entities.
While such developments can, in principle, be of benefit to the system, they must be monitored closely in order to limit the emergence of new vulnerabilities, for example those stemming from shifts driven by regulatory arbitrage. Turning to the banking sector, the onset of the financial crisis revealed significant shortcomings in banks funding structures part of the necessary adjustment I referred to earlier involves a transition to more sustainable funding structures.
However, banks ability to manage this adjustment is being hampered by conditions in European interbank and unsecured credit markets.
As a result, there has been a rise in banks recourse to secured funding markets and innovative funding instruments. The ESRB is analysing these shifts in funding behaviour carefully from a macro-prudential perspective, to ensure that unintended consequences or new systemic vulnerabilities associated with such behaviour do not go undetected. The increased reliance on secured funding raises concerns about the extent to which banks assets become encumbered. If taken too far, insufficient amounts of unencumbered bank assets in the future could reduce the stability of funding within the system and, in a self-fulfilling manner, reinforce the lack of access to private unsecured markets today. Furthermore, innovative sources of private funding for banks such as liquidity swaps between banks and other parts of the financial system could have implications for the level of interconnectedness in the system, as well as the durability of funding during future downturns or stress periods. Turning to the shadow banking sector, the instabilities that can arise from a highly interconnected system were exposed by the financial crisis.
Shadow banking activities were a major contributor to that interconnectedness, in particular given the interlinkages between the regular banking sector and the complex, and opaque chains of financial intermediation that emerged within the system. They also, directly and indirectly, helped to facilitate the substantial rises in leverage in some economies. As indicated in the Annual Report, the ESRB has already begun work in this area. This has involved, for example, identifying and assessing potential systemic risks associated with European money market funds, on which a report is soon to be published as an ESRB Occasional Paper. The ESRB is also finalising its reply to the consultation launched by the European Commission through its Green Paper on Shadow Banking, which was published earlier this year. Looking ahead, from a policy perspective, measures to tackle systemic risks associated with the shadow banking system will need to be tailored to the specific risks stemming from the different activities conducted under the shadow banking umbrella. It is important that horizontal focus be placed on the economic nature of financial activities, i.e. on ensuring that activities carried out within the system, and which involve maturity and liquidity mismatches, leverage and/ or incomplete risk transfer, fulfil the appropriate prudential requirements, irrespective of where they are carried out or by whom. Finally, it will be important to ensure global consistency and therefore the full and consistent transposition in the EU of policy initiatives agreed at the international level, notably those due to be announced by the Financial Stability Board. In this regard, the ESRB stands ready to work together with the relevant international and EU institutions and bodies.
*** Let me now conclude by stressing that all the ESRB activities that I have presented here today have been carried out with the full involvement and support of all ESRB member institutions and bodies notably the Advisory Scientific Committee and Advisory Technical Committee and in close cooperation with the three European Supervisory Authorities. For this we are grateful and look forward to a continued fruitful cooperation in the future. Thank you very much for your attention. I am now at your disposal for questions.
Course Title Certified Solvency ii Professional (CSiiP): Preparing for the Solvency ii Directive of the EU (3 days)
Objectives: This course has been designed to provide with the knowledge and skills needed to understand and support compliance with the Solvency ii Directive of the European Union.
Target Audience: This course is intended for decision makers, managers, professionals and consultants that:
A.Work in I nsurance or Reinsurance firms of EEA countries. B.Work in Groups - Financial Conglomerates (FC), Financial H olding Companies (FHC), Mixed Financial Holding Companies (MFHC), Insurance Holding Companies (IH C) - providing insurance and/ or reinsurance services in the EEA, whose parent is located in a country of the EEA. C.Want to understand the challenges and the opportunities after the Solvency ii Directive. This course is highly recommended for supervisors of EEA countries that want to understand how countries see Solvency I I as a Competitive Advantage. This course is also recommended for all decision makers, managers, professionals and consultants of insurance and/ or reinsurance firms involved in risk and compliance management. About the Course INT RODUCTION The European Unions Legislative Process
Directives and Regulations The Financial Services Action Plan (FSAP) of the EU Extraterritorial Application of European Law Extraterritorial Application of the Solvency I I Directive Solvency ii and the Lamfalussy Process Level 1: Framework Principles Level 2: Detailed Technical MeasuresLevel 3: Strengthening Cooperation Among Regulators Level 4: Enforcement Weaknesses of Solvency I From Solvency I to Solvency I I Solvency ii Players Solvency ii Objectives
THE SOLVENCY I I DIRECTIVE A Unified Legislative Basis for Prudential Regulation of I nsurers and Reinsurers Risk-Based Capital Allocation Scope of the Application Important Definitions Value-at-Risk in Solvency I I Authorisation Corporate Governance Governance Functions Risk Management Corporate Governance and Risk Management - Level 2 Fit and proper requirements for persons who effectively run the undertaking or have other key functions Internal Controls Internal Audit Actuarial Function Outsourcing Board of Directors: Role and Solvency ii Responsibilities
12 Principles System of Governance (Level 2) PILLAR 2 Supervisory Review Process (SRP) Focus on Risk Management and Operational Risk Own Risk and Solvency Assessment (ORSA) ORSA - The I nternal Assessment Process ORSA - The Supervisory Tool ORSA - N ot a Third Solvency Capital Requirement Capital add-on PILLAR 3 Disclosure Requirements The Solvency and Financial Condition Report (SFC)
PILLAR I Valuation Of Assets And Liabilities Technical Provisions The Solvency Capital Requirement (SCR) The Value-at-Risk Measure Calibrated to a 99.5% Confidence Level over a 1-year Time Horizon The Standard Approach The I nternal Models The Collection of Additional H istorical Data External Data The Minimum Capital Requirement (MCR) Non-Compliance with the Minimum Capital Requirement Non-Compliance with the Solvency Capital Requirement Own Funds Investment Rules
INT ERNAL MODEL APPROVAL CEIOPS Level 2 - Tests and Standards for Internal Model Approval
CEIOPS Level 2 - The procedure to be followed for the approval of an internal model Internal Models Governance Group internal models Statistical quality standards Calibration and validation standards Documentation standards
SOLVENCY I I , GROUP SUPERVISION AND TH IRD COUNTRIES Solvency I: Solo Plus Approach Group Supervision under Solvency I I Rights and duties of the group supervisor Group Solvency - Methods of calculation Method 1 (Default method): Accounting consolidation-based method Method 2 (Alternative method): Deduction and aggregation method Parent Undertakings Outside the Community - Verification of Equivalence Parent Undertakings Outside the Community - Absence of Equivalence The head of the group is in the EEA and the third country regime is not equivalent The head of the group is in the EEA and the third country regime is equivalent The head of the group is outside the EEA and the third country is not equivalent The head of the group is outside the EEA and the third country regime is equivalent Small and Medium-Sized I nsurers: The Proportionality Principle Captives and Solvency I I
EQUIVALENCE WIT H SOLVENCY I I AROUND THE WORLD Solvency ii and Countries outside the European Economic Area
The I nternational Association of I nsurance Supervisors (IAIS) The Swiss Solvency Test (SST) and Solvency ii: Solvency ii and the Offshore Financial Centers (OFCs) Solvency ii and the USA Solvency ii and the US National Association of I nsurance Commissioners (NAIC) - The Federal I nsurance Office created under the Dodd-Frank Wall Street Reform and Consumer Protection Act in the USA, and the ORSA in the USA
FROM THE REIN SURANCE DIRECTIVE TO THE SOLVENCY I I DIRECTIVE Directive 2005/ 68/ EC of 16 November 2005 on Reinsurance - The Reinsurance Directive (RID) CLOSING The I mpact of Solvency ii Outside the EEA Providing I nsurance Services to the European Client Competing with Banks Learning from the Basel ii Framework Regulatory Arbitrage: A Major Risk for Countries that see Compliance as an Obligation, not an Opportunity Basel I I , Basel I I I, Solvency I I and Regulatory Arbitrage Challenges and Opportunities: What is next Regulatory Shopping after Solvency I I
To learn more about the course: www.solvency-ii-association.com/ Certified_Solvency_ii_Training.htm

Solvency II News July 2012

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Solvency ii Association

Solvency I I Equivalence Transitionals measure

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Commissions request for EIOPAs input

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Participating third countries and next steps:

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3. Main operational aspects of gap analysis process

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Group supervision specificities:

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Ability/ Willingness to support restrictions on free assets for supervised entities.

- Please provide any examples of actions recently undertaken in this respect.

Principle 2 Professional secrecy, exchange of information and promotion of supervisory convergence

The above mentioned obligations of professional secrecy shall extend to

Principle 3 Taking up of business

- Compliance with the system of governance referred to under Principle 4.

- Assessment of reputation and financial soundness of the owner and acquirer.

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Principle 4 System of Governance; Supervisory Review and Public Disclosure

Group supervision specificities:

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Principle no. 5 Changes in business, management or qualifying holdings

- Thresholds prompting notification.

Principle no. 6 Solvency Assessment

For group supervision assessments:

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- TP are calculated in a prudent, reliable and objective manner;

Principle 8 Parent undertakings outside the Community: group supervision

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Financial Stability Report 2012 First half year report Introduction

Summary of main issues and conclusions INSURANCE SECTOR

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OCCUPATIONAL PENSION FUNDS SECTOR

Recent developments FINAN CIAL MARKET DEVELOPMENTS

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LEGISLATIVE AND REGULATORY DEVELOPMENTS

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Developments in the European insurance sector INSURANCE SECTOR DEVELOPMENTS

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LOCAL MARKET DEVELOPMENTS

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Risk and Challenges

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SUPERVISORY RISK ASSESSMENT FOR TH E INSURANCE SECTOR

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Annex 1: Country abbreviations

SI Slovenia SK Slovakia UK United Kingdom CH Switzerland

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