EN

(...PICT...)|EUROPEAN COMMISSION|

Brussels, 16.8.2010

SEC(2010) 979

COMMISSION STAFF WORKING DOCUMENT

IMPACT ASSESSMENT Accompanying document to the Proposal for a DIRECTIVE OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL amending Directives 98/78/EC, 2002/87/EC and 2006/48/EC as regards the supplementary supervision of financial entities in a financial conglomerate

{COM(2010) 433 final} {SEC(2010) 981 final}

This document commits only the Commission's services involved in its preparation and does not prejudge the final form of any decision to be taken by the Commission

TABLE OF CONTENTS

1. Introduction 4

2. Procedural issues and consultation of interested parties 7

2.1. Consultation process 7

2.2. Inter-services steering group 9

2.3. Impact Assessment Board of the Commission 9

3. Problem definition 10

3.1. Nature and size of the market 10

3.2. EU legislative and international frameworks 12

3.3. Problems 13

3.3.1. Supervision at the holding company level 13

3.3.2. Supervisory coordination 17

3.3.3. Identification 18

3.3.4. Participations – identification and supervision 20

3.3.5. Problem tree 21

3.3.6. Subsidiarity and proportionality of EU action 21

4. Objectives 22

4.1. Coherence of objectives with other initiatives of the Commission 24

5. Policy options, impact analysis and comparison 27

5.1. Supplementary supervision on holding company level and supervisory coordination 27

5.1.1. Alignment of supervisory powers 27

5.1.2. Identification of RCAs 30

5.2. Financial conglomerate identification process 31

5.2.1. Inclusion of AMCs in the identification process 31

5.2.2. Risk-based identification 33

5.3. Participations 37

5.4. The package of preferred policy options and its impact 40

6. Monitoring and evaluation 42

7. Annex I: Acronyms 43

8. Annex II: Glossary 45

9. Annex III: FICOD review process 47

1. Introduction

The establishment and development of large, complex groups combining licenses in various sub-sectors of the financial market, and in particular combining insurance business with banking business, was recognized in the early nineties. The Joint Forum Joint G10 Committee of Basel Committee of Banking Supervisors, International Association of Insurance Supervisors, and International Organization of Securities Committees - the G10 body of supervisors which monitors and discusses financial market trends affecting banking, insurance and securities markets - observed a need for additional supervision of this kind of groups and published their principles for the supervision of financial conglomerates in 1999. These principles explain that such supplementary supervision should enable supervisors to monitor, ring-fence, limit or otherwise influence activities which may spread risks from one entity of a financial conglomerate to another. The objective of this supplementary supervision was the control of potential risks of double gearing (i.e., multiple use of capital) and "group risks", i.e., the risks of contagion, management complexity, concentration, and conflicts of interest, which arise incrementally when licenses for different financial services are combined under the same roof. The typical supervisory tools for this kind of supervision would be not only monitoring tools such as reporting of intra-group transactions, but also requirements for internal governance and group-wide risk management, and, of course, supervisory cooperation requirements. Last but not least supervisors would need exclusive powers to access information when approaching entities in a conglomerate.[1]

Joint G10 Committee of Basel Committee of Banking Supervisors, International Association of Insurance Supervisors, and International Organization of Securities Committees

The Financial Conglomerates Directive Directive 2002/87/EC on the supplementary supervision of credit institutions, insurance undertakings and investment firms in a financial conglomerate ( FICOD), a short directive of about 20 articles, was adopted in 2002 as a response to the need for supplementary supervision of complex groups laid out in those Joint Forum principles. The objective of supplementary supervision has been supported ever since by stakeholders when consulting on this initiative .[2]

Directive 2002/87/EC on the supplementary supervision of credit institutions, insurance undertakings and investment firms in a financial conglomerate

FICOD supplements the two relevant sectoral directives: the Capital Requirements Directive (CRD) Directive 2006/48/EC relating to the taking up and pursuit of the business of credit institutions and directive 2006/49/EC on the capital adequacy of investment firms and credit institutions and the insurance directives. CRD provides for the prudential supervision of deposit-taking banks and electronic money institutions. The activities of such firms build on the leveraging of available capital, CRD Annex I contains a list of relevant activities. and the directive aims at the protection of depositors through ensuring prudential soundness. The capital requirements relate to bank-specific risks, which are applicable to all regulated banking entities, stand alone and in a group. The insurance directives, aimed at the protection of policyholders, provide for the prudential supervision of firms conducting insurance activities and whose activities build on the investment of paid up premiums in such a way that the cashflows from these investments ensure that insurance claims can be paid out. To this end, insurance companies calculate how much provisions (the so-called technical provisions) they should keep for these claims. The capital requirements for insurance companies are related to insurance-specific risks, more specifically to the uncertainty implicit in the calculation of technical provisions. Solvency II Annex I contains a list of non-life insurance activities, Solvency II Annex II contains a list of life-insurance activities. CRD and the insurance directives can be applied on a solo level to each licensed entity, and on a consolidated level so that all licensed legal entities subject to the same directive are aggregated.[3][4][5]

Directive 2006/48/EC relating to the taking up and pursuit of the business of credit institutions and directive 2006/49/EC on the capital adequacy of investment firms and credit institutions

CRD Annex I contains a list of relevant activities.

Solvency II Annex I contains a list of non-life insurance activities, Solvency II Annex II contains a list of life-insurance activities.

While banking and insurance directives are thus aimed at calculating sufficient (capital) buffers for the protection of depositors and policyholders, FICOD, on the other hand, is concerned with the supplementary supervision of group risks, which are not bank- or insurance specific, but are rather inherent in controlling a group of many regulated entities that operate in different kinds of financial markets. This implies that entities which have a mutual relationship that affects the risk profiles of each of them must be included in the supervisory scope. For example, if a group were to invest in an airport, the CRD would require the bank in that group to determine a relevant exposure to the airport, if any, and keep sufficient capital for it. FICOD, for its part, would require the conglomerate to assess the potential contagion risks arising from difficulties or extreme stress scenarios experienced by the airport, and have contingency plans, ringfencing alternatives or other governance measures available. A typical example of the complexity caused by non-regulated entities in the financial conglomerate is the Macquarie group in Australia, which started with technology, aeroplanes and an airport. Now the group also has a bank and an insurer. This implies that the management of the group and the supervisor of the financial sector has to be aware of the effects of the safety on the airport (e.g. the possibilities of terrorist attacks) on consumers' behaviour vis-à-vis the bank – what is called reputation risk or franchise risk. Europe has no experience of this kind of conglomerate, but some American groups (GE, GM) do have (small) banking licenses that operate in the EU, which calls for a specific supervisory perspective.[6]

A typical example of the complexity caused by non-regulated entities in the financial conglomerate is the Macquarie group in Australia, which started with technology, aeroplanes and an airport. Now the group also has a bank and an insurer. This implies that the management of the group and the supervisor of the financial sector has to be aware of the effects of the safety on the airport (e.g. the possibilities of terrorist attacks) on consumers' behaviour vis-à-vis the bank – what is called reputation risk or franchise risk. Europe has no experience of this kind of conglomerate, but some American groups (GE, GM) do have (small) banking licenses that operate in the EU, which calls for a specific supervisory perspective.

(1) FICOD envisaged a review of its provisions some years after implementation. In addition to this formal requirement, a review of the effectiveness of the directive is also justified by the economic and supervisory environment. Markets have developed in a direction where the distinction between banking business and insurance business is not always clear and where the largest groups are active in many countries. The traditional supervisory perspective of monitoring whether a single authorized legal entity complies with its obligations is no longer adequate for groups that contain more than 1,000 licenses in all sectors and in many countries. Both the revision of the 1988 Basel Accord in 2004, and its European implementation by the CRD in 2006, and the introduction of a comprehensive set of regulations for insurance companies in Solvency II (S2) Directive 2009/138/EC on the taking-up and pursuit of the business of Insurance and Reinsurance (Solvency II) (recast) , but until Solvency II is implemented, the FICOD supplements the directives presently in place developed the regulatory framework but, as regards conglomerates, only in so far as legal entities of a group are active in the same sector, banking or insurance. The regulatory framework to address the additional complexity and the additional risks stemming from combinations of licenses, as set out in the FICOD, has not yet been evaluated. This review of the FICOD effectively started in 2008 and formed the basis of the legislative proposal that this impact assessment accompanies. A couple of non-controversial technical issues were included in the Commission's proposal for Omnibus Directive COM(2009) 576 final, proposal for a directive of the European Parliament and of the Council amending Directives 1998/26/EC, 2002/87/EC, 2003/6/EC, 2003/41/EC, 2003/71/EC, 2004/39/EC, 2004/109/EC, 2005/60/EC, 2006/48/EC, 2006/49/EC, and 2009/65/EC in respect of the powers of the European Banking Authority, the European Insurance and Occupational Pensions Authority and the European Securities and Markets Authority in October 2009, accompanying the Regulations COM(2009) 501 final, proposal for a regulation of the European Parliament and of the Council establishing a European Banking Authority; COM(2009) 502 final, proposal for a regulation of the European Parliament and of the Council establishing a European Insurance and Occupational Pensions Authority; COM(2009) 503 final, proposal for a regulation of the European Parliament and of the Council establishing a European Securities and Markets Authority establishing the new European Supervisory Authorities. [7][8][9]

Directive 2009/138/EC on the taking-up and pursuit of the business of Insurance and Reinsurance (Solvency II) (recast) , but until Solvency II is implemented, the FICOD supplements the directives presently in place

COM(2009) 576 final, proposal for a directive of the European Parliament and of the Council amending Directives 1998/26/EC, 2002/87/EC, 2003/6/EC, 2003/41/EC, 2003/71/EC, 2004/39/EC, 2004/109/EC, 2005/60/EC, 2006/48/EC, 2006/49/EC, and 2009/65/EC in respect of the powers of the European Banking Authority, the European Insurance and Occupational Pensions Authority and the European Securities and Markets Authority

COM(2009) 501 final, proposal for a regulation of the European Parliament and of the Council establishing a European Banking Authority; COM(2009) 502 final, proposal for a regulation of the European Parliament and of the Council establishing a European Insurance and Occupational Pensions Authority; COM(2009) 503 final, proposal for a regulation of the European Parliament and of the Council establishing a European Securities and Markets Authority

(2) The review process has indicated that "group risks" arise across the whole financial sector, underscoring the importance of the supplementary supervision of links within financial groups and between financial institutions. While the Commission Services, with the help of the supervisors gathered in the Joint Committee on Financial Conglomerates (JCFC), Advisory committee for financial conglomerates at Lamfalussy level 3 were reviewing the FICOD, similar initiatives were undertaken in the US The Obama Administration proposed to Congress that supplementary supervision of large, complex financial groups should be carried out by the Federal Reserve, on top of the existing license-based supervision by the several existing authorizing bodies. The proposal does not distinguish explicitly between pure banking groups, pure insurance groups or conglomerates. It acknowledges that large, complex financial groups can pose additional risks to society. and Australia The Australian Prudential Regulation Authority, which has a long experience of integrated and supplementary prudential supervision, is considering how to oversee the contagion arising from non-regulated entities of financial groups. See http://www.apra.gov.au/media-releases/10_06.cfm based on the original principles published by the Joint Forum. [10][11][12]

Advisory committee for financial conglomerates at Lamfalussy level 3

The Obama Administration proposed to Congress that supplementary supervision of large, complex financial groups should be carried out by the Federal Reserve, on top of the existing license-based supervision by the several existing authorizing bodies. The proposal does not distinguish explicitly between pure banking groups, pure insurance groups or conglomerates. It acknowledges that large, complex financial groups can pose additional risks to society.

The Australian Prudential Regulation Authority, which has a long experience of integrated and supplementary prudential supervision, is considering how to oversee the contagion arising from non-regulated entities of financial groups. See http://www.apra.gov.au/media-releases/10_06.cfm

(3) The review revealed that where the supplementary supervision was applied as intended, objectives of the FICOD were met. However, the review also showed that achievement of these objectives could be obstructed by issues in the areas of supervisory scope, including supervision at the holding company level, and coordination, financial conglomerate identification and supervisory treatment of participations. For instance, during the crisis several supervisors found themselves not being able to simultaneously apply both sectoral consolidated supervision and supplementary supervision (see Section 3.3.1 ). This specific problem, which relates to the inclusion of "mixed financial holding companies" in the FICOD, the CRD and the Insurance Group Directive (IGD) Directive 98/78/EC on the supplementary supervision of insurance undertakings in an insurance group , calls for an immediate solution. Other issues for improvement were found, in the areas of supervisory scope and regulatory capital, which need more time to mature because of international developments, especially in the Basel Committee and the Joint Forum, as well as ongoing debates about CRD and Solvency II.[13]

Directive 98/78/EC on the supplementary supervision of insurance undertakings in an insurance group

This report accompanies a legislative proposal to amend the FICOD which is primarily aimed at eliminating unintended consequences and technical omissions in the original directive that were identified during the review and ensuring that FICOD's objectives are achieved more effectively. The proposal is meant as a quick fix for these unintended consequences, which need to be restored urgently. The other issues which were found during the review, e.g., in the areas of supervisory scope, especially with respect to the non-regulated entities in a group, and regulatory capital, need to mature because of international developments, including those in the Basel Committee and the Joint Forum, and ongoing debates about the sectoral directives (CRD III, CRD IV; S2). Regulatory capital is being discussed in the Basel committee, the inclusion of non-regulated entities is being discussed in the Joint Forum. These issues are being investigated by the Commission services and discussed with stakeholders publicly, among others, in a Conference of 7 June 2010, already.[14]

Regulatory capital is being discussed in the Basel committee, the inclusion of non-regulated entities is being discussed in the Joint Forum.

2. Procedural issues and consultation of interested parties

2.1. Consultation process

Consultation with three key groups of stakeholders - member states, supervisors, the industry - has been taking place since the first plans for the FICOD review in early 2008 (see Table 1 for a chronological overview of main events in the consultation process; see Annex III for a more detailed overview of the FICOD review process). The Commission services took stakeholder responses into account in order to determine which issues to address, which policy options to consider and assess for their impact.

The member states' regulators, represented by the European Financial Conglomerates Committee ( EFCC) Lamfalussy level 2 committee for financial conglomerates , have been involved in the review since April 2008, and have been kept up-to-date about its progress, including via an EFCC newsletter which is available on the Commission's website.[15]

Lamfalussy level 2 committee for financial conglomerates

The supervisory community, represented by the JCFC, was informed and involved immediately after the regulators had supported the Call for Advice of April 2008. The JCFC set up a FICOD review working group, consisting of about 20 supervisors from across the EU and meeting approximately once a month. The JCFC has been updating regularly the EFCC about the progress of its work. This impact assessment report and the legislative proposal that it accompanies build to a large extent on the JCFC's preparatory work.

The industry has been involved since May 2008 by means of the EFCC first newsletter and dialogues. It was invited to establish an industry "mirror group" consisting of the major financial conglomerates in the EU. Some or all of the following usually participate: Deutsche Bank, ING, BNP Paribas, (Fortis), AXA, Allianz, British Bankers Association representing, among others, HSBC, HBOS, RBS, Barclays. Given the two different perspectives of the CRD and S2, the banking-led groups and the insurance-led groups tend to have specific positions. The mirror group of bank-led conglomerates was facilitated by the European Banking Federation (EBF) and the mirror group of insurance-led conglomerates by the Commission Européenne d'Assurance (CEA). Other European associations such as the European Association of Co-operative Banks (EACB), the European Association of Savings Banks (EASB) and the European Association of Public Banks (EAPB) participated in the hearings and consultations. Also, the industry presented its views at the EFCC meetings on several occasions.[16]

Some or all of the following usually participate: Deutsche Bank, ING, BNP Paribas, (Fortis), AXA, Allianz, British Bankers Association representing, among others, HSBC, HBOS, RBS, Barclays. Given the two different perspectives of the CRD and S2, the banking-led groups and the insurance-led groups tend to have specific positions.

In May 2008 a Call for Evidence to the industry was published in the EFCC newsletter. Several individual groups, national associations and European associations responded to this Call. Industry's main messages, as expressed at the Roundtable on 8 September 2008 in Brussels and at the EFCC meeting on 22 January 2009, and confirmed on 8 July 2009 in Frankfurt, were as follows:

– Harmonize the definition of capital across the sectoral directives (CRD and S2);

– Make the FICOD identification criteria more risk-based;

– Address the interaction of the three directives to ensure a predictable level playing field and converged supervisory practices, particularly with regard to the inclusion and treatment of participations;

– Allow for a supervisory review process (i.e., Pillar 2), including assessment of internal group-wide risk strategies, model development, internal control and related policies at the top level; and

– Clarify which accounting rules should be applied to capital aggregation methods.

– Also, the industry expressed its support for the concept of supplementary supervision as defined in the FICOD for the purpose of supervising conglomerates.

– The draft proposal to amend the FICOD reflects the industry's views with respect to the identification criteria and, by allowing for guidelines, with respect to the supervisory treatment of participations and methods of capital aggregation, as well as alignment between the CRD, S2 and the FICOD in order to to allow for a group-wide supervisory review process. Any harmonization of the definition of capital will be proposed only after the conclusion of sectoral debates, especially on the amendments to the Basel II bank capital framework that are currently ongoing at the Basel Committee.

In May 2009, the JCFC published their review findings and policy recommendations for a consultation which ran from 29 May until 28 August 2009 . As mentioned above, the draft advice was discussed with the industry in a hearing on 8 July 2009 in Frankfurt. A public consultation on the remaining questions and potential policy alternatives, considered by the Commission services, ran from 6 November 2009 until 15 January 2010.

Both consultations were targeted at both member states and the industry. Responses to the Commission's public consultation from both large and small bank- and insurance-led conglomerates, revealed a broad support for its suggestions in four main areas: restoring supervisory powers at the top level of conglomerates, risk-based identification, inclusion of asset management companies and treatment of participations. http://ec.europa.eu/internal_market/consultations/2009/fcd_review_en.htm [17]

http://ec.europa.eu/internal_market/consultations/2009/fcd_review_en.htm

Table 1: Overview of main events and milestones in the consultation process

Time|Event / milestone|Description|Stakeholders involved|

|||Regulators(EFCC)|Supervisors(JCFC)|Industry|

Apr 2008|Call for advice to JCFC|Launch by EFCC|√|√||

May 2008|Industry mirror group|Set up|||√|

May 2008|Call for evidence to the industry|Issued|√||√|

Sep 2008|Roundtable in Brussels|Discussion of main issues|√|√|√|

Dec 2008|Public hearing in London|Discussion of JCFC's initial findings||√|√|

Jan 2009|EFCC meeting|Discussion of interim findings of the JCFC and the industry|√|√|√|

May 2009|Draft advice of JCFC|Published||√||

May - Aug 2009|Consultation on draft JCFC advice|Consultation conducted by the JCFC|||√|

Jul 2009|JCFC meeting in Frankfurt|Discussion of JCFC's draft advice||√|√|

Nov 2009 - Jan 2010|Public consultation on policy alternatives|Consultation conducted by the Commission services|√|√|√|

2.2. Inter-services steering group

The Commission services' impact assessment steering group, chaired by Directorate-General for Internal Market and Services, was set up to follow progress and provide views from other services of the Commission, including Directorates-General for Competition, Economic and Financial Affairs, Employment, Secretariat General, Legal Services and Health and Consumers. The group met three times in March and July 2009, and in April 2010. Before the launch of the Commission Services consultation in October, the group was consulted in a round of written comments.

2.3. Impact Assessment Board of the Commission

The draft impact assessment was discussed with the Impact Assessment Board (IAB) The IAB is an independent internal body of the Commission set up to ensure more consistent and higher quality of impact assessments prepared by various Commission departments. The IAB works under the direct authority of the Commission President. Its members are appointed in their personal capacity and on the basis of their expert knowledge. on 19 May 2010. This revised impact assessment report reflects the comments of the IAB as follows:[18]

The IAB is an independent internal body of the Commission set up to ensure more consistent and higher quality of impact assessments prepared by various Commission departments. The IAB works under the direct authority of the Commission President. Its members are appointed in their personal capacity and on the basis of their expert knowledge.

– Extent, to which the FICOD achieved its objectives, has been elaborated by further explaining how and in which specific areas the effectiveness of supplementary supervision has been compromised during the financial crisis and by including stylised examples;

– Presentation of economic statistics on conglomerates has been improved by including an overview of their market share (with and without the groups that have been waived by national supervisors from the supplementary supervision) in the total financial sector, comprising both banks and insurers;

– The rationale behind maintaining the materiality thresholds in the conglomerate identification process has been clarified;

– A more detailed overview of the several other policy initiatives related to financial conglomerates, including the Omnibus Directive, the Crisis Management Communication and the upcoming fundamental review of FICOD has been included;

– A list of acronyms and a glossary have been added, use of technical language reduced and a number of other more detailed comments by the IAB have been reflected throughout the report.

3. Problem definition

3.1. Nature and size of the market

The current directive covers 69 European groups (end 2009 figures) and 6 third country groups, which are identified as a financial conglomerate. A financial conglomerate is broadly defined as a group that has at least one entity in the banking sector and one entity in the insurance sector, and whose activities in the smallest sector (either banking or insurance) according to Article 3 is more than 10% of the group. The 10% threshold is the average of the part of the smallest sector in i) total assets and ii) total solvency requirement. Article 3 also defines a financial conglomerate if the absolute threshold of €6 billion of assets in the smallest sector is met, but allows for a waiver if the aforesaid 10% threshold is not met. These provisions were intended to examine whether the group is sufficiently cross-sectoral to constitute a financial conglomerate. About 35 of them are small and operate mainly domestically with a relatively small number of licenses. A license is a legal entity that is authorized by a competent (supervisory) authority to conduct a range of business activities in a specifically defined and confined part of the financial sector, for example, a banking license, a life-insurance license. In some countries, licenses can be restricted to a specific set of activities, e.g. a mortgage bank license, or a savings bank license. Each jurisdiction authorizes its own legal entities, but the European passport allows financial institutions to provide financial services throughout the internal market while being authorized in one of its member states. Groups usually make sure they have authorization to conduct all the kinds of businesses in financial services their clients might ask for, in several member states, as well as outside the EU. Although the revision is also intended to simplify the supervision on the smallest conglomerates, it specifically deals with the supervision of the 30 or so biggest financial groups in Europe. These are engaged in both the banking and insurance businesses, and the majority also carry on asset management business. The net list, the list without waived groups, is published: http://ec.europa.eu/internal_market/financial-conglomerates/docs/200907_conglomerates_en.pdf A typical large conglomerate has over 400 licenses in several jurisdictions and several sectors (banking, life and/or non-life insurance, asset management). The biggest conglomerates may have over 900 legal entities or licenses. Total assets of the 30 largest financial groups as of end 2009 exceeded €25 trillion, Including assets of non-regulated parts/entities of these groups which is equivalent to about 208% of the EU GDP and represents a substantial share of the EU banking market of roughly €42 trillion assets As of end 2008, source: ECB and the EU insurance market of roughly €10 trillion assets. Whereas gross insurance premiums written by these 30 groups constituted almost a half of the EU insurance market of €1 trillion gross premiums in 2008 Since the total assets of the remaining 39 groups make up a considerably smaller amount, the total assets of all 69 groups covered by the directive can be assumed to be also equal to €25 trillion while their share in the combined EU banking and insurance market of €52 trillion can be approximated to 48%.[19][20][21][22][23][24]

A financial conglomerate is broadly defined as a group that has at least one entity in the banking sector and one entity in the insurance sector, and whose activities in the smallest sector (either banking or insurance) according to Article 3 is more than 10% of the group. The 10% threshold is the average of the part of the smallest sector in i) total assets and ii) total solvency requirement. Article 3 also defines a financial conglomerate if the absolute threshold of €6 billion of assets in the smallest sector is met, but allows for a waiver if the aforesaid 10% threshold is not met. These provisions were intended to examine whether the group is sufficiently cross-sectoral to constitute a financial conglomerate.

A license is a legal entity that is authorized by a competent (supervisory) authority to conduct a range of business activities in a specifically defined and confined part of the financial sector, for example, a banking license, a life-insurance license. In some countries, licenses can be restricted to a specific set of activities, e.g. a mortgage bank license, or a savings bank license. Each jurisdiction authorizes its own legal entities, but the European passport allows financial institutions to provide financial services throughout the internal market while being authorized in one of its member states. Groups usually make sure they have authorization to conduct all the kinds of businesses in financial services their clients might ask for, in several member states, as well as outside the EU.

The net list, the list without waived groups, is published: http://ec.europa.eu/internal_market/financial-conglomerates/docs/200907_conglomerates_en.pdf

Including assets of non-regulated parts/entities of these groups

As of end 2008, source: ECB

Whereas gross insurance premiums written by these 30 groups constituted almost a half of the EU insurance market of €1 trillion gross premiums in 2008

Chart 1 below shows the distribution of these financial conglomerates - both bank- or insurer-led – in terms of size. The Y-axis shows the arithmetic average of two ratios: i) balance sheet total of the smallest sector to the consolidated balance sheet total, and ii) regulatory capital requirements of the same sector to total regulatory capital requirements of the group. It indicates the proportional shares of the respective sectors within a conglomerate can vary substantially. It also shows that insurer-led conglomerates are smaller in general. This is because the economic impact of insurance groups is usually measured in terms of total premiums collected, which is not plotted in this chart. Comparing insurance and banking business based on their asset size is not a fair exercise, since importance of insurers is usually gauged by the size of their paid up premiums, while banking business is based on leveraging the capital base. Based on balance sheet figures only, the banking activities would by definition be over-stated compared to insurance activities. Also, current identification provisions for financial conglomerates do not clearly cover asset management companies. As a result, practices as to the inclusion of asset management companies vary, with the result that the conglomerates plotted in the Chart are not fully comparable (more about this problem in section 3.3.3 ). [25]

Comparing insurance and banking business based on their asset size is not a fair exercise, since importance of insurers is usually gauged by the size of their paid up premiums, while banking business is based on leveraging the capital base. Based on balance sheet figures only, the banking activities would by definition be over-stated compared to insurance activities.

Chart 1: Distribution of EU financial conglomerates in terms of size of the smallest sector within a group as of 2007

(...PICT...)

Source: JCFC

As to the drivers for establishing a conglomerate business model, academics claim that conglomerates are set up for commercial reasons: new businesses and markets can be accessed by combining banking and insurance and by exploiting existing distribution channels, but that this combination results in extra risks that are discounted by the market. Knot & Van Lelyveld Knot K., Van Lelyveld I., Do financial conglomerates create or destroy value? Evidence for the EU , Journal of Banking & Finance, 2009 and Schmid & Walter Schmid M., Walter I., Do financial conglomerates create or destroy economic value? , Journal of Financial Intermediation, 2009 show how large and complex financial institutions (LCFIs) are valued at a discount, in their view, probably for various group risk related reasons. Bigger groups that combine many activities suffer from a perception of higher complexity and opaqueness. Völz & Wedow Völz M., Wedow M., Does banks size distort market prices?: evidence for too-big-to-fail in the CDS market , Discussion Paper Series 2: Banking and Financial Studies, Deutsche Bundesbank, 2009 , on the other hand, find a premium for potential bail outs (the too big to fail premium) which decreases the discount for groups which are regarded as systemically important. Thus, although the markets know that LCFIs face a risk management challenge, they consider the same groups of such systemic importance that they factor in the 'inevitability' of government rescue. The crisis prompted a discussion on systemically important financial institutions (SIFIs), for which supplementary supervision as well as additional capital requirements would be justified. The groups which are mentioned in this debate regard part of theidentified conglomerates in the EU. Of the 13 European bank-led SIFIs mentioned by the Financial Times, 12 are conglomerates under this directive (Standard Chartered is not), while of the 6 insurer-led SIFIs, 5 are conglomerates (Aviva is not). Some important conglomerates were not in the FT's list, such as Generali and Credit Agricole. Both views, however, would confirm that LCFIs contain additional risks (complexity and systemic) on top of the specific sector-related risks, and that supplementary supervision is justified.[26][27][28][29]

Knot K., Van Lelyveld I., Do financial conglomerates create or destroy value? Evidence for the EU , Journal of Banking & Finance, 2009

Schmid M., Walter I., Do financial conglomerates create or destroy economic value? , Journal of Financial Intermediation, 2009

Völz M., Wedow M., Does banks size distort market prices?: evidence for too-big-to-fail in the CDS market , Discussion Paper Series 2: Banking and Financial Studies, Deutsche Bundesbank, 2009

The crisis prompted a discussion on systemically important financial institutions (SIFIs), for which supplementary supervision as well as additional capital requirements would be justified. The groups which are mentioned in this debate regard part of theidentified conglomerates in the EU. Of the 13 European bank-led SIFIs mentioned by the Financial Times, 12 are conglomerates under this directive (Standard Chartered is not), while of the 6 insurer-led SIFIs, 5 are conglomerates (Aviva is not). Some important conglomerates were not in the FT's list, such as Generali and Credit Agricole.

3.2. EU legislative and international frameworks

As said in the introduction, FICOD supplements the two sectoral directives, the CRD and insurance directives. A consolidated picture of entities authorized under one directive is usually referred to as a sector-silo, or a 'silo'. Supplementary supervision comes on top of the silo-supervision.

In 2008, the Joint Forum evaluated its principles of 1999 identifying the following concerns:

– Regulatory arbitrage possibilities due to misalignment of sectoral capital definitions;

– Pillar 2 supervision (part of the Basel II framework) is equally justified for non-banking entities in conglomerates, both regulated and non-regulated;

– Funding liquidity under stress circumstances, and

– Lack of legal certainty when capital needs to be transferred between entities located in different jurisdictions (i.e., asset transferability problem).

The first problem must be dealt with by aligning capital eligibility provisions in the CRD and S2, however, sectoral debates would have to be completed first. Regulatory arbitrage is also possible when a group structures itself as a holding company, acquires significant activities in another sector, and thus escapes consolidated sectoral supervision at the ultimate parent level (see Section 3.3.1 ). The second concern was part of this review but relates to a more fundamental question of regulatory scope, and will be addressed in the fundamental review following this initiative (FICOD II). The third concern is assessed by the EU stress testing exercise and a possible proposal of the Commission to introduce a new global standard for bank liquidity risk, whereas the fourth one is dealt with in the Commission's Communication COM(2009) 561 final, an EU Framework for Cross-Border Crisis Management in the Banking Sector, Communication from the Commission to the European Parliament, the Council, the European Economic and Social Committee, the European Court of Justice and the European Central Bank published in October 2009 and its follow up in 2010 and 2011 . Although this initiative focuses on banks, the character of the crisis-related problems, as well as their solutions, are not bank-specific, which implies that solutions presented by the Commission may become applicable to conglomerates as well. The Joint Forum's evaluation thus revealed four fundamental issues which cannot be solved in a straightforward technical revision. Therefore, this revision of the FICOD will have to be followed up by a more fundamental debate on scope and capital quality, and how the FICOD interacts with the two silo-directives.[30]

COM(2009) 561 final, an EU Framework for Cross-Border Crisis Management in the Banking Sector, Communication from the Commission to the European Parliament, the Council, the European Economic and Social Committee, the European Court of Justice and the European Central Bank

3.3. Problems

The FICOD review showed that the achievement of its objectives is mostly obstructed by issues in the areas of supervisory scope, including supervision at the holding company level, and coordination, financial conglomerate identification and supervisory treatment of participations. The remainder of section 3.3 elaborates on these issues in more detail Annex 2 of the JCFC's Capital Advice contains a detailed explanation of the existing legal provisions and their consequences . At the end of the section, a "problem tree" is presented to visually illustrate linkages between problem causes and drivers, and the actual problems that they result in for various stakeholder groups.[31]

Annex 2 of the JCFC's Capital Advice contains a detailed explanation of the existing legal provisions and their consequences

3.3.1. Supervision at the holding company level

Supervision at the level of the holding company is affected by the combination of the current provisions of the FICOD, the CRD and the IGD, referring to 'mixed financial holding companies' (MFHC), 'financial holding companies' (FHC) and 'insurance holding companies' (IHC), respectively. The supervisory tools that can be applied at the ultimate parent level, change when the ultimate parent level becomes an MFHC and can no longer be an FHC or an IHC. Figures 1 and 2 below demonstrate that the identification of a financial conglomerate can impact the application of sectoral group supervision differently, depending on the structure of a group.

Figure 1 The same is true for insurance groups, with reference to the application of the CRD replaced by the IGD : FICOD supplements and partly replaces sectoral supervision if a sectoral banking or insurance group becomes a conglomerate. Before the acquisition, a bank or an insurer is subject to consolidated supervision requirements, as laid out in either the CRD or the IGD. After the acquisition, consolidated supervision can only be applied to a top level banking or insurance entity, if there is such an entity on top of all banking and insurance licenses. FICOD supplements that consolidated supervision.[32]

The same is true for insurance groups, with reference to the application of the CRD replaced by the IGD

ON TOP: CRD + FICOD Bank Bank CRD Bank B Bank A Insurer X Bank B Bank A Figure 2: FICOD replaces sectoral supervision at the ultimate parent level. If an MFHC replaces an FHC and/or an IHC and if the ultimate parent is not a banking or insurance entity (i.e., all licenses are owned directly by an MFHC), consolidated or group supervision provisions can no longer be applied. Solo and sub-consolidated supervision remains for the licenses.

ON TOP:

CRD + FICOD

Bank

Bank

CRD

Bank B

Bank A

Insurer X

Bank B

Bank A

ON TOP: FICOD ONLY MFHC CRD FHC Bank B Bank A Bank A Insurer X Bank B CRD/insurance rules at solo level

ON TOP:

FICOD ONLY

MFHC

CRD

FHC

Bank B

Bank A

Bank A

Insurer X

Bank B

A stocktake among supervisors identified the following sub-problems which result from the interaction between the FICOD and the provisions for supervision at the holding company level in the CRD and the IGD:

– Certain tools of sectoral group supervision that can be applied at the level of an FHC or an IHC can not be applied to the whole group when it is determined an MFHC (see Figure 2). This regards, among other things, the waiving of solo-supervision on subsidiaries, the application of provisions on disclosure (Pillar 3) and the internal capital adequacy assessment process and supervisory review (Pillar 2) on a consolidated basis. In other words, the application of sectoral or supplementary group supervision is determined by group structure; acquiring a license in the other sector and becoming an MFHC, can result in a group which has increased in size and complexity, and therefore representing a higher risk to the financial system, being subject to regulations (solo and FICOD) which may not be as comprehensive as before the acquisition.

In practice, structure-related problems as described with Figure 2 can also appear at sub-consolidated conglomerate levels, leading to additional complications for effective supplementary supervision. The AIG case was a typical example of consolidated sectoral supervision disappearing because of holding structures as illustrated by Figure 3:

Figure 3: Impact on consolidated sectoral supervision in case of groups with complex structures:

(...PICT...)

Source: JCFC

The JCFC expects that almost all of the approximately 30 largest international financial conglomerates have an MFHC at the ultimate parent level, but this information is not confirmed.

– As a consequence, the use of a waiver Article 3(3) allows supervisors to apply this waiver for financial conglomerates where the balance sheet size of the smallest financial sector is in excess of €6 billion, but the smallest sector constitutes less than 10% of the group in terms of its balance sheet and solvency requirement by supervisors in determining whether a group is a financial conglomerate, is influenced by the assessment of whether the application of the sectoral supervision may be more prudent (see Figure 4). This happened to at least 8 large banking groups in Europe whose combined assets constituted some €9 trillion in 2009, effectively reducing the relative size of EU banking and insurance market covered by the scope of the FICOD by a third, i.e., from 48% as indicated in section 3.1 to 31%. Application of the waiver may result in: i) additional prudential risks due to the increase of the group in size and complexity, which would otherwise have been addressed by the supplementary aspects of the FICOD, that translated into risks to the financial stability and impairment of the intra-EU and international competitiveness position of groups that have suffered financial losses as intra-group contagion risk materialised; and ii) differences in supervisory treatment (based on the structure rather than on the risk profile) of conglomerates and thus an unlevel playing field among the largest players in the European financial sector. [33]

Article 3(3) allows supervisors to apply this waiver for financial conglomerates where the balance sheet size of the smallest financial sector is in excess of €6 billion, but the smallest sector constitutes less than 10% of the group in terms of its balance sheet and solvency requirement

Figure 4: FICOD replaces sectoral supervision at the ultimate parent level, which is why a supervisor chooses to waive supplementary supervision, if the thresholds allow so. If an MFHC replaces an FHC and/or an IHC and if ultimate parent is not a banking or insurance entity (i.e., all licenses are owned directly by the holding company), supplementary supervision may be waived and only consolidated or group supervision remains. Contagion and other cross-sectoral group risks cannot be controlled.

ON TOP: CRD ONLY FHC CRD FHC Bank B Bank A Bank A Insurer X Bank B CRD/insurance rules at solo level

ON TOP:

CRD ONLY

FHC

CRD

FHC

Bank B

Bank A

Bank A

Insurer X

Bank B

The recent financial crisis showed that "waived" conglomerates got into situations where their supervisors did not have powers to require the control of risk concentrations and intra group transaction-related risks coming from outside the (banking) sector, potentially contributing to the financial instability (see a stylised example in Box 1).

Box 1: Example of the application of waiver under Article 3(3)

Suppose a large bank, having more than 500 bank licenses in several countries as well as in the USA, and a few insurance licenses, has a financial holding company as its ultimate parent. The Board of executives in this holding company takes group wide decisions such as strategic decisions on the business model and markets it wishes to operate in, the gathering of capital, the allocation of capital to various businesses, the risk appetite and return targets, the internal governance and risk management functions, etcetera. The group is supervised as a banking group on a consolidated basis subject to the CRD. Then the Board decides to strategically expand its business model to a specialized insurance business, for which its banking experience is a competitive advantage, especially in the American market. It acquires this specialized insurance business and thus expands the number of licenses in the group to about 800, and the share of insurance business in its total business to 9% . The holding company becomes by definition a mixed financial holding company (MFHC).

Now the supervisor has to choose to either apply consolidated banking supervision at the ultimate parent level, opting for a waiver in the conglomerates directive, or to apply supplementary supervision but not the consolidated banking supervision to the MFHC. Finding themselves between Scylla and Charybdis, they chose the first. This ensures that they keep the full picture of the banking entities at the level where strategic decisions are taken, but it implies that they forego the tool to monitor or control the impact of the specialized insurance business on the bank, and its contagion coming from the US. Now the business in the US turns out to be not only disappointing, but also contagious to the banking business. The supervisor is left barehanded. Had the consolidated banking supervision been possible at the level of the MFHC, they would have had a tool to monitor and control the contagion coming from this insurance business to the banking activities, supplementary to the consolidated picture of banking business.

– The discretion to exempt a subgroup that is a financial conglomerate within a larger financial conglomerate from supplementary supervision under the FICOD Article 5 presents a challenge in avoiding duplication and unnecessary costs arising from applying sectoral group requirements at multiple entities of a group. [34]

Article 5

For instance, insurance rules permit supervisors to waive insurance sub-groups of an insurance group from sectoral group supervision, and supervisors have applied this waiver in order to avoid regulatory duplication that would arise if the same insurance directive were to be applied at multiple levels of the same group. However, while supervisors are able to apply this waiver to sub-groups of an insurance group with a regulated entity on top or an IHC, they are no longer able to apply the waiver if the group had an MFHC as the parent. If an insurance group has ten such sub-groups before becoming a conglomerate, it could go from being subject to one IGD consolidation requirement to ten such requirements under the IGD upon becoming an MFHC.

This would subject the group to a significantly greater supervisory burden that would generate few additional benefits, which is an unintended effect of the interaction between the FICOD and sectoral group directives. This is further complicated when the sectoral sub-groups are located in different jurisdictions, for example, if a pan-European group were identified as a financial conglomerate and had sectoral sub groups located in different European jurisdictions.

JCFC's confidential stocktake in 2006 revealed that identification practices varied enormously among supervisors. The exercise also showed that supervisors usually tried to apply consistent group supervision within a sector within a jurisdiction (for example to all French bank-led groups). Most importantly, the stocktake revealed that all supervisors sought the most prudent outcome when applying group supervision and/or supplementary supervision. Although the objective was the same for all banking or insurance or integrated national supervisors, the identification choices were made to avoid unintended consequences of combinations of directives and keep as much prudence as possible.

The application of group supervision and supplementary supervision at the right level from a prudential point of view, i.e., the ultimate parent level of a financial group, is what is requested now by the JCFC in its advice. During the consultation, this was echoed by the industry who acknowledged the unlevel playing field problem and called for a more predictable application of supervision at the holding company level.

3.3.2. Supervisory coordination

FICOD supplements the CRD and insurance directives for additional supervision at the ultimate parent level of a group. To that end, it also contains provisions for coordination between different supervisors of a group, a necessity that was already recognized in the IGD which dealt with group risks in insurance groups.

FICOD defines who is a relevant competent authority (RCA), providing for obligatory consultation by the coordinator (the ultimate parent level supervisor) with respect to several supervisory questions. Other competent authorities who granted licenses to parts of the conglomerate are in those cases not consulted. The coordinator and the RCAs are published in the list of identified conglomerates on the Commission's website: http://ec.europa.eu/internal_market/financial-conglomerates/docs/200809_conglomerates_en.pdf The directive describes which elements should be covered by the coordination. The coordination is carried out mainly by means of information exchange and consultation within the "college" of a coordinator and RCAs. FICOD coordination provisions regarding supervisory arrangements are thus clear that they were copied into S2 and the CRD, albeit extended with other elements of coordinated supervision. The coordination provisions are found to be supportive of the FICOD's objectives, although the JCFC's stocktake showed that coordination practices may vary with respect to determination of RCAs. The current provisions leave room for various RCA interpretations, for instance, both the combination of a subsidiary with a foreign branch and all subsidiaries within a country could be considered as a group. Any supervisor of more than one authorized entity in his jurisdiction could knock on the coordinator's door and ask to be granted an RCA status despite the additional indicators (market size and importance in the group) in the same provision. As a result, the number of RCAs who should be consulted by the coordinator at the financial conglomerate level could become rather high, which is not conducive for an effective and efficient coordination of the work to be carried out by a group of RCAs. Considering that the FICOD is a supplementary directive to the CRD and the insurance directives, also the college for the assessment of group risks and multiple gearing of capital throughout the group should be supplementary to the sectoral colleges, and, thus, proportionally composed, i.e., not duplicating their work but effectively adding value.[35]

The coordinator and the RCAs are published in the list of identified conglomerates on the Commission's website: http://ec.europa.eu/internal_market/financial-conglomerates/docs/200809_conglomerates_en.pdf

3.3.3. Identification

Another problem area regards the application of the conglomerate identification provisions in combination with the directive's definition of “a financial sector”. The definition of ‘financial sector’ in Article 2.8 (a) and (c) FICOD states that all financial institutions fall within the bank / investment firm sector and not within the insurance sector. Article 2.8 (b) refers to insurance companies as a separate sector. The analysis of the findings of the MTG and the stocktake of the JCFC showed that provisions on thresholds and the scope for differences in their application present three sub-problems:[36]

The definition of ‘financial sector’ in Article 2.8 (a) and (c) FICOD states that all financial institutions fall within the bank / investment firm sector and not within the insurance sector. Article 2.8 (b) refers to insurance companies as a separate sector.

– The directive does not require the inclusion of asset management companies (AMCs) in the threshold tests, because UCITS were excluded from sectoral prudential supervision in 2002, however, it requires including AMCs in the scope of supplementary supervision. They were added to the scope at the very end of the negotiation process, without sufficient clarity as to how and when they should be included in either the identification or the supervision, or both.

AMCs can facilitate the asset management of a banking or an insurance silo, or both, which may increase potential group risks, but the directive is silent on whether that should make the group a conglomerate. If an AMC is part of a banking or an insurance silo, it is consolidated automatically, but if it is structured outside the silo, it can be excluded. Some supervisors include them, others do not. AMCs can also be part of MiFID Markets in Financial Instruments Directive investment firms or AIFM Alternative Investment Fund Managers firms, which may not be subject to the CRD. In general, the different scopes of the CRD, insurance directives, the MiFID and the proposal for a directive on AIFM COM(2009) 207 final, proposal for a directive of the European Parliament and of the Council on Alternative Investment Fund Managers and amending Directives 2004/39/EC and 2009/…/EC leave regulatory arbitrage opportunities to keep entities out of the scope of supplementary supervision under the FICOD and give rise to unlevel playing field among AMCs. More specifically, if groups structure their AMCs directly under the ultimate parent holding company, they can escape supplementary supervision of the combination of asset management business on the one hand and banking or insurance business on the other, or escape being identified as a conglomerate altogether (see Box 2 for a stylised example).[37][38][39]

Markets in Financial Instruments Directive

Alternative Investment Fund Managers

COM(2009) 207 final, proposal for a directive of the European Parliament and of the Council on Alternative Investment Fund Managers and amending Directives 2004/39/EC and 2009/…/EC

Box 2: Example of regulatory arbitrage in identifying conglomerates with an AMC

A large European insurance-led group is providing pension funds products, by using an investment subsidiary which invests the pension fund assets of policyholders. The legal entity of the investment subsidiary is owned directly by the ultimate parent holding company. The funds under management are formally structured as off balance sheet assets, but the supervisor regards them as bank business assets and wishes to identify the group as a conglomerate. The supervisor cannot regard the group as a conglomerate, because it cannot include the asset management entities in the insurance subgroup. The pension fund business is left outside the supervisory scope and potential contagion, concentration or conflicts of interest between the insurance business and the investment services business cannot be monitored or controlled by the supervisor.

– The threshold tests can be based on different parameters with respect to assets and capital requirements and the current directive is ambiguous as to how to calculate the tests arising from, for example, different accounting treatments of assets.

Also, some financial institutions, e.g., brokers that are not part of a banking group which is supervised on a consolidated basis, do not always have a solvency requirement. As a result, the significance of activities within the banking / investment firm sector versus those within the insurance sector have to be determined based on numbers that are not necessarily available or "fair".

Third, insurer-led conglomerates are identified with the same indicators, assets and capital, but the economic impact is usually measured against gross premiums, which is not yet included as an indicator in the identification process.

– The threshold conditions, given their fixed amounts, are not risk-based. The notion of expected group risks is not addressed by the threshold test. This implies that very small groups with a few licenses in each sector are subject to supplementary supervision, while the largest most complex groups can technically be identified as not being a conglomerate. For instance, the upper-left box in Chart 1 contains ten small groups, all of them smaller than €11 billion in combined banking and insurance assets, yet included in the current scope of the directive. The lower-right box contains seventeen groups which could be waived, because their smallest sector is smaller than 10% of total assets, even though that smallest sector can be as big as €123 billion. While some big bank-led groups are subject to supplementary supervision, others are waived (see section 3.3.1 ); of the insurer-led groups only one smaller one is waived. The lack of risk sensitivity of the conglomerate identification process with respect to the latter sub-sample of financial conglomerates, therefore, may have significant implications both for the protection of creditor / policyholder interests and the financial stability.

In conclusion, by identifying conglomerates that are not really considered as such, and are therefore subject to additional supplementary supervision that may not be proportionate to the risks presented by a group, while not identifying others that might be considered as such when assessing potential group risks, the current provisions on identification can have a negative impact on the effective achievement of the underlying objectives of the directive.

3.3.4. Participations – identification and supervision

The term "participation" is defined differently in the CRD, in the insurance directives and the FICOD Article 2(11) of the FICOD defines participations based on the first sentence of Article 17 of Fourth Council Directive 78/660/EEC of 25 July 1978 on the annual accounts of certain types of companies (which, in turn, specifies that participating interest shall mean rights in the capital of other undertakings, whether or not represented by certificates, which, by creating a durable link with those undertakings, are intended to contribute to the company’s activities), or the direct or indirect ownership of 20% or more of the voting rights or capital of an undertaking . They all refer to Article 17 (defining "participating interest") of the Fourth Council Directive Fourth Council Directive 78/660/EEC of 25 July 1978 on the annual accounts of certain types of companies , which combines two elements in its definition of participation: i) ownership/control, and ii) durable link. The specific definitions in the respective directives are fine-tuned to their respective objectives. For the CRD and insurance directives this is the adequacy of capital in view of the risks taken by the banking and insurance entities, respectively. The definition in these directives needs to make clear at what entity-level capital must be held for the risks in the entities below a parent entity, including for partially owned/controlled entities or entities on which significant influence is exercised. [40][41]

Article 2(11) of the FICOD defines participations based on the first sentence of Article 17 of Fourth Council Directive 78/660/EEC of 25 July 1978 on the annual accounts of certain types of companies (which, in turn, specifies that participating interest shall mean rights in the capital of other undertakings, whether or not represented by certificates, which, by creating a durable link with those undertakings, are intended to contribute to the company’s activities), or the direct or indirect ownership of 20% or more of the voting rights or capital of an undertaking

Fourth Council Directive 78/660/EEC of 25 July 1978 on the annual accounts of certain types of companies

As said in the introduction, FICOD is about the supplementary supervision on group risks, which requires a broader scope of potential sources of group risks and thus a wider definition of participations.

Therefore, the definitions in the three directives are justified by their specific objectives. The control-element (i) is more important for the sectoral supervision; the durable link concept (ii) is more important for the supplementary supervision. However, the interpretation of a durable link appears to vary quite a bit throughout the EU, which implies that supervisors include or exclude seemingly similar participations in/from the scope of supplementary supervision. The industry complains about the lack of clarity with respect to which entities they might expect to be included in the supervisory scope. They add the inconsistency with international accounting standards as a complicating factor. See Annex III of the JCFC's Advice to the European Commission on the review of the FICOD [42]

See Annex III of the JCFC's Advice to the European Commission on the review of the FICOD

From the supervisory perspective, consistent treatment of participations on the day-to-day basis is hampered by the lack of guidance on how to effectively account for their heterogeneity which in turn is driven by various factors such as relative versus absolute ownership figures or longer-term business contracts not accompanied by material ownership. The above lack of clarity has indirect negative effects for the industry as well.

The uncertainty about the supervisory treatment is related to the lack of available relevant information to assess group risks, which is not so straightforward when participations are held in listed firms. National company law may prohibit one minority shareholder from receiving more information about that firm than its other shareholders. If information, for instance, about risks with respect to participations in insurance and reinsurance companies cannot be obtained by bank-led conglomerates, they cannot provide their supervisors with evidence on the satisfactory level of integration of management and internal control with these entities and, subsequently, consolidate them, which gives rise to deduction of such participations from their own funds. After all, consolidation assumes the control of the risks, which is not assured if the parent cannot access the relevant risk management information. Article 59 of the CRD and Article 228 of S2 allow for consolidation as meant in the FICOD "if the competent authority is confident about the level of integrated management and control". Article 59 of the CRD entails discretion for supervisors to allow their credit institutions, as an alternative to deduction of participations from own funds, to apply mutatis mutandis methods 1, 2 or 3 of Annex I to the FICOD for participations envisaged in Article 57(o) & (p). Method 1 (accounting consolidation), however, may be applied only when supervisors are confident about the level of integrated management and internal control regarding the entities which would be included in the scope of the consolidation. If information cannot sufficiently be obtained, for whatever reason, there is no way the parent can control the risks of the participation, and consequently, the parent bank or the parent insurer will have to deduct the participation from own funds. Based on the JCFC data, at the end of 2007 EU groups had participations in the financial sector entities of €415 billion, of which participations held by bank-led conglomerates constituted €398 billion with the remainder held by insurer-led conglomerates. [43]

Article 59 of the CRD entails discretion for supervisors to allow their credit institutions, as an alternative to deduction of participations from own funds, to apply mutatis mutandis methods 1, 2 or 3 of Annex I to the FICOD for participations envisaged in Article 57(o) & (p). Method 1 (accounting consolidation), however, may be applied only when supervisors are confident about the level of integrated management and internal control regarding the entities which would be included in the scope of the consolidation.

3.3.5. Problem tree

The below problem tree illustrates the linkages between problem causes and drivers, and the actual problems described in sections 3.3.1 - 3.3.4 . Problem drivers represented by boxes that are not shaded have already been, partially or fully, addressed by legislative initiatives that are very closely linked to the current proposal to amend the FICOD (please see section 4.1 ).

3.3.6. Subsidiarity and proportionality of EU action

In an increasingly integrated EU financial marketplace, cross-border groups of financial services providers – insurers, banks or investment firms - have become a dominant force. The EU passport allows financial firms to operate across the EU. The group risks outlined above have been shown in theory to rise with group size and materialize especially in this larger, more complex environment. Importantly, gravity and implications of these risks for the financial stability have been underscored by the recent financial crisis. While supplementary supervision on a confined, national basis may help in containing them, actions taken by individual Member States will not be sufficient to facilitate effective and coordinated supplementary supervision in a cross border context that is crucial for the stability of these groups and, in turn, the stability of the financial system they operate in.

The principle of subsidiarity for action at the EU level is substantiated further by a need to amend an existing EU-level legislative tool in order to remove potential regulatory arbitrage opportunities which are made possible by it and to enhance level playing field for European financial conglomerates by ensuring a consistent EU approach for tackling various issues covered by the scope of this legislative initiative.

The supplementary supervision provided by the FICOD is only justified when institutions are potentially exposed to group risks, and / or when management complexity could cover up the potential double use of capital. The sectoral directives, the CRD and insurance directives, deal with the required assessment and management of sector-specific risks and the appropriate capital adequacy thereof. The proportionality of the FICOD is rooted in its supplementary nature: it supplements the sectoral directives and is not meant to replace them. This legislative initiative is aimed at enhancing the effectiveness of supplementary supervision at the ultimate parent level of conglomerates where decisions about attraction and allocation of capital across businesses, and group-wide risk management are taken.

4. Objectives

The over-arching objective of this initiative is to ensure that the effectiveness of the supplementary supervision of large and complex groups in the EU, represented by the FICOD, is enhanced while maintaining the competitive position of these groups. This translates into the following three general policy objectives to:

– Enhance financial stability (G-1) ;

– Enhance safeguarding of creditor and policyholder interests (G-2) ;

– Enhance international competitiveness of EU financial groups (G-3) .

In light of the problems presented in section 3.3 , three sets of operational objectives (see Table 2) have been identified to address the specific problem drivers. Effective realization of such operational objectives should contribute to the achievement of the following longer-term specific policy objectives to:

– Enhance effectiveness of supplementary supervision (S-1) . This means that managers responsible for the risk management, internal governance and capital allocation for the whole group should be held accountable by their supervisors for compliance with sectoral and supplementary supervisory provisions, regardless of whether the top level is a regulated entity or an MFHC. Also, the identification criteria should allow for a supervisory assessment of the nature, scale and complexity of the groups and assure supervisors that the supplementary supervision will not weaken the relevant sectoral supervisory frameworks. Supervisors must be able to assess consequences of the ties between different parts of a group and participations in other firms.

– Reinforce financial conglomerates' risk management (S-2). Internal governance and risk management of financial conglomerates should be enhanced due to a more effective and risk-based supplementary supervision.

– Eliminate regulatory arbitrage opportunities (S-3) . Possibilities to circumvent the current FICOD or sectoral provisions, in particular, by creating group structures that limit the application of sectoral or supplementary rules, shall be eliminated.

– Reduce compliance burden (S-4) . Unnecessary compliance costs for the industry should be cut, among others, by removing small and simple financial groups from the scope of the legislation.

Sub-optimal level of risk management by companies Certain supervisory tools can not be applied to some holding companies Duplication of sectoral supervision at sub-group level Implications for competitiveness of EU financial industry Application of threshold tests hampered by ambiguity of parameters and un-availability of data PROBLEM DRIVERS Lack of alignment in supervisory powers under FCD relative to powers at holding company level available under sectoral directives GENERAL PROBLEMS Exclusion of asset management fund from threshold tests Increased risks to financial stability Unlevel playing field Lack of risk-based, forward-looking dimension in threshold application Inconsistent interpretation of 'durable link' Hampered monitoring of risk concentrations & intra-group transactions Lack of cross-border (and cross-sector) convergence in supplementary supervision Ineffective supplementary supervision i.e. insufficient control of group risks (contagion, complexity, concentration, conflict of interest) and double use of capital Regulatory arbitrage opportunities Unwarranted compliance cost burden for supervisors and companies Discretionary use of waivers and sectoral directives PROBLEM TREE: FICOD REVISION List of financial groups subject to FCD provisions is inappropriate Too vague definition of a relevant competent authority Diverse interpretation of coordination provisions Lack of legal clarity with regard to definition of a 'durable link' Lack of availability of information on participations Sub-optimal protection of creditors and policyholders IDENTIFICATION PARTICIPATIONS S U P E RV I S I ON & COORD I N AN T I ON Lack of legal clarity Lack of guidance for day-to-day treatment of participations

Sub-optimal level of risk management by companies

Certain supervisory tools can not be applied to some holding companies

Duplication of sectoral supervision at sub-group level

Implications for competitiveness of EU financial industry

Application of threshold tests hampered by ambiguity of parameters and un-availability of data

PROBLEM DRIVERS

Lack of alignment in supervisory powers under FCD relative to powers at holding company level available under sectoral directives

GENERAL PROBLEMS

Exclusion of asset management fund from threshold tests

Increased risks to financial stability

Unlevel playing field

Lack of risk-based, forward-looking dimension in threshold application

Inconsistent interpretation of 'durable link'

Hampered monitoring of risk concentrations & intra-group transactions

Lack of cross-border (and cross-sector) convergence in supplementary supervision

Ineffective supplementary supervision i.e. insufficient control of group risks (contagion, complexity, concentration, conflict of interest) and double use of capital

Regulatory arbitrage opportunities

Unwarranted compliance cost burden for supervisors and companies

Discretionary use of waivers and sectoral directives

PROBLEM TREE: FICOD REVISION

List of financial groups subject to FCD provisions is inappropriate

Too vague definition of a relevant competent authority

Diverse interpretation of coordination provisions

Lack of legal clarity with regard to definition of a 'durable link'

Lack of availability of information on participations

Sub-optimal protection of creditors and policyholders

IDENTIFICATION

PARTICIPATIONS

S

U

P

E

RV

I

S

I

ON

&

COORD

I

N

AN

T

I

ON

Lack of legal clarity

Lack of guidance for day-to-day treatment of participations

– Enhance level playing field (S-5) . Level playing field conditions for cross-border groups shall be strengthened by limiting the scope for application of national discretions, such as use of waivers in the financial conglomerate identification process.

– Enhance supervisory cooperation and convergence (S-6) . Cross border cooperation and convergence of the supplementary supervision is important since the FICOD is mainly about LCFIs. A lack of convergence of the interpretations by various supervisors of the directive's provisions hampers the achievement of its objectives.

– Enhance legal clarity (S-7). More legal clarity is warranted from the industry's perspective with respect to outcomes of the financial conglomerate identification process, particularly on issues such as treatment of asset management companies and participations, and application of waivers. From the supervisory perspective, more legal clarity is necessary on identification of relevant competent authorities.

Achievement of the specific policy objectives, in turn, should facilitate the attainment of the three aforementioned general policy objectives. Table 2 provides an overview of the identified problems, drivers underlying them as well as operational, specific and general objectives, by indicating linkages between them.

4.1. Coherence of objectives with other initiatives of the Commission

Several problem drivers and problems that they cause that were described in section 3.3 have been already addressed with the proposal for the Omnibus Directive that was adopted by the Commission in October 2009. This does not change the legal text of the FICOD as the proposed Omnibus Directive aims at the convergence of supervisory practices. The proposed Omnibus Directive dealt substantively with the issues of (i) application of the durable link concept and the treatment of participations in the calculation of capital (see section 3.3.4 ) and (ii) alternative indicators in the conglomerate identification process, when data necessary for threshold calculation are not available (see section 3.3.3 ).

The main impact of these technical standards, as explained in the proposal for the Omnibus Directive, will be further convergence of supervisory practices, thus improving the level playing field, increasing predictability of practices and decreasing compliance costs. Therefore, policy objectives of these legislative initiatives, i.e., proposals for Omnibus Directive and revision of the FICOD, are closely aligned.

Like all initiatives in the supervision package, the revision of the FICOD also contributes to the Commission's aim for more convergence and coherence in the supervisory approaches across countries given that cross border financial conglomerates are exactly the case in point for stronger co-ordination and supervision. These amendments constitute an important element in the total package.

While the problem definition and objective sections of this impact assessment have captured the above areas in order to provide a more complete background for the policy proposals included in the legislative proposal to amend the FICOD, further sections of the report tackle only outstanding issues.

For a broader overview of the Commission's initiatives linked to financial conglomerate supervision please see Box 3.

Box 3: Overview of the Commission's initiatives related to financial conglomerate supervision

· Omnibus directives I and II contain examples of provisions for which the new European Supervisory Authorities should get a role in promoting supervisory convergence (such as the list of items which should be monitored when supervising intra-group transactions i.e. potential contagion channels), as well as alignment of provisions that appear in all financial directives and for which the new Authorities should get a role (such as the harmonization of authorization and notification procedures, but also a consistent use of the durable link concept). Omnibus dealt with the existing provisions that needed harmonisation or convergence.

FICOD I aims at addressing urgent issues that are outlined in this impact assessment, such as the MFHC problem or the flaws within identification process, in order to include or exclude those groups in the scope which should have been included in or excluded from the scope as from 2002. In addition, provisions to promote supervisory convergence, in the areas related to the amendments, are included in FICOD I.

FICOD II must address fundamental problems that not only relate to lessons from the crisis, but also to the sectoral directives. These relate to the inclusion of non-regulated entities in the scope of supplementary supervision, a fundamental review of the definition of financial conglomerate in the light of blurring sector-boundaries, and the alignment of eligibility requirements of regulatory capital across directives. However, this has to account for international progress on these issues and conclusions of sectoral initiatives. MARKT will kick off this debate with a conference on 7 June, then discuss a Call for Advice to the Joint Committee of Financial Conglomerates with the member states at level 2 in October 2010, follow the development of the Advice with the JCFC, and prepare for a proposal in the course of 2011.

Communication on EU Framework for Cross-Border Crisis Management in the Banking Sector is about banks, because of the urgency of the resolution problem for banks. However, both the character of the problems and the solutions thereto, are not bank specific. Solving problems like supervisory cooperation and asset transferability for banks implies solving it for all kinds of groups in the financial market.

Table 2: Summary of problem drivers and objectives

Problem Area|Problem Drivers|Operational Objectives|Specific Objectives|General Objectives|

|||S-1|S-2|S-3|S-4|S-5|S-6|S-7|G-1|G-2|G-3|

|||Enhance effectiveness of supplementary supervision|Reinforce financial conglomerates' risk management |Eliminate regulatory arbitrage opportunities|Reduce compliance burden|Enhance level playing field|Enhance supervisory cooperation and convergence|Enhance legal clarity|Enhance financial stability|Enhance safeguarding of creditor and policyholder interests|Enhance int'l competitiveness of EU financial groups|

Supervision on holding company level and supervisory cooperation|Loss of certain supervisory powers at holding company level available under sectoral directives if MFHC replaces FHC or IHC|Align supervisory powers under the FICOD with powers at holding company level under sectoral directives, regardless of group structure|√|√|√||√||√|√|√|√|

|Loss of certain waivers at sectoral level when MFHC replaces FHC or IHC|Prevent duplication of supervision at consolidated (sub) levels||||√|√||||||

|Definition of 'relevant competent authority' too vague |Enhance legal clarity with regard to the determination of 'relevant competent authority'|√|||||√|√||||

Financial conglomerate identification|Exclusion of asset management companies from threshold tests|Account for the role of asset management companies, when identifying financial conglomerates|√|√|√||√||√|√|√|√|

|Application of quantitative threshold tests hampered by ambiguity of certain parameters and data unavailability|Enhance identification process by allowing for more leeway to qualitatively assess potential group-wide risks, that quantitative tests alone do not capture|√|√||√|√||√||||

|Lack of risk-based, forward-looking dimension in threshold application||||||||||||

Treatment of participations|Lack of legal clarity with regard to definition of a 'durable link'|Provide a more clear definition of 'durable link' or improve clarity on the application of the durable link criterion|√|√||||√|√|√|√|√|

|Lack of availability of information on participations|Devise appropriate prudential treatment for situations where necessary information on participations is not available|√|√||√||√|||||

5. Policy options, impact analysis and comparison

This section presents the policy options and their impacts on stakeholders for each of the major problem areas. As pointed out above, the analysis covers possible policy options with respect to those problems that are still outstanding following the adoption by the Commission of a proposal for the Omnibus Directive. The identification, analysis and comparison of policy options have been combined for each area to allow for a more coherent presentation. Cumulative impacts of all preferred options are discussed at the end of the section.

5.1. Supplementary supervision on holding company level and supervisory coordination

5.1.1. Alignment of supervisory powers

In order to align supervisory powers at the ultimate parent level of a conglomerate, to prevent both the loss of powers when a group structure changes and the duplication of supervision at the conglomerate level, four options have been considered:

– Policy option 1.1: Retai n current approach;

– Policy option 1.2: Allow an MFHC to be at the same time an FHC or an IHC;

– Policy option 1.3: Add to the MFHC level supervisory powers that are lost at the sectoral level;

– Policy option 1.4: Allow supervisors at the MFHC level to exercise discretionary powers that are lost at the top sectoral level.

Policy option 1.1: Retai n current approach

The current provisions in the FICOD, applying supplementary supervision at the MFHC Article 2(15) level, exclude the form of an MFHC as the top level of a banking group Article 29(1) or an insurance group Article 28(1) . This exclusion was explicitly preferred when the directive was negotiated in 2002, in order to prevent an increase in supervision of (non-regulated) top level holding companies. [44][45][46]

Article 2(15)

Article 29(1)

Article 28(1)

An unforeseen and unintended consequence of the FICOD appeared to be the loss of supervisory reporting waivers at sub-consolidated levels under the IGD that were applicable to IHCs. Another unforeseen and unintended consequence transpired after the adoption of the CRD which introduced supervision at the consolidated, i.e., the FHC level. The interaction of different holding company forms was not considered during the negotiations of the CRD, which focused on the European transposition of the 2004 Basel II framework. The inability to apply several rather important CRD provisions at the MFHC level prompted the waiving from the supplementary supervision of several, mainly larger, banking groups. Without a change to the current provisions problems outlined in section 3.3.1 would remain unaddressed.

In short, the FICOD would continue to provide for a substituting or duplicating supervision, rather than the intended supplementary supervision. Secondly, the waiving of groups from the supplementary supervision by supervisors who wish to retain the powers at the sectoral top level would continue to contribute to the unlevel playing field conditions. As importantly, for European citizens this policy option implies that these complex groups would not be supervised in a comprehensive and prudent way that was aimed for when establishing the FICOD, impairing the supervisory toolkit essential for safeguarding of creditor and policyholder interests and provision of the financial stability.

Policy option 1.2: Allow an MFHC to be at the same time an FHC or an IHC

This policy option entails a legal amendment to end the exclusion of the form of an MFHC as the top level holding company of a banking or an insurance group. This amendment would imply that provisions and powers regarding the ‘old’ FHC or the ‘old’ IHC do not disappear when a group is identified as an MFHC as a result of an acquisition in the other sector. All consequences listed in section 3.3.1 are prevented, and consistency is ensured with any future provision added to the sectoral directives which will be applicable at the top level holding company. To ensure consistency, the provisions of the sectoral directives referring to holding companies should include references to an MFHC, too.

Also, those supervisors who decided to waive their conglomerates from supplementary supervision, because of the loss of powers at the sectoral top level, would be enabled to apply supplementary checks on group-wide available capital, internal control mechanisms and group-wide management of risk concentrations and intra group transactions (this regards especially the largest bank-led conglomerates, see section 3.3.1 ). This would not only provide for a level playing field , legal clarity The study conducted by Europe Economics looked at, among others, compliance costs of financial institutions with the FICOD. It found that for the sample of 44 banks and financial conglomerates, one off implementation costs of this directive were about 0.01% of their operating costs (for a sub-sample of only financial conglomerates the respective estimate was 0.019%). In terms of implementation cost drivers, some 30% of them were caused by legal advice costs, consultancy fees and familiarisation with the directive. Therefore, a share of this 30% of overall implementation costs may be potentially saved by banks as a result of enhanced legal clarity pertaining to supplementary supervision. Source: Europe Economics, Study on the Cost of Compliance with Selected FSAP Measures , 2008 and smaller compliance burden (as sectoral sub-group supervision could be "waived" under this option) to firms as well as more legal clarity to those supervisors who did not have a possibility to apply the group level provisions of the CRD, the IGD and the FICOD as intended, but also enhance the effectiveness of group supervision, thus, aiding the financial stability and better protection of the interests of bank creditors and insurance policyholders. [47]

The study conducted by Europe Economics looked at, among others, compliance costs of financial institutions with the FICOD. It found that for the sample of 44 banks and financial conglomerates, one off implementation costs of this directive were about 0.01% of their operating costs (for a sub-sample of only financial conglomerates the respective estimate was 0.019%). In terms of implementation cost drivers, some 30% of them were caused by legal advice costs, consultancy fees and familiarisation with the directive. Therefore, a share of this 30% of overall implementation costs may be potentially saved by banks as a result of enhanced legal clarity pertaining to supplementary supervision. Source: Europe Economics, Study on the Cost of Compliance with Selected FSAP Measures , 2008

The "open" character of this policy option might give rise to concerns about the duplication of supervision, in case a sectoral directive contains similar provisions. In the CRD this concerns the large exposures regime only, one element of the supervision of risk concentrations. In the IGD there is no provision that could be duplicated. In case the same policy option were chosen for S2 (for which level 2 measures are being developed), a mapping of provisions for concentrations of risks, contagion through intra-group relationships, and group-wide internal governance would be necessary. In order to ensure that only once supplementary supervision is applied, this policy option may need to be accompanied by a general safeguarding provision in specific parts of the legal text, allowing for waivers of either sectoral or top-level supervision on aspects already dealt with by one of the other directives.

Policy option 1.3: Add to the MFHC level supervisory powers that are lost at the sectoral level

This is a version of policy option 1.2 which would entail an amendment of a "closed" character by listing precisely which sectoral top level provisions can also be applied at the conglomerate level. This would pertain especially to (sectoral) group-wide internal capital adequacy assessment process (ICAAP) and capital requirements on a consolidated basis, group-wide internal governance, reporting waivers, and fit & proper management provisions.

Similar to option 1.2, this option would ensure that important supervisory powers at the consolidated level and important waivers for the industry are no longer lost. Similar safeguards to prevent duplication of supervision would be necessary. The main difference with option 1.2 is that the amendment would only affect the legal text of the FICOD, and leave aside the CRD and insurance directives. This difference also implies, however, that any subsequent addition or amendment of the sectoral top level provisions would have to be added to the FICOD as well.

More importantly, this policy option would also imply a deviation from the underlying principle of the FICOD, i.e., supplementary supervision. Currently, top level sectoral supervision is provided for in the sectoral directives and the FICOD is meant to supplement supervision in case complexity is introduced by acquisitions in the other sector. If it were also to correct for losses of powers at the sectoral level, the FICOD would no longer be a solely supplementary legislation.

Policy option 1.4: Allow supervisors at the MFHC level to exercise discretionary powers that are lost at the top sectoral level

An amendment allowing discretion to supervisors to apply sectoral top level powers also at the MFHC level, could have an "open" character, as in option 1.2, or a "closed" character, as in option 1.3. The main difference with policy options 1.2 and 1.3 would be that supervisors themselves would decide whether to apply the sectoral top level powers at the MFHC level.

This policy option would address supervisors’ concern of not being able to apply certain checks at the top level, but would provide no legal clarity whatsoever to the supervised firms. Also, convergence of practices would be difficult to achieve and, thus, unlevel playing field from the perspective of financial conglomerates would be maintained.

Conclusion

Retaining the current scenario (option 1.1), implies that the current problems would persist and, therefore, contribution of the supplementary supervision of financial conglomerates towards all the relevant policy objectives would remain sub-optimal. While policy options 1.2, 1.3, and 1.4 seem to be comparable in terms of their effectiveness as regards contribution towards the objectives of reinforced risk management of financial conglomerates (S-2) and reduced compliance burden (S-4), policy option 1.2 is the most effective among them with respect to objectives of enhanced supplementary supervision (S-1), elimination of regulatory arbitrage opportunities (S-3), enhanced level playing field (S-5) and enhanced legal clarity (S-7). Policy option 1.2 also appears to be the most efficient from the regulatory angle as it preserves a supplementary nature of the FICOD and, therefore, is a preferred option. This preference is in line with the supervisors’ advice. Feedback of the industry to the public consultation showed that it prefers this option as well, provided that potential duplication is explicitly addressed. The member states gathered in the EFCC expressed a similar preference to change the definitions and to make provisions across directives consistent.

Table 3: Summary of policy options' effectiveness and efficiency

PolicyOptions|Policy Option Comparison Criteria|

|Effectiveness|Efficiency|

|Enhance effectiveness of supplementary supervision|Reinforce financial conglomerates' risk management|Eliminate regulatory arbitrage opportunities |Reduce compliance burden |Enhance level playing field|Enhance legal clarity||

1.1 Retain current approach|4|4|4|4|4|4|4|

1.2 Allow an MFHC to be at the same time an FHC or an IHC|1|1-3|1|1-3|1|1|1|

1.3 Add to the MFHC level supervisory powers that are lost at the sectoral level|2|1-3|2|1-3|2|2|2|

1.4: Allow supervisors at the MFHC level to exercise discretionary powers that are lost at the top sectoral level.|3|1-3|3|1-3|3|3|3|

Scale of option ranking: 1=most effective / efficient, 4=least effective / efficient

Effectiveness measures extent to which options achieve relevant objectives

Efficiency measures extent to which objectives can be achieved for a given level of resources

5.1.2. Identification of RCAs

To address the lack of clarity stemming from Article 2(17)(a), defining RCAs as "Member States competent authorities responsible for the sectoral group wide supervision of any of the regulated entities in a financial conglomerate", the following two policy options have been considered:

– Policy option 1.5: Retai n current approach;

– Policy option 1.6: Narrow down the defi nition of RCA to supervisors of ultimate parent entities within individual sectors and supervisors regarded as relevant by the supervisor of the ultimate parent.

Policy option 1.5: Retai n current approach

Under this policy option, the lack of clarity with respect to the interpretation of current provisions, as outlined in section 3.3.2 , would remain.

Policy option 1.6: Narrow down the definition of RCA to supervisors of ultimate parent entities within individual sectors and supervisors regarded as relevant by the supervisor of the ultimate parent

The original objective of the definition under Article 2(17)(a) was to determine the RCA as a supervisor of the ultimate parent within a sector. Policy option 1.6 would make this explicit in the RCA definition. This option in the first place would enhance the legal clarity for the supervisors. Secondly, it would increase the effectiveness of the financial conglomerate determination process, as it focuses on the right sub-group of competent authorities. Most importantly, clarifying the definition by explicitly pointing to the group-wide supervisor of the ultimate parent entity in a sector would be consistent with the objective of the supplementary supervision and is expected to contribute to both the efficiency and effectiveness thereof. The other part of the definition, i.e., those supervisors who are regarded as relevant by the supervisor of the ultimate parent, would remain.

Conclusion

Policy option 1.6 is a preferred option as it is more effective and efficient than option 1.5 in contributing to the attainment of the policy objectives of enhanced supplementary supervision (S-1), enhanced supervisory cooperation and convergence (S-5) and enhanced legal clarity (S-7). This is what both the JCFC and the EFCC would prefer, since they are currently facing a confusing legal provision and would welcome clarity, so that they can focus on the relevance of authorities when determining the college, not on the interpretation of a vague provision. The effectiveness of the amendment will be re-enforced by guidelines regarding its application, as well as the possibility that the Joint Committee of newly established European Supervisory Authorities may mediate in case of disputes.

Table 4: Summary of policy options' effectiveness and efficiency

PolicyOptions|Policy Option Comparison Criteria|

|Effectiveness|Efficiency|

|Enhance effectiveness of supplementary supervision|Enhance supervisory cooperation and convergence|Enhance legal clarity||

1.5 Retain current approach|2|2|2|2|

1.6 Narrow down definition of RCA to supervisors of ultimate parent entities within individual sectors and supervisors regarded as relevant by the supervisor of the ultimate parent|1|1|1|1|

Scale of option ranking: 1=most effective / efficient, 2=least effective / efficient

Effectiveness measures extent to which options achieve relevant objectives

Efficiency measu