Opinion of the Economic and Social Committee on the "Proposal for a Directive of the European Parliament and of the Council on the supplementary supervision of credit institutions, insurance undertakings and investment firms in a financial conglomerate and amending Council Directives 73/239/EEC, 79/267/EEC, 92/49/EEC, 92/96/EEC, 93/6/EEC and 93/22/EEC, and Directives 98/78/EC and 2000/12/EC of the European Parliament and the Council"

(2002/C 36/01)

On 11 May 2001, the Council decided to consult the Economic and Social Committee, under Article 47 (2) of the Treaty establishing the European Community, on the above-mentioned proposal.

The Section for the Single Market, Production and Consumption, which was responsible for preparing the Committee's work on the subject, adopted its opinion on 26 September 2001. The rapporteur was Mr Ravoet.

At its 385th plenary session on 17 and 18 October 2001 (meeting of 17 October), the Economic and Social Committee unanimously adopted the following opinion.

1. Summary of the Commission's document

1.1. The Lisbon Council has taken a strong commitment to integrate European financial markets and set a deadline of 2005 for the implementation of the Commission's Financial Services Action Plan(1) (FSAP). The FSAP announces the Directive for the beginning of 2001.

1.2. The Directive will implement the recommendations of the G-10 Joint Forum of February 1999 on monitoring financial conglomerates, and its additional recommendations issued in December 1999 on intra-group transactions and exposures and risk concentrations. It will also take into account the conclusions of the Brouwer Report on Financial Crisis Management, published by the European Economic and Financial Committee on 21 April 2001 (30 pages). The directive will have a part to play in the development of an integrated world financial market. Consequently, there will be a need to harmonise the rules governing its operation; other initiatives work along the same lines, such as the intention to adopt international accounting standards in the EU, developed in conjunction with the International Accounting Standards Committee (IASC).

1.3. Current EU financial regulation is mainly sector-based and addresses primarily homogeneous financial groups, whose activities are limited either to banking and investment in securities or to insurance. However, within financial conglomerates (groups combining insurance companies, banks and investment firms) existing risks in one specific sector may be amplified, or new risks may be created. These risks should be adequately supervised.

1.4. The draft Directive therefore introduces rules for cross-sector holdings in undertakings as well as group-wide supervision of financial conglomerates. Financial conglomerate supervision supplements the existing sectoral rules for credit institutions, insurance undertakings and investment firms. Thus the proposed directive will (under Articles 18 to 25) amend existing directives in the following areas: "the taking-up and pursuit of the business of credit institutions" (2000/12/EC), "capital adequacy of investment firms and credit institutions" (93/6/EEC), "investment services in the securities field" (93/22/EEC), "coordination of laws, regulations and administrative provisions relating to direct assurance other than life assurance" (73/239/EEC), amended by the "third non-life insurance directive" (92/49/EEC), "coordination of laws, regulations and administrative provisions relating to the taking-up and pursuit of the business of direct life assurance" (79/267/EEC), amended by the "third life assurance directive" (92/96/EEC), and the "supplementary supervision of insurance undertakings in an insurance group" (98/78/EEC).

1.5. The main objectives of conglomerate supervision are:

- to ensure that the financial conglomerate has adequate capital, in particular by preventing the same capital being counted twice over and so used simultaneously as a buffer against risk in different entities ("multiple gearing");

- to introduce methods for calculating a conglomerate's overall solvency position; and

- to deal with the risks of transactions within groups, risk concentration, the suitability and professionalism of management at financial conglomerate level.

2. Details of the Proposal

2.1. The existing sectoral rules for credit institutions, insurance undertakings and investment firms (regulated entities) are supplemented by provisions to avoid an unlevel playing field or regulatory arbitrage between the sectoral rules (Article 18-25). Among these is introduced an obligation to deduct, for supervisory purposes, cross-sector holdings in undertakings amounting to 10 % of their own funds/solvency margin or of 10 % of the holding's own funds/solvency margin (Article 18 No 3, 19 No 3, 25 No 5) from the respective own funds/solvency margin. Member states may however opt not to deduct such holdings, when the undertakings are subject to conglomerate supervision.

2.2. Article 1 lays down that credit institutions, insurance undertakings and investment firms, are subject to conglomerate supervision if they are part of a financial conglomerate. The general definition of the latter is to be found in Article 2 (definitions), whereas the relevant thresholds to be applied are laid down in Article 3.

2.3. According to this definition and these thresholds, a financial conglomerate is a group:

- whose activities mainly consist in providing financial services in the financial sector (exceeding 50 % on the basis of the annual accounts), and

- which comprises at least one insurance or reinsurance undertaking, and at least one other entity of a different financial sector,

- whose cross-sectoral activities are significant. The ratio of the smallest financial sector should exceed 10 % of the balance sheet total and the solvency requirements of the group.

2.4. However, the competent authorities may agree to lower these ratios to avoid frequent regime shifts for firms operating close to the ratio limits or consider income structure or off-balance-sheet activities instead of the balance sheet total [Article 3 (3)].

2.5. Besides meeting the existing sectoral capital requirements, regulated entities in a financial conglomerate must provide sufficient own funds at the level of the financial conglomerate (Article 5). Technical annex I on capital adequacy provides three different methods for carrying out the calculation of the supplementary capital adequacy. The competent authorities may apply any one of these methods alone or in combination.

2.6. For the purposes of these calculations, only own funds elements that are eligible according to each of the sectoral rules ("cross-sector capital") may be considered, thereby excluding a number of sector-specific own funds elements. The own funds at conglomerate level are sufficient, if aggregated own funds are higher than total sectoral capital requirements, if need be taking into account the book value of the holdings in other entities of the group (Annex I).

2.7. Regulated entities within a conglomerate have to establish adequate risk management processes and internal control mechanisms in order to appropriately identify, measure, monitor and control the transactions within the financial conglomerate (i.e. between the entities which make up the conglomerate) and the risk concentration at the level of the financial conglomerate [Article 6 (2)]. On a regular basis, they have to report all significant internal transactions to the supervisory authorities, as well as any risk concentration which is significant to the conglomerate [Article 6 (3)].

2.8. Member States may set quantitative limits with regard to internal transactions within a financial conglomerate and its risk concentration [Article 6 (4)].

2.9. Articles 7 to 13 set rules for co-operation and information exchange among the competent authorities involved in the supervision of the regulated entities within a financial conglomerate (Article 7). The central issue is the identification of one competent authority as "coordinator", responsible for exercising the supplementary supervision. This is supposed to facilitate the co-operation amongst the supervisors involved and to clarify roles among them.

2.10. Other articles relate to adequate internal control mechanisms for the provision of data (Article 10), access to information (Article 11) and on-the-spot verification (Article 12). Article 13 relates to additional powers of the competent authorities, who are given the power to take any supervisory measure necessary to deal with the circumvention of sectoral rules (Article 14).

2.11. Article 14 provides for the application (by analogy) of the rules on conglomerate supervision to regulated entities inside the EU but belonging to a "non EU" group (i.e. whose headquarters are located outside the EU), if not equally supervised.

2.12. Clarification of the definitions in Articles 2 and 3, the alignment of terminology and framing of definitions as a consequence of future legislation, the clarification and adaptation of the capital adequacy requirements in Article 5 and Annex I may be undertaken by "comitology procedure" (Article 16). The latter requires a Commission proposal and the consent of a future "Financial Conglomerates Committee".

3. General Comments

3.1. The Economic and Social Committee supports the objective of the proposed Directive, i.e. to establish an EU-wide framework for an effective supplementary supervision of credit institutions, insurance undertakings and investment firms in a financial conglomerate. Financial conglomerates number among the biggest financial groups worldwide. If financial conglomerates, and in particular credit institutions, investment firms and insurance undertakings that are part of such a conglomerate, were to face financial difficulties, these could seriously destabilise the financial system worldwide and affect individual depositors, insurance policy holders and investors.

3.2. For the ESC, this proposal presents the right approach to prevent situations in which the same capital is used simultaneously as a buffer against risk in two or more entities in the same financial conglomerate ("multiple gearing"), and situations where a parent issues debt and down-streams the proceeds as equity to its regulated subsidiaries ("excessive leveraging").

3.3. Even though, in the opinion of the ESC, this proposal represents an important step forward towards an integrated European financial market and enhanced financial stability, it has to be recognized that its approach is imperfect. Since it is based on the supervisory framework for the different regulated entities, there is no aggregated view on risks, and the effects of diversification and the fact that some activities are not correlated cannot be taken into account. International research underlines the benefits and positive impact of cross-sector diversification. For this reason, the ESC feels that there is a need to debate and further develop risk assessment techniques for financial conglomerates within the regulatory community and with the sectors and other parties concerned. The ESC is therefore of the opinion that rules should be introduced into the Directive which favour the effects of diversification and non-correlated activities, and thus provide incentives for conglomerates to enhance their risk measurement and management capabilities.

3.4. Unlike the method which the Basle Committee followed, there does not seem to have been either a quantitative analysis using simulations or an assessment of the specific risks associated with financial conglomerates, when this draft directive was being prepared; if there have been any, then the ESC is not aware of its results. The European Commission has been informed of these calculations which were carried out at the initiative of the Joint Forum of Supervisors of financial establishments (established at the Bank for International Settlements, including the Basle Committee for monitoring banks, the International Organization of Securities Commissions (IOSCO) as regards investment companies and the International Association of Insurance Supervisors (IAIS); the Committee regrets the fact that the results of these calculations have not been made available to it, since this would allow it to express its opinion with a much fuller knowledge of the facts. These results may raise a question mark over the quantitative technique of deducting holdings. As a consequence, a choice must be made between the speedy adoption of a directive which is basically qualitative in nature, and a directive containing quantitative provisions following more in-depth examination of the actual circumstances and in so far as the simulations to be carried out would warrant it.

3.5. The proposed concept for co-operation and co-ordination among supervisory authorities represents considerable progress; achieving this will constitute a significant step towards establishing a properly organised EU-wide supervisory overview. It will not only improve the flow of information and the quality of supervision, but will also reduce the workload of all parties considerably. The identification of a "Coordinator" will help to prevent conflicts of competence between the various national supervisors and make supervision more effective. In particular it will be essential for the regulated entities to report to their sectoral authority only, and for the coordinator to provide for the communication and co-ordination between the various authorities.

3.6. The proposal, as a legal text, is designed as a framework directive, confining itself to the minimum required. There are few precise benchmarks, as minimum standards, many possible derogations and a very high degree of discretion is given to the Member States and their supervisory authorities. It will be up to the future Financial Conglomerates Committee and the Commission to refine supervisory practice and clarify the terms of the Directive. At a later stage, a convergence of sectoral regulations might be considered. Due to the high complexity of the issues involved and a limited degree of empirical experience in conglomerate supervision, the ESC favours such a flexible approach to conglomerate supervision. It will allow appropriate practice and methods to develop that can be quickly adapted to supervisory standards.

3.7. However, it has to be noted that the very high degree of discretion given to Member States and their supervisors, even concerning many key aspects, creates the possibility of an enormous bandwidth of national supervisory rules and practices. This could create major competitive distortions, if steps are not taken early enough to achieve convergence.

3.8. Therefore, as a general rule, the Committee recommends reducing national options in the Directive, especially those that might have a serious impact.

3.9. Furthermore, the ESC underlines the necessity of achieving convergence of the discretionary decisions of the supervisory authorities. For many questions the proposal gives little guidance e.g. the selection of a calculation method for the capital ratio. Those methods may produce results that diverge considerably. Therefore, as a first step, general principles of law should be taken into account when exercising these discretionary powers, and first of all the principle of proportionality. Thus, as a general rule, supervisors should only apply the least restrictive measures necessary to achieve the envisaged supervisory aims.

3.10. However, it is the firm belief of the Economic and Social Committee that guidelines for the execution of discretion need to be developed. The law and its application have to be transparent and predictable. Therefore, appropriate measures should be taken, e.g. the publication of decisions and findings, including general conclusions relating to individual cases. On the basis of such decisions, calculation methods may be refined and guidelines may be drafted and introduced to the Directive via the comitology procedure.

3.11. The ESC stresses the importance of collaboration and dialogue of supervisors within the "future" Financial Conglomerates Committee. This will be very important for the development of converging supervisory practices.

3.12. Convergence will also flow from experience backed up by as extensive a dialogue as possible between the supervisory authorities and the firms concerned, each at its own level, and especially between the main coordinator and the conglomerate concerned. Actively seeking the most suitable solutions, taking into account previous experience with convergence, will provide a powerful force for convergence, in particular by publishing the guidelines which are applied, as indicated above.

3.13. With regard to the legislative powers of the European Commission, assisted by the future Financial Conglomerates Committee, the ESC also suggests establishing procedures for consultation, in particular of the relevant sectors and other interested parties, with the aim of creating an on-going dialogue. Such procedures should oblige the Commission and the Financial Conglomerates Committee to invite interested parties for consultation, take notice of the presentations given and give reasons for their decisions where appropriate. When combined with similar committee procedures, coordinators' contacts with conglomerates and the contacts which sectoral supervisory authorities have with the firms they are monitoring, this approach is likely to provide consistent momentum towards much-needed gradual convergence.

3.14. Even though conglomerates originated in Europe and have to date expanded in this part of the world in particular, they now seem to be expanding elsewhere, such as in the United States. Introducing a strict supervisory framework in the EU alone would mean seriously distorting competition, to the detriment of its own financial institutions; for this reason the rules should not initially be too strict. It is all the more important for the EU to begin - as soon as the directive is adopted - by consulting the Basle Committee on the need to introduce comparable rules in the other member countries represented on this committee. It is, moreover, a good sign that the Basle Committee has proved to be highly active on the joint forum in drafting rules to govern cooperation between supervisory authorities on conglomerates. The Basle Committee has nevertheless stressed that it has no powers to make the insurance industry adopt international rules on own funds; that is one reason why European rules will not initially be too demanding. The Basle Committee should also be brought into the moves to encourage convergence.

4. Specific Comments

4.1. According to the proposal, a holding above a given threshold in an entity belonging to a sector for which deduction of the holding is not stipulated in the current rules has to be deducted from the respective own funds/solvency margin of a regulated entity (Article 18 No 3, 19 No 3, 25 No 5). However, when passing the threshold for such a deduction, regulated entities will not necessarily have the right to calculate own funds according to the financial conglomerate rules, because as a group they may not be a financial conglomerate according to Articles 2 and 3. This may, in some cases, imply serious disadvantages for a financial group and cause competitive distortions. Therefore, the ESC is of the opinion that there should be an option to apply the capital adequacy rules for conglomerates whenever thresholds for deduction are passed, but not those for qualifying as a financial conglomerate.

4.2. For the ESC it seems essential that financial conglomerates report to one authority only, that is to say that one coordinating body should be their single, direct point of contact.

4.3. For the definition of a conglomerate, the Committee recommends considering not only the aspects laid down in Articles 2 and 3. The best solution might be to take a flexible approach allowing several criteria to be taken into account, such as income, capital, balance sheet total or possibly other parameters.

4.4. According to Annex I, only those sectoral own funds shall qualify for the calculation of the conglomerate solvency requirements that are eligible according to each of the sectoral rules (cross-sector capital). Furthermore, the eligibility of certain own funds as well as the effectiveness of the transferability and availability of the own funds shall be taken into account. Such restrictions may cause serious disadvantages vis-à-vis competitors not subject to conglomerate supervision. Even sector capital may serve as a buffer within the conglomerate and contribute to the reduction of any "contagion risk".

4.5. The proposal considers minority interest on a proportional basis only under the first calculation method (as indicated in Annex I). This would, among other aspects, create a considerable disadvantage for those entities that are subject to supplementary supervision under the other methods. In order to avoid such an imbalance, the Committee suggests sticking to the current rules and allowing full consideration under the two other calculation methods as well.

4.6. Article 6(4) empowers the Member States or the national supervisors to set quantitative limits for transactions internal to the group or to take other supervisory measures that have the same effect. However, there are already a number of sectoral limits. Furthermore, the relevance of transactions within the group and risk concentration is specific to each conglomerate. Therefore the ESC suggests a more flexible approach in this regard and recommends qualitative criteria.

4.7. In order to determine the own funds needed for covering risks which the conglomerates actually run, the directive ought to take better account of the risk reductions flowing from diversification and from techniques created for this purpose, such as hedging. Initially there will probably be frequent major technical obstacles, but that should not prevent a clear objective being defined and a number of stages being completed, such as cross-sector hedging of foreign exchange positions taken by different companies belonging to the conglomerate.

4.8. According to the proposal, a regulated entity may be part of several financial conglomerates, as shareholdings of less than 50 % are sufficient to exercise significant influence. However, in order to avoid any useless restraints, the ESC recommends defining transactions within the group on a narrower base and only including entities where a dominant influence can be exercised by the conglomerate.

4.9. The future directive on conglomerates also aims to improve directives relating to other groups, inter alia insurance groups, while ensuring a certain consistency with the measures it is introducing on conglomerates. As regards the calculation of the solvency margin for an insurance group (i.e. basically its own funds), the draft directive stipulates (in Article 24 (5) amending the Directive on the supplementary supervision of insurance undertakings in an insurance group) that national supervisory authorities be delegated the power to determine which proportional share of this margin must come from the undertakings in an insurance group, where there are no capital links between them. Any such absence of financial links means that reciprocal commitments between these companies can only flow from agreements reached between them. This being the case the ESC proposes:

- the undertakings concerned should preferably determine themselves what this proportional share should be and the onus should be on them to justify their decision at the request of the supervisory authorities;

- failing that, these authorities should take into account any such reciprocal agreements and commitments when setting this proportional share, so as not to commit the undertakings to more than anything that is legally provided for. In this case, the directive could simply align the wording of this paragraph on the corresponding part of Annex I of the proposal (Section I.1, fourth paragraph).

4.10. The implementation of the Directive will involve considerable efforts by the regulated entities as well as by the supervising authorities as far as organisation, reporting procedures and information technology are concerned. Furthermore, it has to be noted that the new Basle Agreement will soon introduce corresponding rules for international banks at a global level. Therefore the ESC recommends that this Directive should be implemented at least a year after its publication in the Official Journal, but not earlier than in 2005, when the Basle Agreement will have to be implemented.

5. Conclusions

5.1. The Committee finds this draft directive valuable because:

- it has a suitable role to play in the globalisation of financial markets and fulfils the consequent need for harmonisation adjusted to circumstances;

- it provides better protection for consumers, meaning here depositors, investors and insurance policy holders;

- it establishes a general framework to cover the currently very different situations between countries, enabling them to draw closer together.

5.2. The mechanism set out in the directive can be expected to entail a marked increase in the own funds of conglomerates. Given the cost of capital, but also the growth in internal services flowing from additional prudential rules and the concomitant increase in the cost of operating these conglomerates and their constituent undertakings, the increase in own funds should lead to some rise in the final cost of the services the conglomerates provide. It is therefore important to have in advance enough of an idea of the specific risks involved and their extent, as well as an idea of the own funds needed to cover them, before adopting cumbersome techniques such as the deduction of own funds.

5.3. A choice must be made between the speedy adoption of a directive which essentially adopts a qualitative approach and a directive containing quantitative provisions - such as the deduction of own funds - following more in-depth examination of the actual circumstances and insofar as the simulations to be carried out would warrant it. The ESC advocates a directive adopting a qualitative approach.

5.4. As soon as possible procedures will have to be put in place for launching, maintaining and gradually stepping up moves towards convergence, in view of the considerable leeway initially allowed to the Member States which is at first probably inevitable up to a certain point. However, such leeway must be as restricted as possible. The above-mentioned procedures will have to guide relations between the supervisory authorities themselves and also between these authorities and the financial conglomerates. Too little convergence would cause major distortions of competition.

5.5. Since conglomerates are being set up and expanding fast in non-member states, the EU must, as soon as the directive is adopted, impress on the Basle Committee the need to have similar binding rules introduced and start a process of convergence at its own level. Otherwise, the EU's financial conglomerates would suffer a major competitive disadvantage vis-à-vis their non-EU counterparts.

5.6. Consultation of the supervised sectors will be a vital component in the comitology procedure in order to end up with rules that are as efficient as possible.

Brussels, 17 October 2001.

The President

of the Economic and Social Committee

Göke Frerichs

(1) COM(1999) 232 final of 11.5.1999.