Solvency ii News May 2013

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Solvency ii Association1200 G Street NW Suite 800 Washington, DC 20005-6705 USA Tel: 202-449-9750 www.solvency-ii-associa

tion.com

Dear member,

Life is becoming more complex for risk managers. We must have a “forward- looking perspective”, remember?

We have all these new laws and regulations …… but we also have rules, proposals and reports to consider.

Have you ever discovered the common elements of the various initiatives, including the Volcker rule in the United States, the proposals of the Vickers Commission for the United Kingdom, the Liikanen Report to the European Commission?

Leonardo Gambacorta and Adrian van Rixtel from the Monetary and Economic Department of the BIS will help us today to see the common elements and the differences!

This is a great analysis! We read:

The Volcker rule is narrow in scope but otherwise quite strict.

It is narrow in that it seeks to carve out only proprietary trading while allowing market-making activities on behalf of customers.

Moreover, it has several exemptions, including for transactions in specific instruments, such as US Treasury and agency securities.It is strict in that it forbids the coexistence of such trading activities andother banking activities in different subsidiaries within the same group.

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It similarly prevents investments in, and sponsorship of, entities that could expose institutions to equivalent risks, such as hedge funds and private equity funds.

That said, it imposes very few additional restrictions on the transactions of banking organisations with other financial firms more generally (eg such as through constraints on lending or funding among them).

However, it is worth remembering that the current US legislation does constrain the activities of depository institutions.

The Liikanen Report proposals are somewhat broader in scope but less strict.

They are broader because they seek to carve out both proprietary trading and market-making, without drawing a distinction between the two.

They are less strict because they allow these activities to coexist with other banking business within the same group as long as these are carried out in separate subsidiaries.

The proposals limit contagion within the group by requiring, in particular, that the subsidiaries be self-sufficient in terms of capital and liquidity and that transactions between the legal entities take place on market terms.

Just like the Volcker rule, the proposals do not envisage significant restrictions between the protected banking unit and other financial firms, except that they require the separation of exposures to entities such as hedge funds and special investment vehicles (SIVs) in the trading entity.

The Vickers Commission proposals are even broader in scope but have a more articulated approach to strictness.


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Solvency I I : where are we now?

Although there is no certainty on the Solvency I Iimplementation date, EU policymakers are continuing to finalise key aspects of the framework.

Recent developments include EIOPA’s consultation on interim measures, the impact assessment of the long-term guarantee package and a debate on whether new legislation is needed formally to delay Solvency I I ’s application.

Solvency I I implementation date

The legal position is that Member States must transpose the Solvency I I Directive into national laws by 30 June 2013 and apply it to firms from 1 January 2014.

It is clear, however, that this Solvency I I timetable is not feasible.

EU Member States cannot implement theSolvency I I framework by the set dates, for the simple reason that it is not finalised.

A Member State’s failure to meet the legal implementation deadlines for Solvency I I would mean that it was not complying with EU law and could have legal implications.

As a result, Member States are keen to ensure that further legislation amends the Solvency I I Directive to postpone deadlines for Solvency I I implementation on a formal basis.

This can be done by means of another “quick-fix Directive”, similar to the one adopted last summer, which established current transposition and implementation dates.Solvency ii Association

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Many people expect implementation to be put back to January 2016.

The European Commission, however, is resisting pressure to introduce another quick-fix, so as to encourage others in the EU’s legislative process to agree the Omnibus I I Directive as a priority.

Instead, the Commission proposes to produce a letter of comfort to Member States confirming that it will not commence proceedings against them for failure to implement Solvency I I.

The discussion is ongoing and we are monitoring it.

EIOPA’s consultation on Solvency I I interim measures

Although the Solvency I I legislative process is delayed, EIOPA believes that the insurance industry should build on preparatory work already undertaken.

In addition the IMF’s Financial Sector Assessment Programme (FSAP) review of the EU concluded that early harmonised implementation of Solvency I I would reduce risks arising from the current regime.

EIOPA has therefore published a set of consultation documents proposing to introduce some core Solvency I I provisions in advance of the formal deadline (still to be confirmed).

EIOPA’s guidelines are addressed to national supervisors and cover the following areas:

- System of governance

- A forward looking assessment of the undertaking’s own risks (based on the ORSA)

- Submission of information to national supervisors (reporting requirements)


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- Pre-application for internal models

Lloyd’s is reviewing the guidelines and contributing to the debate at UK and EU levels.

Many insurers are most concerned about EIOPA’s proposed reporting requirements, which look very onerous.

In a related development, the European Central Bank (ECB) plans to pass a Regulation enabling it to collect information from insurers for financial stability and statistical purposes.

The ECB is working with EIOPA and, so far as possible, will rely on data collected through the Solvency I I reporting templates.

In the interim period, before Solvency I I is implemented, it probably will not require insurers to report any additional data.

Longer-term, however, its requirements may become more

extensive. Legally, this Regulation will apply to Eurozone

Member States only,although central banks in other Member States may decide to imposesimilar reporting requirements.

It is unclear what position the Bank of England will take.

Impact assessment of the long-term guarantee package

Last year’s debates on the long-term guarantee package proved inconclusive and the Commission decided to conduct an impact assessment to inform Omnibus I I ’s development.

EIOPA launched the assessment in January 2013: insurers had until the end of


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March 2013 to submit information.

Lloyd’s did not participate due to the issue’s limited relevance to most of Lloyd’s business.

EIOPA is expected to publish a report with its findings in June this year, followed by a communication from the Commission.

Parliament has scheduled a vote on the Omnibus I I Directive for 22 October 2013.

This is indicative only, but suggests the deadline by which agreement on the long-term guarantee package should be reached.

Compromises over the long-term guarantee package and subsequent adoption of the Omnibus I I Directive are important to the Solvency I I implementation timeline.

If agreement is not reached and the Directive is not finalised in 2013, this is likely to delay Solvency I I implementation beyond the expected deadline of January 2016.


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The importance of culture in driving behaviours of firms and how the FCA will assess this

Speech by Clive Adamson, Director of Supervisionat the CFA Society - UK Professionalism Conference 19 April 2013, London.

Introduction

Good afternoon and my thanks to CFA Society for inviting me to speak today.

The subject of my speech today is the importance of culture in driving key behaviours in firms and how the FCA will assess this.

But before I take you through that, I would like to provide some context.

As many of you will know, the Financial Conduct Authority (FCA) came into official being earlier this month, taking over the conduct supervision of 25,000 firms in the UK.

This is a significant moment in UK financial regulation, with the creation of a focused conduct regulator seeking to protect consumers, enhance market integrity and promote effective competition.

I think it is fair to say that we are all aware of the erosion of trust in financial services.

This has been caused partly by the financial collapse in the banking sector, but also by a series of large-scale conduct failings stretching back over many years, from pensions mis-selling, endowment mis-selling, split caps to more recently, PPI and the sale of interest rate hedging products to SMEs.

In the wholesale space too we have seen the LIBOR scandal.


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These events, and associated lack of trust, have imposed substantial costs on consumers, firms and the economy.

So what has gone wrong?

We accept that the FSA has not been as effective a conduct regulator as it could have been.

But there are other reasons too.

Firms have designed, manufactured and sold products not always with the needs and interests of their customers in mind but instead, seeing the customer as somebody to maximise profit from.

This has been accentuated by a view, and it has to be said encouraged by the FSA, that disclosure at the point of sale absolves the seller from a real responsibly of ensuring that the product or service represents a good outcome for the customer.

This, in turn, has led in many cases to a tick-box and overly legalistic compliance culture within firms, encouraged by what has been seen as a tick-box regulatory approach.

Underpinning all of this is the issue of culture.

In many cases, where things have gone wrong, whether it is mis-selling of PPI or in attempting to manipulate LIBOR, a cultural issue is at the heart of the problem.

It is fair to say that to many in the outside world, the cultural approach of doing the right thing has been lost for financial services.

It is clear to us, therefore, particularly as a conduct regulator, that the cultural characteristics of a firm are a key driver of potentially poor

behaviour and I would like to explore this further with you today.


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What do I mean by culture?

Culture is like DNA.

It shapes judgements, ethics and behaviours displayed at those key moments, big or small, that matter to the performance and reputation of firms and the service that it provides to customers and clients.

For us, we view culture through the lens of what matters to us as a conduct regulator.

This means an effective culture is one that supports a business model and business practices that have at their core, the fair treatment of customers and behaviours that do not harm market integrity.

This is very different from what we have today where, as I said earlier, the focus has been on ensuring compliance with a set of rules rather than doing the right thing for customers.

Looked at this way, the responsibility for ensuring the right outcomes for customers resides with everyone at the firm, led by senior management, and not something delegated to compliance or control functions.

The challenge for many firms is that culture is hard to change and requires dedicated and persistent focus over a number of years in order to embedded different approaches and ways of behaving.

As the Saltz Review recently concluded, if culture is left to its own devices, it shapes itself, with the inherent risk that behaviours will not be those desired.

Drivers of culture at a firmIt seems to me that we can identify key drivers of culture at a firm. These include:


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- setting the tone from the top;

- translating this into easily understood business practices; and

- supporting the right behaviours through performance management, employee development, and reinforcing through reward programmes.

Let me say a few words about each of these.

Setting the tone from the top

Setting the tone is all about creating a culture where everyone has ownership and responsibility for doing the right thing, because it is the right thing to do.

It is about setting values and translating them into behaviours.

This can only be established by the CEO and other members of the senior management team, who need to not only set out the key company values, but also personally demonstrate they mean them through their actions.

These clearly go wider than those that directly impact what we, as the conduct regulator, are looking for but should clearly include these.

We have been encouraged to see that a number of firms are re- articulating their key values and principles, led by their respective CEO– and we support this move.

For us, though, we will want to see this new tone translated into behaviours through the organisation.

Business practices and ways of behaving


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The task then is to translate this tone into business practices that drive how business decisions are made, how the firm responds to events, how individuals should behave and how issues are elevated in an open way.

For me, therefore, translating culture into business practices is a way to make culture into something more hard edged.

I heard one CEO say earlier this year that one of their key values was to ‘treat our clients like you would a member of your family.

If you see a product feature you wouldn’t feel comfortable selling to a relative, then we shouldn’t be selling it to our customers either’.

Let me give you an example that was passed on to me last week.

Those who commute around London will be aware of the problems some weeks ago on the M25, which meant hundreds of passengers ran late for flights out of Heathrow and Gatwick.

One airline, which spotted this, and in light of so many of its passengers facing disappointment at the prospect of missing their flights, chose to hold back certain planes so that passengers had a chance to make their flights.

Of course this meant it faced complaints at the other end from the domino effect of the delayed flights, not to mention the additional costs due to inactive planes sat on the runway.

I am told though, that once the announcement made it to the other end, there were no customer complaints made.

They key point from this example is that the airline took a judgement call and did what it thought was the right thing for its customers, even though it came at a cost.

This is the kind of consumer-focused behaviour that customers would reasonably expect to be shown by the financial services industry.


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But we have also seen cases when this has not been the case.

Take our use of mystery shopping as a supervisory tool, as an

example. When we assessed the quality of investment advice at

the major retailbanks and building societies, we found that the messages communicated from the top of a firm were not fully embedded into theday-to-day operations on the shop floor.

This translated into poor advice being given to consumers - in fact we found that in one quarter of cases, consumers were given unsuitable advice or the adviser hadn’t gathered enough information to ensure their advice was suitable.

The point here is that, although senior management may have thought that good advice was being given, this wasn’t happening on the ground.

Performance management, employee development and reward programmes

Performance management, employee development and reward programmes are clearly a powerful lever to influence the culture of any organisation.

We have seen in financial services how the misalignment between incentives structures and corporate values has led to significant damage.

Our own work on financial incentives noted that high-risk incentive schemes with the potential for sales staff to earn big bonuses were common across authorised firms.

Sadly, we also uncovered a catalogue of serious failings, including firms struggling to understand their own incentive schemes because they were so complex.

So it is not surprising that we see more events such as the ‘shareholder

spring’ last year, which sent a strong message to the executives of those


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firms that financial incentivisation is still a critical factor that needs to be carefully balanced to reinforce positive corporate expectations.

I am pleased though that many firms have either already changed or are currently changing their sales incentives plans.

The question is then, how can a firm incentivise and reward its employees in a responsible way to encourage the right outcomes?

I mentioned remuneration as being an important lever, but so too are effective recruitment and promotion policies, development and performance management of employees – so, if by advancing someone you are essentially telling them that their behaviour within the workplace is appropriate, or even outstanding, then you need to ensure, and be able to demonstrate, that they are reinforcing the right values before making that decision and embedding that behaviour.

How will the FCA assess culture?

I’d like now to turn my attention to how the FCA will be assessing culture.

Our approach today is to draw conclusions about culture from what we observe about a firm – in other words, joining the dots rather than assessing culture directly.

This can be through a range of different measures such as how a firm responds to, and deals with, regulatory issues; what customers are actually experiencing when they buy a product or service from front-line staff; how a firm runs its product approval process and the considerations around these; the manner in which decisions are made or escalated; the behaviour of that firm on certain markets; and even the remuneration structures.

We also look at how a board engages in those issues, including whether it probes high return products or business lines, and whether it understands strategies for cross-selling products, how fast growth is


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obtained and whether products are being sold to markets they are designed for.

We are able, from all of this, to draw conclusions about the culture of a firm.

This includes assessing if the perceived customer-focused culture is supported by, for example, regular discussions on conduct at board level and appropriate sales incentives plans.

How will the FCA encourage positive culture change in firms?

We don’t have direct rules about culture, although our high-level principles for business come close to this in some respects.

As I have set out here, we don’t directly supervise ‘culture’.

However, as culture and business practices are so important in driving behaviours, we do want to encourage positive culture change in firms.

We will therefore increasingly, as I have indicated, draw conclusions about a firm’s culture and reflect that back to firms as part of the risk assessment process.

Where we believe cultural measures exposure the firm to a high level of risk in the context of our objectives, we will expect the firm to take account of it.

Of course, there are other ways to improve standards.

With the Retail Distribution Review (RDR), we have set new professional standards and I am pleased with the progress industry made to meet these by the deadline of last year.

In addition, as part of our new supervisory approach, we will be placing greater emphasis on individual accountability as well as corporate


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accountability for meeting our standards and we will be more prepared to hold these to account when things go wrong.

Summary

I hope this has given you a better idea of why we at the FCA are interested in the culture of firms and how we are going about assessing it.

There is no doubt that this is a complex subject and one where our thinking will continue to evolve as the FCA establishes itself, which is why we would like to encourage wider debate about it and how we can positively influence it.

So to summarise, culture is important to us as a conduct regulator because of its role in driving behaviours in firms and direct impact on our intended outcome of ensuring that customers get the right outcomes.

We certainly support the role of the CFA Society in raising professional standards and look forward to discussing this issue over the years ahead.

Thank you.


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Letters…

… between Andrew Tyrie MP, and the Executive Director of the Prudential Regulation Authority, Andrew Bailey, discussing Solvency I I .


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Erkki Liikanen: Banking structure and monetary policy – what have we learned in the last 20 years?

Presentation by Mr Erkki Liikanen, Governor of the Bank of Finland and Chairman of the Highlevel Expert Group on the structure of the EU banking sector, at the conference “Twenty years of transition – experiences and challenges”, arranged by the National Bank ofSlovakia, Bratislava.

How is today’s perspective on monetary policy different from what prevailed 20 years ago?

Twenty years ago, the world of today was being formed in many

ways. 1993 was the year when the Economic and Monetary Union

project wasbecoming political reality: the Maastricht treaty had been signed andwas in the process of being ratified.

It was also the time when the mainstream approach to monetary policy was beginning to converge to the flexible inflation targeting framework.

A number of countries had then just adopted an explicit inflation targeting strategy.

In the sphere of banking regulation, too, a new era was beginning.

A significant reorientation was going on, away from regulating the conduct of banks and towards the new risk-based approach.

The regulatory trend, based on increased freedom for banks but subject to risk based capital requirements, would continue all the way to the eruption of the financial crisis in 2008.


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In the EU, the second banking directive took effect from the beginning of 1993, creating a single market in banking.

The directive sought to prevent discrimination and to increase efficiency through competition.

There was discussion on the implications of this for supervision, but little action.

So, while European banking markets were being integrated, financial supervision remained a national competence.

In the U.S., deregulation was also moving forward.

For instance the Glass-Steagall Act, separating banking from securities and insurance, was under growing criticism and would be ultimately repealed in 1995.

One reason for the dissatisfaction with the Glass-Steagall system in the US was competition from European banks which were less restricted in what they could do.

Twenty years ago, the striking improvement in macroeconomic performance, later named “the great moderation” by chairman Bernanke, was spreading to the whole developed world.

The almost surprising success of monetary policy in improving price stability and reducing fluctuations in economic activity, while also keeping interest rates at historically low levels, was interpreted as a major victory for the art of economic policy making.

Now we know that there was trouble brewing under the surface.

The underpinnings of global financial stability were becoming weaker. Global indebtedness increased, fuelled by current account balances and the “deepening” of international financial markets (read: recycling the same funds several times over).


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The decline of inflation was not only due to monetary policy, but also the avalanche of cheap consumer goods from the emerging economies such as China contributed to it.

For banks, the new financial environment was characterized by low interest rates and low perceived risks.

It also turned out that the new risk-based capital requirements allowed the banks to expand their balance sheets enormously without increasing their equity capital in the same proportion.

So, gradually the large banking groups started to increase their trading portfolios.

This development happened in a gradual fashion in the 1990’s but accelerated dramatically from about 2004.

Banks redirected their business focus from interest margins to fee-based and trading activities.

Universal banking, as it had been known in Europe, started to change.

The asset mix of the largest banks changed so that securities portfolios activities grew more and more important.

Only now, from the perspective given by the worst financial crisis since the Second World War, do we see clearly the fragility and weakness of the regulatory arrangements which came into force in the 1990s.

From today’s point of view, they performed well only as long as no major systemic risks materialized.

Even worse, they allowed risks to accumulate in the financial system which were only waiting to be realized.Then came 2007 and the collapse of the US property market; 2008 and the collapse of interbank money markets following the Lehman Brothers crisis; and 2009 with The Great Recession.Solvency ii Association

























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The painful process of competitive deleveraging started.

The reassessment of economic policies followed in the last two decades has also started.

Especially financial regulation has been reconsidered and is being strengthened.

We need to think of monetary policy, too, especially in its connection to financial stability.

Monetary policy and financial stability

There is a common dictum that a stable financial system is a necessary condition for successful monetary policy, and that price stability in turn creates the best preconditions for financial stability.

I agree.

Still, the experience of this crisis has thought us a lot more.

First of all, we now know that price stability does not by itself guarantee financial stability.

Risks can accumulate in the banking system even if monetary policy succeeds in maintaining price stability and controlling inflationary expectations really well.

Second, we also know that central banks can maintain an admirable degree of price stability even when financial stability is under a lot of strain.

Do these two points mean that financial stability and monetary policy are not connected after all?

No.


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They are very closely related.

Independence of monetary policy

One of the lasting lessons learned in the last decades is the value of the independence of monetary policy.

The independence of central banks has been essential keeping inflation expectations as well anchored as they have been in this crisis despite all the turmoil in the financial markets.

Independence has also made it easier for central banks to act quickly when it has been necessary in order to maintain financial stability.

It is especially important to avoid two threats to independence: fiscal dominance and financial dominance.

Fiscal dominance is the older concept of the two.

It would arise if the government financing constraint would become an overriding influence on monetary policy.

The idea of fiscal dominance was formalized by Tom Sargent and Neil Wallace in 1981, but of course the worry that deficit financing may cause inflation has much longer roots in monetary thought.

The idea that tight monetary policy may become impossible without accompanying fiscal adjustment was also well understood when the blueprints for the EMU were being prepared.

This is why the Maastricht treaty had its fiscal policy clauses and also why the Stability and Growth Pact was concluded.

Also the prohibition of direct central bank credit to the government and the institutional independence of the central banks are in effect protections against fiscal dominance.


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Now we know, of course, that the fiscal framework as put in place before the start of the EMU was not strong enough to prevent fiscal problems from emerging.

Some have argued that fiscal dominance has taken hold in the in the big industrialized countries during the crisis when the central banks have used government bond purchases in order to stabilize the markets (as the ECB) or to produce additional monetary stimulus when the interest rate instrument has already been used to the maximum (like the Federal Reserve and the Bank of Japan).

As to the euro area, for me there is now no evidence of fiscal dominance. Fiscal dominance implies that monetary policy would break its price stability objective for the sake of maintaining the solvency of the government sector.

This is not the case.

Price stability has not and will not be abandoned.

We have well known fiscal problems in some of the euro area

countries. Still, the ECB’s ability to go on maintaining price

stability has not beenweakened.

In particular the inflation expectations, which are the most essential indicators of the credibility of monetary policy, have remained well in line with the price stability objective.

The parallel idea of financial dominance is more recent than fiscal dominance.

Financial dominance refers to the possibility that the condition of the banking system could become a constraint, or dominant influence, on monetary policy, effectively forcing the central bank to pursue second- or third-best monetary policies in order to maintain financial stability.


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Is the spill-over from financial instability to monetary policy a realistic threat?

Can financial stability considerations lead the central banks to tolerate too high inflation, just to keep the banking sector afloat?

In principle it is easy to see why it could be.

One can imagine a central bank which would have to tighten its monetary policy for price stability reasons, but is prevented from doing so for the fear that the value of the assets of the banking system would decrease and a financial crisis could ensue.

Episodes which fit the description of financial dominance have been observed in emerging economies after some banking crises in the past.

But looking at recent experience, this has not been the case in the developed economies.

The bust of the credit boom has not led monetary policy to tolerate a higher-than-mandated rate of inflation.

Instead, in the large developed economies at least, the bursting of the bubble has coincided with a sudden contraction of private demand and a deep recession.

The negative effect of the bust on economic activity has actually reduced inflationary pressures and in some cases (such as in Japan in the 1990’s) created a real danger of deflation.

The main problem has then become how to prevent the credit contraction from starting a deflationary spiral.

In such conditions, the same monetary policy will then both ease the strain on the banking sector and support price stability.


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This observation does not mean that financial instability would not pose a serious challenge to monetary policy.On the contrary, the downward impact of a bust, if it is large, may be more difficult to control than the preceding period of credit expansion.

There was a famous discussion on how monetary policy should relate to asset prices in the Jackson Hole conference of 2007, where Rick Mishkin introduced the topic.

At that time, the prevalent thinking in central banking circles was what professor Issing later called “the Jackson Hole consensus”, meaning that it is better for monetary policy only to “clean” (up afterwards) than to “lean” (against the wind).

After the hard lessons we learned over the last five years the case for benign neglect of asset booms and only picking up the pieces afterwards is not so strong any more.

The crisis experience supports rather the idea that financial excesses are better prevented as they happen than only managed after they have caused a recession.

This would be the best way to prevent “downward financial dominance” which could arise if monetary policy could not effectively counteract credit contraction.

Unconventional tools and the independence of monetary policy

Recent experience shows that the central banks’ box of potential tools is actually very deep, and if it has become necessary to utilize unconventional tools, as in the present crisis, these new tools have been developed and deployed.

In the case of the ECB, the new tools have included the transition to full allotment auctions, the long term refinance operations up to three years, widening of the scope of eligible collateral, and the various bond purchase programmes.Solvency ii Association

























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The most recent of these is the OMT programme announced last summer but not yet commenced in practice.

The development of new tools has been justified.

The slip of the depressed economies to dangerous deflation has been averted, and the debt and banking problems have not developed into systemic financial meltdowns in the affected countries.

We have seen that central banks can pursue successful price stability policy also under very difficult conditions.

The events around the world since the collapse of Lehman Brothers are evidence of that.

Deflation has been avoided despite a severe recession in many countries.

However, there are also certain problems with relying on the enlarged toolkit of the central banks.

The ability to act in crisis has led to the central banks being even called “the only game in town”.

We should resist this idea and beware of the danger that problems which are fundamentally political could be pushed to central banks to solve.

A division of responsibilities between appointed officials and elected politicians should be preserved.

Monetary policy cannot administer the needed structural transformation in the real sector of the economy or solve excessive deficit problems of governments.

There are situations where the central banks just have to act and do their best to stabilize the economy, even if they would have to use tools which go beyond just adjusting the short rate of interest or the aggregate liquidity of the banking system.


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The present financial crisis has constituted one such situation.

Avoiding the busts which seem to follow credit booms and periods of “financial exuberance” would make the tasks of monetary policy much easier and protect the independence of central banks.

But there are also difficulties with the leaning against the wind.

One has to do with the problem of detecting the credit cycle in time, and correctly timing the monetary policy response.

Another problem is that price stability might get less attention.

To mitigate these problems, something else besides more vigilant interest rate policy is needed to prevent low and stable interest rates from leading to excesses in banks and financial markets.

One development can be the development of macro-prudential instruments which are designed to improve the stability of the financial system as a whole.

The major work in this field was done by the de Larosière group.

Otmar Issing was a member of the group.

Especially interesting are those macro-prudential instruments which have a time dimension so that they can be adjusted according to the changing situation in the credit markets.

Such instruments include, in particular, the countercyclical capital requirements, as well as the adjustable restrictions on Loan-to-Value ratios.

The CRD IV directive will make the former instrument obligatory in the EU countries; implementation of the latter is left to national discretion. Solvency ii Association

























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Now it is very important to establish an effective toolkit for both European and national authorities.

We must also create institutional conditions which do not prevent these tools to be used when needed.

Therefore, we need clear decision making competences at all levels.

The connection between macro-prudential policy and its time dimension with monetary policy is so intimate that central banks must be closely involved in macro-prudential analysis and decision making.

Macro-prudential policy is important, but it needs to be supported by structural reforms which would make the banking system more resilient, and - I emphasise - less prone to unstable behaviour.

The Structural reform proposals

In order to prevent the present crisis from being ever repeated, governments and authorities have started a large-scale overhaul of financial regulation.

The regulatory agenda can be broadly divided into the following areas:

•Strengthening of the prudential regulation of solvency and liquidity

•Improving the institutional basis for supervision and crisis management

•Introduction of macro-prudential instruments to prevent systemic risks in the banking system and financial markets

• Regulating the structure of the banking sectorSolvency ii Association

























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The structural reform proposals which appear as the last item on this list aim to separate the riskiest securities and derivatives business from the deposit banking activities.

This is the essential content of the proposals by the EU High Level Expert Group, which I chaired, published last autumn.

It is also at the core of the Volcker rule which is being implemented in the US, and the Vickers proposal in the UK.

The current legislative proposals which are underway in France and Germany are also in the same vein.

A particular concern of these proposals has been to limit the extent of explicit or implicit public guarantees, so that they would not induce additional risk taking.

This kind of competitive distortion could result in securities trading getting concentrated in the largest deposit banks, and these deposit banks becoming enormous risk concentrations built on implicit or even explicit public guarantees.

Separation proposals try to isolate securities business from the sources of this distortion and reduce the incentives to excessive risktaking and risk concentration.

In must be emphasized that the structural reform we proposed is not a cure-all but should be seen as a part of a comprehensive regulatory agenda which is already moving forward.

This includes better solvency and liquidity rules.

Also, the EU will finally get supervision and resolution frameworks at the union level.

The different components of the current regulatory agenda complement and support each other.


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In this European context, the structure and stability of the banking sector is of vital importance to the economy.

It is imperative to improve its resiliency.

The High Level Expert Group report contains five main recommendations on how to reform the banking sector.

I will just refer to three of them here:

•The first is to separate any significant proprietary trading in securities and derivatives from deposit banks.

These activities could be carried out in a separately capitalized and funded subsidiary, a trading entity, which could belong to the same banking group as the deposit bank.

We proposed that also market making be allocated to the trading subsidiary in order to prevent the use of trading inventory to circumvent the prohibition on proprietary trading.

•The use of trading subsidiaries would allow the banking groups to offer “one-stop banking” to their clients, but without the possibility of funding trading activities with insured retail deposits.

Financial linkages between the deposit bank and the trading unit would have to be restricted in accordance to normal large exposure rules.

•Another of our proposals is to develop specific, designated bail-in instruments to improve the loss absorbency of banks.

A requirement to issue such bail-in debt would help ensure the participation of investors to the recapitalization of a bank if this should become necessary.


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Such designated bail-in instruments would clarify the hierarchy of debt commitments and allow investors to predict the eventual treatment of the respective instruments in case of recapitalization or resolution.

•The group also proposed that the capital requirements on trading assets and real estate related loans be reviewed.

Both of these asset categories came to have very low risk weights in the Basel I I regime, mostly because the way internal models were applied.

Why banking structure matters for monetary policy

Let me recapitulate my main points.

First, for monetary policy, financial stability is very important.

While monetary policy has proven to be able to pursue price stability even under rather strained financial conditions, the central banks are not able to insulate the real economy completely from the after-effects of financial crises.

A more stable banking sector which is less prone to crisis will reduce the likelihood of crises and therefore protect the balance sheets of the central bank from financial risks and thereby protect its independence and credibility.

Second, the most important part of stability policy is crisis prevention.

Improving loss absorbency of banks and the crisis management powers of the authorities are necessary, but it is even more important to make sure that excessive growth of credit and indebtedness can be better controlled in the future.

In this way, credit crunches and banking crises can be made less likely – and milder, should they happen.


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Third, financial stability would benefit from structural reform of the banking system.

By separating the most risky securities and derivative activities from deposit banking, the spill over from deposit protection to speculative risk taking would be prevented.

This would reduce the distorted incentives to expand trading activities and concentrate risks in deposit banks because of their privileged position in the deposit market.

Finally, the structural reform of banking is a complement, not a substitute for other regulatory improvements.

For central banks, the development of macro-prudential policies and instruments is especially relevant.

Those macro-prudential instruments which can be adjusted over time to manage the conditions in the credit market will offer a way to better control the accumulation of excess risk and help prevent future crises.

These instruments operate so close to monetary policy that central banks should be very closely involved, if not themselves responsible, in developing and using them.


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Changes in the Large Exposure Regime

CONSULTATION PAPER GUERNSEY FINANCIAL SERVICES COMMISSION

1: Executive Summary1.1 Overview

This paper contains full details of the proposals to substantially alter the Large Exposure principles and guidance that apply to licensed deposit takers that are incorporated in Guernsey.

It is proposed that the new regime would take effect from 1

January 2014. These proposals include changes to enhance the

quarterly prudentialreporting to the Commission and this would affect not only licenseddeposit takers incorporated in the Bailiwick, but also those licensed deposit takers whose principal place of business is outside the Bailiwick.

The context for the review is that the existing Principle 1/ 1994/ 24 “Principles and Guidance to be followed by a locally incorporated licensed deposit taking institution entering into a large exposure” paper published by the Commission in 1994 no longer adequately addresses the risks associated with large exposures, particularly those arising from the systemic and market risks that became evident as a result of the 2007/ 2008 financial crisis.

In respect of large exposures, the Commission has tended to be a “pragmatic” supervisor rather than a rigid standard based supervisor, and, it has from time to time allowed suitably collateralised large exposures in excess of 25% of net capital base.


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Given that any change to a more restrictive approach may have a business impact on licensees the Commission feels that it is appropriate to seek the views of industry.

The Commission is proposing to retain several elements of its pragmatic approach and in seeking the views of industry it will be open to bilateral discussions with licensees about particular types of exposures.

2. What is proposed?

The substantive changes being proposed in updated guidance are as follows:

- Exposures to central governments and market loans of less than 12 months’ maturity, which are exempt from the current large exposure regime, will be deemed to be large exposures under the new regime.

- The current upstreaming regime will change to express agreed exposure limits to parent/ group banks as a proportion (i.e. %) of capital base rather than a proportion of assets. The upstreaming regime will include on balance sheet and off balance sheet exposures.

- Exposures to third party banks will normally be limited to a maximum of 100% of net capital base and will comprise cash placements, holding of debt instruments and off balance sheet exposures. The maximum proportion (%) of exposure will be determined according to the rating of the third party bank, although limited flexibility will be permitted in the case of exceptional short- term excesses.

- In relation to exposures to sovereigns, the concept of Zone A and Zone B countries will be replaced with two different OECD-based groupings - High Income OECD countries and other countries.


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Exposures will be capped at a maximum of 1000% of net capital base and will be determined according to the rating of the sovereign.

- Exposures to clients or groups of connected clients will be capped at a maximum of 25% of net capital base, unless the exposure is secured by cash and/ or High Income OECD government securities, or the exposure is subject to a parental guarantee (which in itself would need to be included in any upstreaming limit).

Sub-participation agreements that transfer credit risk off the balance sheet of the Guernsey bank will also be considered.

- Better definition of what constitutes “connected clients” will be provided.

- The prudential reporting forms will be changed to better capture large exposures that have not previously been reported; e.g. holdings of debt that equate to more than 10% of a bank’s net capital base.

In accordance with expected international developments, the Commission also proposes to capture the top twenty, rather than the current top ten, largest exposures.

Branches will be asked to report similar details, but in terms of their parental capital, so that data on any significant credit concentration risk in a branch in Guernsey that may impact on a head office elsewhere can be collected.

- Breaches of large exposure limits will be a reportable event. The Commission is proposing a staged approach to dealing with exposures that cannot be regularised.

- The 800% aggregate limit on exposures would be retained, but exposures to Group, to third party banks and to sovereigns would be excluded from this aggregate.


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- Large exposures existing prior to the intended effective date for the new regime of 1 January 2014 would be grandfathered in.

1.3 Rationale for change

The large exposure regime is all about capturing concentration risk and it is covered by s24 of The Banking Supervision (Bailiwick of Guernsey) Law, 1994.

Conventional wisdom, as dictated by the Capital Requirements Directive and the Basel Core Principles for Effective Banking Supervision, states that no exposure to a client or connected group of clients should equate to more than 25% of net capital.

Short term interbank exposures have historically been exempt from this requirement.

Our current environment reflects these exemptions and also permits exposures to clients to exceed the 25% limit.

Whilst pure concentration risk to single obligor counterparties was not seen as a major direct contributor to the 2008 financial crisis, nonetheless elements of concentration risk were seen as indirect contributors.

Interconnectedness within and between groups were seen as magnifiers of some exposures and concentrations through sectoral exposures to particular economic sectors (e.g. the I rish property development sector) affected credit assessments of many organisations.

That said, the guidance on large exposures remains historic in nature; the Basel Committee guidance on measuring and controlling large exposures dates back to 1991, and our own local regime has not been significantly updated since 1994.

However, there have been substantial changes to the EU large exposure regime. Solvency ii Association

























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These substantial changes have their origin in late 2007 and early 2008, when the Committee of European Banking Supervisors (CEBS), which has since become the European Banking Authority, reported to the European Commission on the effectiveness of the large exposure provisions of the Capital Requirements Directive.

The report concluded that market failures associated with systemic risk and moral hazard applied to interbank exposures regardless of maturity.

Accordingly, the large exposure regime for EU member states was revised with effect from December 2010 to tighten large exposure limits, particularly in relation to interbank and intra-group lending, which the European Commission agreed was a major systemic risk in the wake of the financial crisis.

Under the revised EU regime, short term loans to banks are no longer exempt and whilst limited national discretion is available to member states in relation to intra-group lending, loans to third party banks are now capped at 25% of net capital, unless the lending bank is very small.

In reality, by the time the changes to the EU regime came along, market practice had already changed to reflect this more cautious approach to interbank lending.

It is worth noting that the CEBS conclusions were also reflected in the UK Government’s response to the report on banking reform by the Independent Commission on Banking (“the Vickers Report”).

The HM Treasury white paper “Banking Reform – delivering stability and supporting a stable economy” published in June 2012 envisages the limiting of a ring-fenced bank’s exposure to financial institutions in order to prevent systemic shocks.

Clearly Guernsey is not in the EU, but nevertheless we would not wish to be a complete outlier in respect of large exposures.Solvency ii Association

























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The Basel Core Principles for Effective Banking Supervision do give the supervisor some latitude in permitting “minor deviations” from the 25% limit, but the economic climate that has prevailed for all but the last few years combined with the Commission’s wish to be a pragmatic regulator has meant that these “minor deviations” have been permitted more frequently in the past than is arguably now prudent in the current economic and regulatory climate.

The guidance however, remains the same and a change is needed to manage expectations and formalise a prudent approach.

In developing proposals for a new large exposure regime the Commission has had regard to a number of other regimes, including those operating in the UK and the other Crown Dependencies.

None of these are a good fit in their entirety for the type of banking business done in and from within the Bailiwick.

The Commission has therefore tried to balance the requirements of other regimes against the type of banking business that exists in the Bailiwick, recognising also the intra-group funding that many licensees provide.

1.4 Who would be affected?

Licensed deposit takers that are incorporated in Guernsey would be those principally affected, given that limits on exposures are being proposed in relation to capital.

However, the proposed revisions to the large exposure regime include enhanced quarterly prudential reporting for all licensees and branches would therefore be affected by these changes to the BSL/ 2 reports.

The Commission

The Guernsey Financial Services Commission is the regulatory body for the finance sector in the Bailiwick of Guernsey. The Commission’s


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primary objective is to regulate and supervise financial services in Guernsey, with integrity and efficiency, and in so doing help to uphold the international reputation of Guernsey as a finance centre.

To learn more: http://www.gfsc.gg/Banking/News/Documents/Consultation%20pap er%20for%20Commission%20website.pdf


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Adjustment and growth in the euro area

Speech by Mr Peter Praet, Member of the Executive Board of the European Central Bank, at the European Business Summit, Brussels, 16 May 2013.

Introduction

Thank you very much for inviting me to speak at this conference of the European BusinessSummit.

The theme of my address today is “Adjustment and Growth in the Euro Area”.

This is a title that, to some, may sound contradictory.

Many of you will have come across commentators who claim that adjustment is in fact inimical to growth; and that consolidating government budgets while introducing structural reforms is the main cause of our current difficulties.

Yet, in my view, this is a short-sighted assessment.

While it is clear that fiscal consolidation has affected economic activity in the euro area in the short-term, it does not follow from this that adjustment and growth are incompatible.

Restoring the sustainability of public finances and implementing well- designed structural reforms are key to restoring confidence.


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Measures that are now being undertaken help to lay the foundations for future growth and bring back a climate of confidence already in the short-term.

First, by prioritising fiscal consolidation, euro area countries can anchor medium-term expectations about public debt sustainability, which is essential to support confidence among investors and taxpayers.

As many euro area countries already have high public debt levels, and some have seen their market access threatened, credible fiscalconsolidation ensures that debt can be refinanced at affordable rates in the future, and fiscal crises avoided.

Moreover, if consolidation is focused to the greatest extent possible on unproductive expenditure items rather than those, like investment, that are conducive to long-term growth, the negative effects on growth can be contained.

Second, by implementing structural reforms, euro area countries should raise their future growth potential.

Research has shown that a comprehensive package of product and labour market reforms could significantly increase euro area output – by more than 4.5% over 5 years, according to a recent IMF study.

This improved outlook, when incorporated into medium-term expectations, should encourage forward-looking firms to increase investment, and could hence lead to higher growth also in the short- term.

Such reforms should be undertaken with due protection of the most vulnerable members of society.

The key point is that for adjustment and growth to be mutually supportive, the commitment to reform has to be credible. Solvency ii Association

























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Investors, firms and households have to be convinced beyond doubt that governments will stay the course.

If they fear policy commitments may be delayed or reversed in the future, they will neither be sufficiently confident in the sustainability of public finances nor in future growth potential to alter their behaviour today.

“Wait-and-see” will remain the rational response and short-term growth will lag behind potential.

In other words, proposing to reverse course on fiscal and structural reforms does not support growth.

In fact, it only weakens credibility and hence undermines the hard work that has already been done to put the euro area on a surer footing.

For the remainder of my remarks, I would like to first review the ongoing process of adjustment across the euro area and what has been done by national authorities, and the ECB acting within its price stability mandate, to facilitate that process.

Thereafter, I will put forward some suggestions for what remains to be done by euro area governments to ensure a return to growth as speedily as possible.

1. Restoring growth and employment in the euro area

Let me begin by reviewing the economic situation.

Euro area real GDP still remains about three percentage points below its pre-crisis peak, although this aggregate figure hides some divergence.

For the group of countries which are still under some financial stress (Greece, Spain, I reland, I taly, Portugal, Cyprus and Slovenia), real GDP remains near the trough of the crisis reached in 2009. Solvency ii Association

























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Other euro area countries, however, had by 2011 already recovered the previous maximum level of real GDP.

The same is true of labour markets.

The employment rate in the euro area as a whole is still more than two percentage points below its peak, according to OECD figures.

However, Germany has increased its employment rate by more than three percentage points (to 73.1%) while, at the other extreme, Greece has seen its employment rate dropping by more than ten percentage points (to 50.1%).

Youth unemployment rates in a number of stressed countries also remain unacceptably high.

Looking forward, we expect the euro area economy to resume growth at a modest pace later in 2013, although it will take more time for this to feed through into higher employment.

Why is growth not rebounding more quickly and evenly across the euro area?

A key explanation is that the adjustment process has been hindered by adverse feedback loops resulting from the interaction of accumulated fiscal and macroeconomic imbalances, weak bank balance sheets and the lack of a genuinely European approach to bank resolution and recapitalisation.

To give just one example of such interactions, large fiscal imbalances in a Member State can lead financial markets to drive up yields on its sovereign debt.

This in turn creates higher funding costs for its domestic banks and reduces their profitability, thereby hampering credit growth to the real economy.


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Lower credit growth then contributes to lower nominal GDP, which not only further weakens banks’ balance sheets by increasing non- performing loans, but also increases concerns about the sustainability of sovereign debt through the denominator effect; and thus, the feedback loop restarts again.

Without a European approach to banking sector repair, if the sovereign intervenes to break the feedback loop by recapitalising or resolving banks, it may only heighten market concerns about its debt sustainability and aggravate the situation.

a. Actions by governments

Addressing such adverse feedback loops between government finances, credit and growth implies a triple policy response from governments:

First, fiscal consolidation and current account rebalancing to secure public debt sustainability and lower external financing needs.

Second, structural reforms to increase potential growth and offset the potential negative effects of fiscal consolidation.

Third, comprehensive banking sector repair to acknowledge impaired assets and strengthen bank balance sheets.

Fortunately, in all three areas the euro area is heading in the right direction.

First, fiscal and macroeconomic imbalances have improved significantly: fiscal deficits have declined from their 2009 peaks throughout the euro area based on sizeable consolidation efforts and despite strong economic headwinds, while there has been a pronounced reduction of current account deficits.

However, these sizeable flow adjustments have not yet fully translated into improvements in the accumulated stock of imbalances – public debtSolvency ii Association

























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ratios on the fiscal side, net international investment positions on the macroeconomic side – because of depressed nominal GDP growth.

Most EU countries made significant progress towards further reducing budgetary imbalances in 2012, in an environment of weaker than expected output growth.

The euro area government deficit has decreased to 3.7% of GDP (3.1% of GDP excluding one-off government support for financial institutions).

In 2013, the Commission expects the euro area deficit to reach 2.9% of GDP – i.e. below the Maastricht reference value.

This level would be less than half the peak reached in 2009 (6.4% of GDP), and it puts the euro area as a whole on track to comply with the commitment made by G-20 leaders in Toronto in 2010 to halve fiscal deficits by 2013.

It has to be stressed that correcting for the effects of the weak cycle the fiscal adjustment has been even larger than suggested by these figures.

Progress with fiscal consolidation has been particularly strong in countries subject to an economic adjustment programme.

The primary structural deficit (cyclically-adjusted deficit net of interest payments and net of one-off factors and temporary measures) as a ratio of GDP over the period 2009–2012 has fallen by around 14 percentage points in Greece, 6 percentage points in Portugal and 4 percentage points in I reland.

The true adjustment effort is likely to have been even larger than these numbers suggest due to significant revenue shortfalls in a context of rebalancing from (tax-rich) domestic demand towards (taxpoor) exports.

This rebalancing has also been associated with significant improvements in current account positions.


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Current account deficits fell on average by 10 percentage points of GDP in Greece, Ireland and Portugal from 2008–2012, and by 8 percentage points of GDP in Spain over the same period.

Second, the euro area witnessed a renewed momentum to implement structural reforms.

It has been well-understood by euro area countries that restoring fiscal sustainability must rest not only on fiscal adjustment to achieve sizeable primary surpluses, but also on measures to revive growth to avoid adverse snowball effects undoing the debt-stabilising impact of primary surpluses.

This requires structural reforms that improve labour market and product market functioning and hence increase potential growth.

There are numerous studies, for instance by the OECD and the IMF, showing the significant benefits in terms of employment and growth that could accrue to the euro area from such measures – and not only in the medium-term.

A credible commitment by euro area governments to implement structural reforms could already create a permanent upward shift in expectations of future growth, improve labour market performance, and as a welcome side-effect, improve the health of public finances over the medium-term.

And to a certain extent, this is what we are seeing in the euro area today.

As regards labour market reforms, several euro area countries have moved towards a negotiating framework for wages and working conditions based more on firm-level agreements.

This should enhance competitiveness by promoting a closer link between wages and productivity and, at the same time, allow firms to rapidly adjust their internal organisation of labour and production in response to changing economic conditions.


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In addition, labour market functioning has been strengthened by addressing distortions related to the “two-tier” systems that characterise a number of euro area economies – in particular Spain and I taly.

These measures should support social fairness by bringing to an end the situation where vulnerable temporary workers, mainly young people, de facto bear the full burden of the adjustment.

Moreover, they should increase potential growth by improving the employment conditions of young workers and their relatively lower opportunities for on-thejob training, which significantly hampers human capital formation; and by reducing inefficient labour turnover, since firms would be less reluctant to transform temporary jobs into permanent ones.

At the same time, to reduce unemployment traps and create incentives for job-seeking, welfare systems are being reformed so as to shift from a system providing security “on the job” to one providing income support “in the market”, while setting up strict eligibility criteria and a system of active labour market policies.

Together with these labour market measures, reform efforts have focused on increasing competition in a number of sectors, including retail and wholesale, transport, energy, and professional services; reducing the administrative requirements to set up or expand businesses; and improving the efficiency of civil justice and public administration.

Third, euro area countries have taken a series of measures to address balance sheet weaknesses in the banking sector.

Capital requirements are in the process of being strengthened following the conclusion of the Capital Requirements IV Directive, which transposes the Basel I I I agreement into EU law.

At the same time, a number of banks raised new capital to address balance sheet weaknesses.


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The greatest progress in financial sector repair has of course taken place in the countries under EU-IM F programmes, where there has been a comprehensive restructuring and recapitalisation of the domestic banking sectors.

Spain has also taken decisive measures to address the imbalances of the past via its ESM indirect bank recapitalisation programme.

b. Actions by the ECB

What is the role of the ECB in this process?

While the ECB has consistently played its part and maintained price stability in the euro area, it is important to keep in mind that the role that the central bank can play in terms of crisis resolution is limited.

The ECB’s monetary policy can only play a crisis mitigation role.

Hence, our monetary policy approach has focused on providing

liquiditysupport, intended to relieve banks of liquidity and funding stress bygiving them unlimited access to central bank money at a fixed price against adequate collateral.

To facilitate this support, we expanded the set of eligible assets that can be used as collateral and extended the maturity of our lending.

It is widely recognised that these measures have been effective in averting a disorderly spiral of deleveraging in the banking system, which would have taken place in an environment of severe liquidity constraints and fire sales.

This was necessary in order to avoid deflationary downward pressures that would have prevented us from delivering on our mandate of preserving price stability in the euro area.


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However, to mitigate the crisis we have also had to go beyond liquidity support, in particular to counter financial fragmentation in the euro area– created by the adverse feedback loops I described above – that was disrupting the transmission of monetary policy across the euro area.

Diverging credit conditions by countries, by sectors and by size of companies have prevented the ECB’s very accommodative monetary policy stance from being passed on evenly in the financing conditions faced by euro area firms and households.

As the euro area economy relies heavily on bank credit, this has serious implications for growth and ultimately for our ability to maintain price stability.

In particular, in the first half of last year we perceived a situation last year where severe upward pressure on sovereign yields was being driven by unfounded fears about the future of the euro area.

These fears were causing investors to charge risk premia to lend to some Member States that could not be justified by economic fundamentals.

We therefore decided to open the possibility of undertaking Outright Monetary Transactions (OMTs), entailing ex ante unlimited interventions in short- to medium-term securities issued by governments which have submitted to strict and effective conditionality, in order to eliminate the pricing of un-warranted tail risks in the bond markets.

This has played an important role in reducing financial market fragmentation, as financial markets understood OMTs as a credible backstop for countering redenomination risk.

2. What remains to be done

These measures by the ECB, however, can only buy time; they cannot substitute for the responsibilities of national governments to address the


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unsound fiscal, economic and financial policies that are the root causes of the crisis.

And while a great deal has already been done by euro area authorities to address these root causes, there are three areas in which more progress still needs to be made.

First, the euro area needs to continue to deepen structural reforms aimed at enhancing competition, flexibility, efficiency, and productivity.

The reform process takes time, and so a medium-term, comprehensive approach is crucial to anchor expectations and maximise the positive effects of adjustment in the short-term.

The greatest challenge today is to maintain reform momentum and implement fully those changes which have already been announced or even enacted into law.

Concretely, this means, for the labour markets, addressing the remaining insider-outsider dualities and enhancing labour mobility, including across borders.

For product markets, the key challenge is to open up regulated professions and network industries that are sheltered from competition by government regulations.

This requires a simplification and streamlining of regulations, a reduction of barriers to entry and limits to competition, a resolute deepening of the Single Market in Europe.

Going forward, structural reforms also need to go into the government sector itself.

In several euro area countries, modernisation of public administration is essential to increase efficiency in the provision of public goods, like infrastructure, and essential services, like civil justice. Solvency ii Association

























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This will also support fiscal consolidation, by reducing the size of the government sector.

Second, the euro area needs to persevere in fiscal consolidation efforts and reduce steadily the government debt ratio.

Despite the important progress on fiscal consolidation, debt ratios have yet failed to stabilise in most euro area countries, as improvements in primary balances were outweighed by the debt-rising impact of unfavourable developments in interest-growth differentials and deficit- debt adjustments.

The euro area government debt ratio is projected to rise further to above 95% of GDP in 2013 – far above the 60% Maastricht reference value– with debt ratios displaying large differences across countries. Further adjustment is thus inevitable, and unfortunately it must take place in an environment of rising consolidation fatigue.

Five years into the crisis this rise in consolidation fatigue is understandable.

Going forward, it will be important for policymakers to communicate effectively both on the need for further adjustment and how this adjustment will be distributed in an equitable way across different groups of the population.

In this context, it is necessary to review consolidation strategies that have relied predominantly on tax rate increases, exacerbating the burden on already compliant taxpayers, without much broadening of the tax bases.

Such an approach has had substantial negative effects on disposable income and demand, at the same time raising resistance and negative reactions in the electorate, based on inter-temporal uncertainty and fairness considerations.

Due protection of the most vulnerable is needed here.Solvency ii Association

























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On the expenditure side, adjustment has relied disproportionally on cuts in government investment, thereby weakening the prospects for long- term growth.

Going forward, there is a need to focus adjustment on unproductive expenditure while as far as possible safeguarding government expenditure that is conducive to long-term growth.

Third, the euro area needs to press ahead with constructing a genuine Banking Union.

A first and important step has been made with the decision to create the Single Supervisory Mechanism (SSM), the responsibility for which was assigned to the ECB.

Political agreement by the ECOFIN Council and the European Parliament was reached on a legislative package in March, and technical agreement is expected very soon, so that national parliamentary proceedings can start, which should be concluded by the summer.

The existence of the SSM, by reducing regulatory capture and increasing supervisory consistency and coherence, should play an important role in increasing confidence in the overall euro area banking system, and as a result, reduce fragmentation of interbank and other financial markets.

However, for the Banking Union to be fully effective, a Single Resolution Mechanism (SRM) to accompany the SSM is essential.

This is the case for a number of reasons.

First, an SRM would allow for the euro area to complete the process of banking sector repair without aggravating market concerns over public debt sustainability, which would help break the adverse feedback loop I described above and restore the functioning of the credit channel.

Second, this confidence in EU level resolution capacity would ensure that the SSM can be a credible supervisor, as it would be able to push


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non-viable banks towards winding down without endangering financial stability.

Third, an SRM would facilitate speedy and effective resolution of large and complex cross-border banks, removing the need for drawn-out and inefficient cooperation between multiple national authorities.

To generate these benefits, in our view the SRM must be built around a Single Resolution Authority and a European Resolution Fund.

Conclusion

Let me now conclude.

The ongoing process of adjustment in the euro area, if persevered with, will create a path out of the crisis.There is no doubt that this path is a challenging one, as it depends on deeprooted reforms to the structure of the euro area’s economies, and these require courage to implement and a willingness to confront vested interests.

But it is critical that governments stay the course, as this will allow the confidence effects of a brighter outlook to start being felt already in the short-term.

For its part, the ECB will continue to fulfil its mandate to maintain price stability, and to use its standard and non-standard measures to support the flow of credit to the real economy.

But one must also recognise the limits to what we as the central bank can achieve.

We cannot remove barriers to bank lending that stem from insufficient capital or lack of bank repair: these can only be addressed by governments.


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This is why establishing a Banking Union with a strong Single Resolution Mechanism is a priority.

I am glad that the elements of a Banking Union are beginning to fall into place.

A swift implementation of the remaining elements is

needed. Significant progress has been made on fiscal

consolidation andstructural reform.

Looking ahead, credibility is crucial.

Therefore, I welcome the stronger rules for fiscal and macroeconomic policies like the Fiscal Compact.

All these ongoing important adjustment efforts in the euro area should restore confidence in the short-term and lead steadily back to sustainable growth.

Thank you for your attention.


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Disclaimer

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Solvency I I Speakers Bureau

The Solvency I I Association has established the Solvency I I Speakers Bureau for firms and organizations that want to access the expertise of Certified Solvency ii Professionals (CSiiPs) and Certified Solvency ii Equivalence Professionals (CSiiEPs).

The Solvency I I Association will be the liaison between our certified professionals and these organizations, at no cost. We strongly believe that this can be a great opportunity for both, our certified professionals and the organizers.

To learn more:www.solvency-ii-association.com/Solvency_II_Speakers_Bureau.html


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Course TitleCertified 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 Insurance or Reinsurance firms of EEA countries.

B. Work in Groups - Financial Conglomerates (FC), Financial Holding 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.


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About the Course

INTRODUCTION The

European Union’s 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

Insurers 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


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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 Internal Assessment Process ORSA - The Supervisory Tool ORSA - Not 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 Internal 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


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INTERNAL 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 Insurers: The Proportionality

Principle Captives and Solvency I ISolvency ii Association

























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EQUIVALENCE WITH SOLVENCY I I AROUND THE WORLD Solvency ii and Countries outside the European Economic

Area The International Association of Insurance 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 Insurance

Commissioners (NAIC) - The Federal Insurance Office created under the Dodd-Frank Wall Street Reform and Consumer Protection Act in the USA, and the ORSA in the USA

FROM THE REINSURANCE DIRECTIVE TO THE SOLVENCY I I DIRECTIVE

Directive 2005/ 68/ EC of 16 November 2005 on Reinsurance - The Reinsurance Directive (RID)

CLOSING The Impact of Solvency ii Outside the EEA Providing Insurance 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


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Solvency ii News May 2013

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