COMMISSION STAFF WORKING DOCUMENT Technical analysis Accompanying the document Report from the Commission to the European Parliament and the Council Report on the review of the Directive 2002/87/EC of the European Parliament and the Council on the supplementary supervision of credit institutions, insurance undertakings and investment firms in a financial conglomerate
Date: 2012-12-20
Institutions: European Commission
Subjects: credit institution, holding company, insurance company, investment company, market supervision, parent company

EUROPEAN 
COMMISSION 

Brussels, 15.3.2013  
SWD(2013) 71 final 

CORRIGENDUM: Suite à une erreur technique, ce document n'a pas été distribué avec le 
rapport qu'il accompagne 

COMMISSION STAFF WORKING DOCUMENT 

Technical analysis 

Accompanying the document 

Report from the Commission to the European Parliament and the Council  

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

{COM(2012) 785 final}

EN 

   EN 

 
 
 
 
 
  
 
TABLE OF CONTENTS 

1. 

INTRODUCTION & OBJECTIVES ................................................................................................3 

1.1. 
1.2. 

BACKGROUND ..............................................................................................................................3 
THE PURPOSE OF THE REVIEW AND THE JOINT FORUM’S REVISED PRINCIPLES ..............................4 
1.2.1.  Review objective given new market dynamics ........................................................................4 
1.2.2.  The Joint Forum’s revised principles .....................................................................................4 

THE SCOPE OF THE DIRECTIVE AND THE LEGAL ADDRESSEES OF THE 

2. 
REQUIREMENTS .......................................................................................................................................6 

2.1. 

SCOPE...........................................................................................................................................6 
2.1.1.  The scope of FICOD and sectoral legislation ........................................................................6 
2.1.2.  Coverage of unregulated entities including those not carrying out financial activities .........6 
2.1.3.  Coverage of systemically relevant financial conglomerates...................................................8 
2.1.4.  Thresholds for identifying a financial conglomerate..............................................................8 
2.1.5.  Coverage of industrial groups owning financial conglomerates..........................................10 
ENTITIES RESPONSIBLE FOR MEETING GROUP-LEVEL REQUIREMENTS.........................................10 
SUMMARY ..................................................................................................................................13 

2.2. 
2.3. 

3.  GROUP RISK REQUIREMENTS..................................................................................................13 

3.1. 

3.2. 

3.3. 

CAPITAL — ARTICLE 6...............................................................................................................14 
3.1.1.  Harmonisation of calculation methods.................................................................................14 
3.1.2.  Availability of own funds ......................................................................................................15 
RISK CONCENTRATION — ARTICLE 7 .........................................................................................15 
3.2.1.  Current requirements and supervisory powers.....................................................................15 
Inter-related exposures .........................................................................................................16 
3.2.2. 
INTRA-GROUP TRANSACTIONS — ARTICLE 8..............................................................................17 
3.3.1.  Current requirements and supervisory powers.....................................................................17 
3.3.2.  Features of intra-group transactions....................................................................................18 
CORPORATE GOVERNANCE — ARTICLES 9 AND 13.....................................................................19 

3.4. 

3.4.1.  Responsibilities of the board and senior management of the head of the conglomerate; 
conflict of interest................................................................................................................................20 
3.4.2.  Complexity and business structures......................................................................................21 
3.4.3.  Living wills............................................................................................................................21 
SUMMARY ..................................................................................................................................22 
3.5.1.  Capital — Article 6 ...............................................................................................................22 
3.5.2.  Risk concentrations and intra-group transactions — Articles 7 and 8.................................22 
3.5.3.  Corporate governance — Articles 9 and 13 .........................................................................22 

3.5. 

4. 

SUPERVISORY TOOLS AND POWERS .....................................................................................23 

4.1. 

THE CURRENT REGIME AND THE NEED TO STRENGTHEN SUPERVISORY TOOLS AND POWERS.......23 
4.1.1. 
Supervisory powers under FICOD .......................................................................................23 
4.1.2.  Enhancing enforcement to cover the ultimately responsible entity ......................................24 
Supervisory responsibilities; existing supervisory coordination provisions ........................24 
4.1.3. 
THE POSSIBILITY TO INTRODUCE MANDATORY STRESS TESTING .................................................25 

4.2. 

ANNEX 1 — RISK CONCENTRATIONS, CRISIS LESSONS............................................................28 

ANNEX 2 — SPECIAL PURPOSE ENTITIES ......................................................................................33 

ANNEX 3 — ECONOMIC CAPITAL MODELS...................................................................................38 

ANNEX 4 — INTRA-GROUP TRANSACTIONS AND EXPOSURES TURNING INTO 
CONTAGION CHANNELS......................................................................................................................40 

ANNEX 5 — DEFINITION OF GROUP.................................................................................................42 

 
 
 
ANNEX 6 — THE JOINT FORUM’S REVISED 2012 PRINCIPLES AND THE EU 
FRAMEWORK ..........................................................................................................................................43 

2 

 
 
1. 

INTRODUCTION & OBJECTIVES  

1.1.  Background 

The Financial Conglomerate Directive (FICOD) was adopted on 20 November 2002.1 It 
follows  the  Joint  Forum’s  principles  of  1999,2  aiming  in  particular  to  provide  methods 
for  assessing  the  capital  adequacy  of  conglomerates,  including:  detecting  multiple 
gearing; facilitating the exchange of information among supervisors; coordination among 
supervisors;  testing  the  fitness  and  propriety  of  managers,  directors,  and  major 
shareholders  of  the  conglomerate;  and  the  prudent  management  and  control  of  risk 
concentrations and intra-group transactions and exposures. 

The  first  review  of  FICOD  (FICOD1)  was  adopted  in  November  20113  following  the 
lessons  learnt  during  the  financial  crisis  of  2007-2009.  Revision  was  needed  to  fill  the 
identified  gaps  immediately  by  giving  supervisors  more  powers.  FICOD1  amended  the 
sector-specific  directives  to  enable  supervisors  to  perform  consolidated  banking 
supervision  and  insurance  group  supervision  at  the  level  of  the  ultimate  parent  entity, 
also  if  that  entity  was  a  mixed  financial  holding  company.  In  addition  to  that  urgently 
needed  solution,  FICOD1  introduced  a  waiver  for  the  smallest  conglomerates,  added  a 
transparency requirement for a group’s legal and operational structures, and brought non-
harmonised  asset  managers  within  the  scope  of  supplementary  supervision  in  the  same 
way as harmonised asset-managers. 

Given the need to review further aspects to determine whether the Directive is achieving 
its  objective,  FICOD1  required  the  Commission  to  deliver  a  review  report  before  31 
December 2012, and to follow it up with legislation if deemed necessary (Article 5): 

The  Commission  shall  fully  review  Directive  2002/87/EC,  including  the  delegated  and 
implementing  acts  adopted  pursuant  thereto.  Following  that  review,  the  Commission 
shall  send  a  report  to  the  European  Parliament  and  to  the  Council  by  31  December 
2012, addressing, in particular, the scope of that Directive, including whether the scope 
should be extended by reviewing Article 3, and the application of that Directive to non-
regulated entities, in particular special purpose vehicles. The report shall also cover the 
identification criteria of financial conglomerates owned by wider non-financial groups, 
whose  total  activities  in  the  banking  sector,  insurance  sector  and  investment  services 
sector  are  materially  relevant  in  the  internal  market  for  financial  services.  The 
Commission shall also consider whether the ESAs should, through the Joint Committee, 
issue guidelines for the assessment of this material relevance. 

In the same context, the report shall cover systemically relevant financial conglomerates, 
whose  size,  inter-connectedness  or  complexity  make  them  particularly  vulnerable,  and 

1  Directive  2002/87/EC  of  the  European  Parliament  and  of  the  Council  of  16  December  2002  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. 

2  The  Joint  Forum  is  the  joint  body  of  the  international  standard  setters:  the  Basel  Committee  for 
Banking Supervision (BCBS), the International Association of Insurance Supervisors (IAIS), and the 
International Organisation of Securities Committees (IOSCO). 

3  Directive 2011/89/EU of the European Parliament and of the Council of 16 November 2011 amending 
Directives  98/78/EC,  2002/87/EC,  2006/48/EC  and  2009/138/EC  as  regards  the  supplementary 
supervision of financial entities in a financial conglomerate. 

3 

 
                                                 
which  are  to  be  identified  by  analogy  with  the  evolving  standards  of  the  Financial 
Stability  Board  and  the  Basel  Committee  on  Banking  Supervision.  In  addition,  that 
report shall review the possibility to introduce mandatory stress testing. The report shall 
be followed, if necessary, by appropriate legislative proposals. 

This Staff Working Document accompanies the Commission Report. It explains in more 
detail the analysis carried out by the Commission, building on work done in international 
fora,  discussions  with  stakeholders,  supervisors  and  Member  State  experts,  and  a  vast 
amount  of  literature  on  lessons  learnt  during  the  crisis  with  respect  to  large,  complex 
financial  groups.  For  issues  needing  supervisory  expertise  and  experience,  the 
Commission  asked  advice  from  the  Joint  Committee  Subcommittee  on  Financial 
Conglomerates.4 To obtain the views of a larger group of stakeholders, the Commission 
organised two conferences in June 20105 and June 2012,6 and carried out a consultation 
between February and April 2012.7  

1.2.  The purpose of the review and the Joint Forum’s revised principles 

1.2.1.  Review objective given new market dynamics 

This review is guided by the objective of FICOD, which is to ensure the supplementary 
supervision  of  regulated  entities  that  form  part  of  a  conglomerate.  To  do  this,  FICOD 
focuses on the potential risks of contagion, complexity and concentration, i.e. the group 
risks, and the detection and correction of double gearing as well as the multiple use of 
capital.  The  review  aims  to  analyse  whether  the  current  provisions  of  FICOD,  in 
conjunction with the relevant sectoral rules for group and consolidated supervision, are 
effective  beyond  the  provisions  introduced  by  FICOD1.  The  review  is  justified  as  the 
market  dynamics  in  which  financial  conglomerates  operate  have  changed  substantially 
since the Directive entered into force in 2002. 

The  financial  crisis  showed  how  group  risks  materialised  across  the  entire  financial 
sector.  This  demonstrates  the  importance  of  group-wide  supervision  of  such  inter-
linkages  within  financial  groups  and  among  financial  institutions,  supplementing  the 
sector-specific authorisation requirements. 

1.2.2.  The Joint Forum’s revised principles 

The  Commission  participates  in  G20  work  streams  dealing  with  crisis  lessons.  In  this 
particular area, the Joint Forum’s revised 2012 principles for the supervision of financial 
conglomerates  are  important.  The  revised  principles  follow  up  recommendations 
endorsed by the Financial Stability Board (FSB) on 9 January 2010, with specific regard 
to  the  inclusion  of  non-regulated  entities  within  the  scope  of  supervision  and  the 
inclusion of the full spectrum of risks that a financial group can be exposed to. 

The Joint Forum’s revised 2012 principles recognise that the financial crisis that began in 
including 
2007  highlighted 

financial  groups, 

role  played  by 

the  significant 

4 

5 
6 
7 

https://eiopa.europa.eu/consultations/consultation-papers/2012-closed-consultations/may-2012/eba-
eiopa-and-esmas-joint-consultation-paper-on-its-proposed-response-to-the-european-commissions-
call-for-advice-on-the-fundamental-review-of-the-financial-conglomerates-directive-
jccp201201/index.html All the references to ESAs’ advice in this text refer to this particular advice.  
http://ec.europa.eu/internal_market/financial-conglomerates/supervision_en.htm. 
http://ec.europa.eu/internal_market/financial-conglomerates/conference_28062012_en.htm. 
http://ec.europa.eu/internal_market/financial-conglomerates/call_for_evidence_en.htm. 

4 

 
                                                 
conglomerates,  in  the  stability  of  global  and  local  economies.  Due  to  their  economic 
reach and the mix of regulated and unregulated entities (such as special purpose entities 
and  unregulated  holding  companies),  financial  conglomerates  cross  sector  boundaries 
and  present  challenges  for  sector-specific  supervisory  oversight.  In hindsight, the  crisis 
exposed situations where regulatory requirements and oversight did not fully capture all 
the activities of financial conglomerates or fully consider the impact and cost that these 
activities may pose to the financial system. 

At  the  request  of  the  Financial  Stability  Board  in  2009,  the  Joint  Forum  delivered  a 
report    in  January  2010  on  the  differentiated  nature  and  scope  of  regulation  (DNSR 
report),8  with  the  aim  of  identifying  gaps  in  the  overall  framework  of  prudential 
supervision. The DNSR report noted a number of issues that, if addressed, could improve 
supervision. The report recommended that all financial groups, particularly those active 
across borders, should be subject to regulation and supervision covering the full spectrum 
of their group-wide activities and risks, including all risks from entities within the group 
(whether  regulated  or  unregulated)  that  may  have  a  significant  impact  on  the  financial 
position  of  the  group.  The  report  also  noted  that  gaps  in  regulation  and  supervision 
should be avoided and the potential for regulatory arbitrage minimised. 

The DNSR report stated that the Joint Forum’s 1999 principles should be updated to 

(i) 

(ii) 

(iii) 

(iv) 

(v) 

(vi) 

ensure that the principles properly address developments in sectoral frameworks 
and in markets since 1999; 

facilitate  more  effective  monitoring  of  activities  and  risks  within  a  financial 
group, particularly when these activities span borders and the boundaries across 
the regulated and unregulated areas of the financial system; 

provide  a  basis  for  increased  supervision  and  regulation  of  financial  groups, 
particularly  when  a  group  or  any  of  its  parts  is  identified  as  systemically 
important; 

improve  international  collaboration,  coordination,  and  cooperation  among 
supervisors across sectors; 

clarify  the  responsibility  and  power  of  supervisors  with  respect  to  the  risks  in 
their jurisdictions stemming from an entity being part of a financial group; 

ensure  that  a  financial  group’s  structures  are  transparent  and  consistent  with  its 
business plan, and do not hinder sound risk management; and 

(vii)  provide, as far as possible, credible and effective options for action during a crisis 

or to avoid a crisis. 

The  Joint  Forum’s  revised  2012  principles  are  referred  to  and  cited  in  this  document 
where appropriate. An overview of the principles and the EU framework is presented in 
Annex 6. 

8 

http://www.bis.org/press/p100108a.htm. 

5 

 
                                                 
2.  THE  SCOPE  OF  THE  DIRECTIVE  AND  THE  LEGAL  ADDRESSEES  OF  THE 

REQUIREMENTS  

2.1.  Scope 

2.1.1.  The scope of FICOD and sectoral legislation 

Most  of  the  groups  operating  in  the  financial  sector  have  a  broad  spectrum  of 
authorisations. Focusing on the supervision of only one type of authorised entity ignores 
other factors that may have a significant impact on the risk profile of the entity’s activity. 
Fragmented  supervisory  approaches  are  not  sufficient  to  cope  with  the  challenges  that 
current group structures pose to supervision. 

The supplementary supervision framework for conglomerates is meant to strengthen and 
complete  the  full  set  of  rules  applicable  to  financial  groups,  across  sectors  and  across 
borders.  However,  from  a  regulatory  standpoint,  this  should  not  mean  that  additional 
layers of supervision have to be added when the sectoral requirements already cover all 
types of risk that may arise in a group. 

Technical provisions, own funds and insurance-specific capital rules are well catered for 
by Solvency II9, and are crucial for sound insurers both on a stand-alone basis and as part 
of a group. Capital requirements for banking exposures10 are crucial for adequate pricing 
of  the  assets  of  licensed  banking  entities,  the  continuous  monitoring  and  measuring  of 
risks,  and  the  availability  of  own  funds  to  absorb  unexpected  losses.  The  monitoring, 
measurement,  pricing and control of sector-specific risks forms the core of the sectoral 
frameworks and should not be touched upon in a context of complex conglomerates with 
many licences. 

2.1.2.  Coverage of unregulated entities including those not carrying out financial 

activities 

In  order  to  address  group  risks,  which  was  the  original  aim  of  FICOD  and  the  Joint 
Forum’s  1999  principles,  as  re-affirmed  by  the  revised  2012  principles,  group 
supervision should cover all entities in the group which are relevant for the risk profile of 
the  regulated  entities  in  the  group.  The  FICOD  definitions  of  a  group  and  a  financial 
conglomerate  do  not  exclude  unregulated  entities.  However,  the  lack  of  a  harmonised 
approach towards unregulated entities may have caused uncertainty and inconsistencies 
in the application of the requirements by supervisory authorities in Europe. 

The Joint Forum suggests including unregulated entities, as it is important for supervisors 
to  consider  risks  arising  from  the  activities  of  entities  that  form  part  of  the  financial 
conglomerate (or the wider group to which the financial conglomerate belongs) but are 
not directly prudentially regulated. Each unregulated entity may present different risks to 
a financial conglomerate and each may require separate consideration and treatment. In 
deciding  which  unregulated  entities  are  relevant,  the  Joint  Forum  suggests  considering, 
as  a  minimum,  holding  companies  (including  intermediate  holding  companies), 

9  Directive 2009/138/EC of the European Parliament and of the Council of 25 November 2009 on the 

taking-up and pursuit of the business of Insurance and Reinsurance (Solvency II). 

10  Directive 2006/48/EC of the European Parliament and of the Council of 14 June 2006 relating to the 
taking  up  and  pursuit  of  the  business  of  credit  institutions  (recast),  as  amended  by  Directive 
2011/89/EU of the European Parliament and of the Council of 16 November 2011. 

6 

 
                                                 
unregulated parent companies and subsidiaries, and special purpose entities (SPEs). This 
implies  a  total  balance  sheet  approach,  aiming  not  to  regulate  all  entities  related  to  the 
regulated financial entities, but to include all entities relevant for the risk profile of the 
regulated financial entities within supervisory monitoring. 

The number of SPEs and the complexity of their structures increased significantly before 
the  financial  crisis,  in  conjunction  with  the  growth  of  markets  for  securitisation  and 
structured finance products, but have declined since then. While the use of SPEs yields 
benefits  and  may  not  be  inherently  problematic,  the  crisis  has  illustrated  that  poor  risk 
management  and  a  misunderstanding  of  the  risks  of  SPEs  can  lead  to  disruption  and 
failure.  The  need  for  enhanced  monitoring  of  intra-group  relationships  with  SPEs  was 
highlighted  in  the  Joint  Forum’s  2009  SPE  report11.  Inclusion  is  also  supported  by  the 
scope of consolidation  under  the accounting  rules. According to the current accounting 
standards  (IAS27/SIC12),  and  even  more  so  under  the  new  principles  (IFRS10), 
controlled  special  purpose  entities  are  included  within  the  scope  of  accounting 
consolidation.  IFRS12  will  require  disclosure  of  material  SPEs  that  would  not  be 
consolidated under the IFRS10 standard. This approach is also in line with the approach 
in  Solvency  II,  where  a  specific  set  of  provisions  is  established  for  special  purpose 
entities, at both individual and group level.12 

In their advice, the ESAs recommend enlarging the scope of supervision to ensure a more 
thorough  group-wide  supervision  and  avoid  possible  regulatory  arbitrage,  by  extending 
the  groups  of  entities  that  can  be  included  in  the  identification  of  financial 
conglomerates.  Accordingly,  the  ESAs  propose  a  more  consistent  and  broader 
identification  of  financial  conglomerates  and  suggest  modifying  the  definition  of 
‘financial sector’ [according to Article 2 (8) FICOD] and/or the definition of ‘regulated 
entities’ [according to Article 2 (4) FICOD]. With regard to SPEs, they recommend that 
in  principle  all  special  purpose  entities  must  fall  under  the  supervision  of  a  financial 
conglomerate,  because  they  may  not  always  be  covered  by  sectoral  legislation  or 
accounting  rules.  The  inclusion  of  these  entities  should  guarantee  that  the  risks  arising 
from  entities  within  a  group  are  appropriately  captured,  regardless  of  their  nature  (e.g. 
shadow banking). 

The  ESAs  have  assessed  whether  institutions  for  occupational  retirement  provision 
(IORPs)  should  be  included  as  part  of  a  financial  conglomerate  and  are  mindful  of  the 
national specificities of IORPs. Views are mixed, especially as the national specificities 
are very diverse. The ESAs recommend maintaining the status quo for the time being, i.e. 
FICOD should not include IORPs within group-wide supervision at cross-sectoral level. 
The  ESAs  note  that  the  IORP  Directive  is  currently  being  reviewed  and  a  quantitative 
impact assessment is being carried out in order to determine the capital requirements for 

11   http://www.bis.org/publ/joint23.pdf 
12  At  individual  level,  special  purpose  entities  may  be  regulated  entities  under  the  Solvency  II 
Framework  Directive,  including  conditions  for  the  authorisation  of  undertakings  that  assume  risks 
from insurance and reinsurance undertakings and fully fund their exposure. These conditions will be 
further  specified  in  a  delegated  act.  They  include  the  specification  of  the  fully  funded  principle, 
together with fit and proper requirements for shareholders and accounting and reporting procedures. 
These  provisions  were  meant  to  strike  the  right  balance  between  the  need  to  preserve  the  beneficial 
role  played  by  SPEs  in  the  financial  market  and  the  need  to  subject  them  to  a  minimum  set  of 
prudential requirements. 
Moreover, the Commission intends to make sure in the delegated acts that SPEs are subject to group 
supervision and, where relevant, to group solvency calculation to fully capture the risk of SPEs where 
risk is not really transferred to the SPE from the sponsor undertakings.. 

7 

 
                                                 
 
IORP activities. The work is expected to be completed by June 2013. The ESAs therefore 
recommend  that  the  Commission  should  then  include  a  review  clause  and  mandate  the 
ESAs to work on this issue again. 

The inclusion of non-regulated entities within the scope of group supervision should be 
consistent across the various sectors, in order to prevent restructuring to avoid regulation 
in  a  specific  sector.  This  should  also  apply  to  the  way  unregulated  entities  are 
consolidated in order to calculate sector-specific capital requirements. 

2.1.3.  Coverage of systemically relevant financial conglomerates 

The  FICOD1  review  clause  also  covers  systemically  relevant  financial  conglomerates. 
The  challenges  of  supervising  conglomerates  are  most  evident  for  groups  whose  size, 
inter-connectedness and complexity make them particularly vulnerable. 

Any systemically important financial institution (SIFI) should in the first place be subject 
to  more  intense  supervision  through  application  of  the  CRD  IV13  and  Solvency  II 
framework,  both  at  individual  and  group/consolidated  level.  If  the  SIFI  is  also  a 
conglomerate,  supplementary  supervision  under  FICOD  would  also  be  applicable. 
Although  most  SIFIs  are  conglomerates,  this  is  not  necessarily  always  the  case.  Also, 
systemic  risks  are  not  necessarily  the  same  as  group  risks.  Therefore,  it  does  not  seem 
meaningful  to  try  to  bring  all  SIFIs  under  FICOD.  Furthermore,  discussions  at 
international  level  are  still  continuing  on  insurance  SIFIs,  and  the  sectoral  legislation, 
including the treatment of banking SIFIs, is not yet stable. 

2.1.4.  Thresholds for identifying a financial conglomerate 

The  supplementary  group  supervision  provisions  under  FICOD  should  be  applied 
proportionally. It does not seem necessary to apply them to groups that are fully covered 
by  one  sector-specific  framework,  as  their  risks  are  already  addressed  in  the  sectoral 
legislation.  However,  when  one  or  more  regulated  entities  in  a  financial  sector  are 
combined with other regulated or non-regulated entities outside the ‘original’ sector, the 
group risks to which the conglomerate is exposed should be covered by supplementary 
supervision. 

The  existing  thresholds  in  FICOD  are  meant  to  take  into  account  proportionality  and 
materiality  in  identifying  conglomerates  that  should  be  subject  to  supplementary 
supervision  of  group  risks.  The  two  thresholds  set  out  in  Article  3  serve  two  different 
purposes:  the  first  restricts  supplementary  supervision  to  those  conglomerates  that 
carryout business in the financial sector and the second restricts application to very large 
groups. 

The  level  of  the  thresholds  limits  supplementary  supervision  to  very  large  groups,  as 
10 % of the billions in mostly banking assets is a very large amount in insurance assets. 
This has led to a situation where a small number of very large banking groups that are 
identified  as 
also  serious  players 
conglomerates.  It  should,  indeed,  be  noted  that  some  European  banks  identified  as 

insurance  market  are  not 

the  European 

in 

13  Commission  proposals  COM(2011)  452  and  COM(2011)  453  final  for  a  Regulation  on  prudential 
requirements  for  credit  institutions  and  investment  firms  final  and  for  a  Directive  on  the  access  to 
activity of credit institutions and prudential supervision of credit institutions and investment firms and 
amending Directive 2002/87/EC on financial conglomerates  

8 

 
                                                 
systemically  important  (SIBs)  are  not  subject  to  supplementary  supervision.  The 
identification  of systemically  important  insurance-led groups is still being discussed by 
the Financial Stability Board (FSB) 

FSB SIBs14 

FICOD groups15 

Bank of America 
Bank of China 
Bank of New York Mellon 
Barclays 
BBVA 
BNP Paribas 
Citigroup 
Credit Suisse 
Deutsche Bank 
Goldman Sachs 
Groupe BPCE 
Group Crédit Agricole 
HSBC 
ING Bank 
JP Morgan Chase 
Mitsubishi UFJ FG 
Mizuho FG 
Morgan Stanley 
Nordea 
Royal Bank of Scotland 
Santander 
Société Générale 
Standard Chartered 
State Street 
Sumitomo Mitsui FG 
UBS 
Unicredit Group 
Wells Fargo 

Aegon 
AIG 
Allianz 
Alm. Brand 
Ameriprise 
Argenta 
Avanza 
Axa (Belgium) 
Banco Comercial Português 
Bank of Ireland 
Banque Neuflize OBC 
Banque Postale 
Belfius Bank 
BNP Paribas 
Caixa Geral de Depositos 
Co-operative Banking 
Group Limited 
Credit Agricole 
Credit Mutuel 
Danske Bank 
DEBEKA Group 
Delta Lloyd 
Deutsche Bank 
DnB-NOR 
DZ Bank Gruppe 
EVROHOLD 
Generali 
Gjensidige 
GRAWE 
Groupe BPCE  

Gruppo Azimut 
Gruppo Carige 
Holmo 
ING 
Inter Group 
Intesa San Paolo 
Jernbane-personalets 
KD-AS Finančni Konglomerat 
Länsförsäkringar 
Lloyds Banking Group 
Mediolanum 
National  Australia Group 
Nordnet 
Old Mutual 
OP-Pohjola Group 
Petr Kellner 
Rabo-Eureko 
Resurs 
RZB — UNIQA 
Sampo 
SEB 
Signal Iduna Gruppe 
SNS-Reaal 
Societe Generale 
Sparebank1 
Storebrand 
Svenska Handelsbanken 
Swiss Re 
Terra Group 
Triglav Group 
Wüstenrot 
Wüstenrot und 
Württembergische Group 

The  table  above  shows  which  groups,  on  the  left,  should  be  subject  to  more  intense 
supervision,  higher  loss  absorbency  standards,  and  living  will  obligations,  according  to 
the  FSB.  These  groups  are  exposed  to  group  risks,  but  are  not  necessarily  subject  to 
supplementary  group  risk  provisions  under  the  current  conglomerates  framework. 
Comparing  the  two  columns,  it  is  not  clear  whether  the  thresholds,  combined  with  the 

14  http://www.financialstabilityboard.org/publications/r_121031ac.pdf  List dated 1 November 2012.  
15    http://www.eba.europa.eu/cebs/media/Joint-Committee/List-of-Identified-Financial-Conglomerates-as-

at-1-July-2012.pdf  List dated 20 July 2012 

9 

 
 
 
                                                 
possibility  for  supervisors  to  waive  the  application  of  FICOD  where  groups  have  less 
than 10 % of their total assets in the smaller financial sector, even though these smaller 
sector assets exceed the absolute threshold of €6 billion will ensure coverage of the most 
relevant  financial  conglomerates.  Supervisors  report  that  the  thresholds  can  hamper 
rather than support the proportional application of supplementary group supervision. At 
the same time, it is considered important that the definition and criteria for identification 
of a financial conglomerate are clear and enforceable in court. Simple thresholds would 
meet  this  need  and  at  the  same  time  ensure  a  level  playing  field  across  the  European 
Union.  However,  to  take  account  of  the  risks  of  certain  complex  groups,  a  more  risk-
sensitive  approach  to  the  thresholds  is  called  for.  Furthermore,  the  wording  of  the 
identification provision may leave room for different ways to determine the significance 
of cross-sectoral activities. It could be improved to ensure consistent application across 
sectors and borders. 

The Joint Forum does not apply thresholds, nor does it distinguish only two sectors like 
the  current  FICOD.  If  the  Joint  Forum’s  definition  were  to  be  applied,  without  further 
restriction  by  thresholds,  the  intensity  of  supplementary  supervision  for  group  risks 
would become inherent to the complexity of the group structure. In the European context, 
however,  it  needs  to  be  remembered  that  credit  institutions  and  investment  banks  are 
subject  to  the  same  rules  under  the  CRD,  and  a  different  regime  for  supplementary 
supervision could lead to an unclear regulatory situation. 

2.1.5.  Coverage of industrial groups owning financial conglomerates 

The  current  regulatory  framework  for  prudential  supervision  builds  on  the  notion  of 
authorising specified businesses. If an undertaking wants to engage in financial business 
such  as  banking  or  insurance,  it  needs  to  apply  for  an  authorisation.  However,  when 
hundreds or even thousands of legal entities with or without authorisation are combined 
in one and the same group with one and the same business strategy, the authorisation of 
individual  legal  entities  lacks  a  group-wide  view.  This  is  why  the  supplementary 
framework for conglomerates was invented in the first place. However, the crisis showed 
that  this  supplementary  set  of  provisions  was  ineffective  in  managing  the  risks  that 
conglomerates are exposed to. While there is agreement that regulated financial entities 
are exposed to group risks from the wider industrial group to which they might belong, 
no conclusion can be drawn at this stage as to how to extend the FICOD requirements to 
wider  non-financial  groups  in  addition  to  what  is  discussed  below  regarding  the 
establishment  of  an  intermediate  financial  holding  company.  Currently  there  is  no 
legislation  on  the  supervision  of  industrial  groups  owning  financial  conglomerates  and 
the  ESAs  have  no  empowerment  to  issue  guidelines.  Therefore,  while  the  ESAs  will 
certainly play a key role in ensuring the consistent application of FICOD, it is premature 
to  reach  any  conclusions  on  the  need  for  the  ESAs  to  issue  guidelines  on  this  specific 
topic. 

2.2.  Entities responsible for meeting group-level requirements 

Article  5  of  FICOD  determines  the  scope  of  supplementary  supervision  and  describes 
which entities should be subject to the requirements of Section II. Member States should 
determine  which  legal  entities  fit  the  description  of  Article  5  in  their  national  legal 
framework. However, a closer look at the list of entities in Article 5(2) reveals that only 
the regulated entity heading the conglomerate can actually comply with the requirements 
set out by FICOD for conglomerates. What remains unclear is the distinction between: 

10 

 
•  the entities to be included within the scope of supplementary supervision, 

•  the  entities  that  can  be  held  liable  for  any  breach  of  the  supplementary  supervision 

requirements, i.e. the ultimately responsible entities. 

The academic literature confirms that FICOD does not sufficiently capture certain group 
structures.  De  Vuyst  (2010  p.  314  et  seq.)  observes  that  the  entities  subject  to  the 
requirements of the Directive as described in Article 5 may not cover all possible group 
structures. Gruson (2004) observes that the range of entities listed in Article 5 implies a 
huge  administrative  reporting  burden,  the  supervisory  effectiveness  of  which  may  be 
questionable. Sarsa (2005) adds that the responsibilities of supervisors in FICOD Section 
3 do not match the list of entities subject to supervision in Article 5. The requirements do 
not target either the entity that can take responsibility for meeting them, or the authority 
that is to enforce them. 

The provisions of FICOD to detect and control group risks and multiple gearing have by 
their nature group-wide relevance. The entity in charge of decisions on how to meet the 
requirements  should  be  the  main  or  ultimate  entity  responsible,  in  order  to  enable 
supervisors to impose sanctions on breaches. Also, the entity responsible for compliance 
with  the  requirements  needs  to  be  the  entity  that  can  determine  how  to  meet  these 
requirements. 

At the same time, the Treaty on the Functioning of the European Union ensures freedom 
of entrepreneurship and does not harmonise the legal form for businesses. Determining 
which  entity  should  be  the  responsible  entity,  while  not  affecting  the  choice  of  legal 
statute,  could  thus  be  guided  by  clear  criteria.  According  to  that  line  of  reasoning, 
Member  States  should  ensure  that  supplementary  supervision  applies  to  those  legal 
entities that meet the criteria within their national legal frameworks. The ESAs note that 
prudential  supervision  cannot  go  against  company  law  principles,  such  as  the 
fundamental  principle  of  each  entity  within  a  group  having  legal  personality  and  the 
reverse  side  of  this  principle,  namely  that  the  group  as  such  cannot  be  addressed  by 
supervisors. Similarly, the answers given to a JCFC questionnaire when the ESAs were 
preparing their advice to the Commission indicate that the interaction between company 
law and the content of the responsibility for compliance with group requirements needs 
to be considered.    

The  ESAs  recommend  making  mixed  financial  holding  companies  (MFHCs),  even  if 
unregulated,  subject  to  supplementary  supervision  or the requirements proposed below. 
Accordingly,  MFHCs  should  be  regarded  together  with  regulated  entities  as  the  legal 
addressees of supplementary supervision. 

Moreover,  the  ESAs  recommend  a  different  approach  for  companies  pursuing  solely 
industrial  activities  (with  no  financial  services  activity  at  all),  such  as  industrial 
conglomerates,  as  the  supervisory  focus  might be diverted from  financial undertakings. 
The ESAs explain that mixed-activity holding companies (MAHCs) and mixed-activity 
insurance holding companies (MAIHCs) should not be directly addressed by FICOD, but 
the  supervisor  should  be  able  to  access  relevant  information  from  such  MAHCs  and 
MAIHCs  as  part  of  its  supervisory  tool  kit.  This  could  be  done  by  requiring  the 
establishment  of  an  intermediate  financial  holding  company,  by  identifying  a  point  of 
entry  for  supervisors,  or  by  designating  one  regulated  entity  explicitly  as  the  point  of 
entry for group supervision. 

11 

 
The ESAs ask the Commission to identify and define an entity ultimately responsible for 
the financial conglomerate according to the following minimum criteria: 

a. 
Control:  the  company  ultimately  at  the  top  of  the  financial  conglomerate  is 
presumed to exercise legal or de facto control over most of the entities of the group and 
to drive the activities of the whole group. Accordingly, the ultimately responsible entity 
should in general be the ultimate parent company. 

b. 
Market counterparty / listed entity: Where a financial conglomerate is listed on a 
stock market, the listed entity is likely to be the ultimate parent entity and, in principle, 
qualifies  as  the  ultimately  responsible  entity.  However,  if  the  financial  conglomerate 
includes  a  company  that,  although  not  the  parent  company,  influences  through  its 
relations with the market the overall setting (in terms of both structure and strategy) of 
the group, then such a company would qualify as the ultimately responsible entity. 

c. 
Ability: In cases where there are no control relationships (e.g. horizontal groups) 
or in cases when no single decision-making entity can be identified (for example, when 
company  law  provides  for  a  particular  governance  agreement  under  which  direction  is 
exercised  in  consensus  with  controlled  entities),  the  criteria  for  identification  of  the 
ultimately responsible entity will relate to the ability to perform specific duties towards 
supervisors and other entities within the group. When the ultimate parent does not have 
this  ability,  it  will  explicitly  indicate  which  entity  within  the  financial  conglomerate 
possesses this ability. 

According  to  the  ESAs,  the  ultimately  responsible  entity  should  be  responsible  for 
compliance  with  group-wide  requirements.  The  ESAs  ask  the  Commission  to  propose 
that the ultimately responsible entity should have a coordinating and directing role over 
the  other  entities  of  the  conglomerate.  Moreover,  some  existing  requirements  for 
regulated  entities  and  requirements  that  can  be  derived  from  the  ESAs’  guidelines  on 
internal controls should also apply to the top parent entity, whether the entity is a holding 
company or a financial holding company (FHC), insurance holding company (IHC) or an 
MFHC. 

Following their own analysis as well as the Joint Forum’s revised principles, the ESAs 
suggest  assigning  the  following  ‘responsibilities’  to  ultimately  responsible  entities  as 
examples: 

a)  Acting  as  a  reference  point  for  supervision  and  meeting  reporting  obligations 

towards supervisors for the whole conglomerate.  

b)  Providing  consolidated  accounts  for  the  whole  financial  conglomerate.  It  is 
proposed that the scope of these duties should cover ‘participations’. This would 
take  into  account  the  fact  that  FICOD/FICOD1  already  provides  for  some 
‘supplementary  supervisory’  tools  to  have  a  wider  scope  than  the  equivalent 
supervisory tool at sectoral level.   

c)  Ensuring  adequate  group  structure  and  organisation,  so  that  the  supervision  of 
each  entity  in  the  conglomerate,  the  exchange  of  information  among  group 
entities, and the performance of the duties under a) and b) above are not impeded. 
This strengthens the idea that the group’s autonomous choice of internal structure 
and governance cannot put at risk (or prevail over) the objectives of supervision, 
for both the group and each entity in the group. 

12 

 
d)  Coordinating and directing other entities in the group. 

e)  Ensuring that the conglomerate complies with conglomerate-level requirements. 

These responsibilities have two objectives: one relates to the need for supervisors to have 
a  single  point  of  entry  for  specific  intervention  (including  in  stress  and  emergency 
situations) in the financial conglomerate; the other relates to the need for groups to have 
an internal organisation that ensures compliance with supervisory rules at both individual 
and group level. 

2.3.  Summary 

The current framework does not specifically cover the monitoring of unregulated entities, 
which  hampers  effective  group  supervision.  Unregulated  entities  should  be  included 
within the scope of supplementary supervision in the same way across all sectors, not as 
regulated entities, but as entities whose activities matter for the risk profile of regulated 
entities  and  as  such  should  be  monitored.  It  should  be  clear  as  to  what  constitutes  a 
relevant group for supervisory purposes, without regulating each and every single legal 
entity  in  the  group.  Special  attention  needs  to  be  paid  to  SPEs.  Unregulated  entities 
should  be  treated  by  group  supervision  in  the  same  way  across  all  sector-specific 
frameworks. 

The combined application of the two thresholds and the use of the waiver by supervisors 
have led to a situation where very big banking groups that are also serious players in the 
European  insurance  market  are  not  subject  to  supplementary  supervision.  At  the  same 
time,  it  is  considered  important  that  the  definition  and  identification  criteria  for  a 
financial  conglomerate  are  clear  and  enforceable  in  court.  However,  the  question  is 
whether  the  thresholds  and  waivers  should  be  amended  or  complemented  by  applying 
supervision  in  a  proportionate  manner  depending  on  the  risk  inherent  to  the  group. 
Furthermore,  the  wording  of  the  identification  provision  may  leave  room  for  different 
ways  to  determine  the  significance  of  cross-sectoral  activities.  It  could  be  improved  to 
ensure consistent application across sectors and borders. 

Part  of  that  question  concerns  the  distinction  between  only  two  sectors,  the  combined 
banking and investment firm sector versus the insurance sector, instead of a distinction 
between  three  sectors  (banking,  insurance,  securities)  as  in  the  Joint  Forum  definition. 
However,  as  the  CRD  applies  equally  to  credit  institutions  and  investment  firms,  the 
clarity and coherence of the legislative framework needs to be ensured. The lack of group 
risk provisions for complex banking groups that do not meet the FICOD thresholds may 
be a question for the CRD rather than for FICOD. 

The setting of requirements at group level should be accompanied by clear identification 
of  the  ultimately  responsible  entity  in  a  financial  group,  which  should  be  in  charge  of 
controlling  risks  on  a  group-wide  basis  and  responsible for regulatory compliance with 
group  requirements.  This  would  ensure  more  effective  enforcement  by  the  supervisory 
authorities. The interaction with company law needs to be considered. 

3.  GROUP RISK REQUIREMENTS  

The  objective  of  the  supplementary  framework  is  to  detect,  monitor  and  control  group 
risks.  Group-wide  requirements  are  important  to  achieve  that  end.  The  framework 

13 

 
assumes  that  sector-specific  risks,  taken  by  the  authorised  entities,  are  sufficiently 
addressed in the sector-specific (authorisation) frameworks. 

Group risks are generally considered to include the risk of multiple gearing of capital, the 
risk  of  contagion,  risk  concentration,  conflicts  of  interest,  and  complexity  (the  5  Cs). 
Among these are risks that increase with size and complexity: leverage risk and funding 
risk.  Assessing  group  risks  is  all  the  more  important  in  a  context  where  risk-based 
supervision  is  organised  according  to  apparently  distinguishable,  pre-defined  risk 
categories, the detectability of which is often an illusion (Hutter 2005). The Solvency II 
framework  recognised  this  by  adding  a  separate  chapter  on  group  supervision  to  the 
chapters  on  dealing  with  sector-specific  risks.  Consequently,  Solvency  II  and  FICOD 
overlap to a large extent in both aim and substance.16 

As the Joint Forum points out, accounting consolidation mitigates supervisory concerns 
as to double gearing, which FICOD Article 6 is intended to combat. The two main tools 
to  control  the  other  group  risks  are  structural  regulation  (certain  types  of  financial 
business  activities  are  not  compatible)  and  behavioural  regulation  (corporate  structure 
and  internal  incentives  should  be  adequate  for  proper  group-wide  risk  management) 
(Lumpkin 2010, p. 120). As to structural regulation, FICOD contains two requirements: 
the  monitoring  of  group-wide  risk  concentration  and  the  possibility  to  restrict  this 
(Article  7)  and  the  monitoring  of  intra-group  transactions  and  the  possibility  to  restrict 
these  (Article  8).  There  are  no  general  group  structure  requirements  in  the  current 
framework. Finally, behavioural concerns should be mitigated by sound internal control 
and transparent governance structures, regulated by Articles 9 and 13. 

3.1.  Capital — Article 6 

3.1.1.  Harmonisation of calculation methods 

Article 6 is meant to enable supervisors to check and correct double gearing. It lists two 
methods,  the  consolidation  method  and  the  deduction  &  aggregation  method,  and 
requires sector-specific requirements to be met when these two methods are applied. The 
Joint Forum investigated economic capital models and their use in capital calculation and 
risk aggregation in order to understand how capital and risks are aggregated. 

The  JCFC’s  Capital  Advice,  published  in  three  parts  in  2007  and  2008,17  revealed  that 
authorities  applied  in  an  inconsistent  way  the  consolidation  methods  when  calculating 
available  and  required  capital  at  the  level  of  the  conglomerate.  This  hampered  the 
calculation  of  sector-specific  capital  requirements  to  allow  for  consolidation  of  cross-
sector  holdings  if  entities  are  part  of  the  same integrated internal control  system.  More 
harmonisation of calculation methods was called for, which is why an invitation to draft 
binding technical standards was included in the Omnibus I initiative in October 2010.18 
This  invitation  was  changed  into  a  requirement  in  the  CRD  IV  proposal.  A  draft 

16  The  reason  for  not  including  supplementary  supervision  in  the  banking  framework  is  because  the 
Basel  bodies  structure  their  frameworks  this  way  too:  Basel  2/3  +  Joint  Forum  principles  =  CRD  + 
FICOD. Indeed, the CRD, like the Basel agreements, does not have a group risk regime for groups of 
banking entities only. IAIS does not have a similar framework yet, so the Commission has pursued its 
own initiative. 

17  http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=CONSLEG:2002L0087:20110104:EN:PDF. 
18  Level 2 measures for Solvency II will be published after Omnibus 2 is approved. 

14 

 
                                                 
regulatory technical standard (RTS) was published for consultation on 31 August 201219 
and  will,  if  adopted,  specify  the  methods  for  the  calculation  of  capital.  The  standard 
should  be  ready  in  time  for  the  implementation  of  Basel  III,  as  part  of  the  improved 
banking  regulation  framework.  In  parallel,  delegated  acts  for  Articles  228  and  230  of 
Solvency II will be developed to specify how the consolidation has to be carried out for 
the purpose of insurance capital requirements. 

3.1.2.  Availability of own funds 

However, the discussions accompanying the development of these technical calculation 
standards  revealed  another  concern  regarding  group-wide  capital  policy.  Supervisors 
sometimes  lack  insight  into  the  availability  of  capital  at  the  level  of  the  conglomerate. 
Solvency II sets requirements for the availability of capital at the level of the group and 
reporting requirements as regards the classification and tiering (quality) of own funds at 
group  level  and  their  availability.  The  availability  of  own  funds  across  the  constituent 
entities of a banking group is not the primary target of the banking requirements, leaving 
room  for  banks  to  allocate  the  excess  capital  of  their  subsidiaries,  over  the  minimum 
required amount, across their group in line with fiscal drivers. 

Given the complexity problem in large banking groups, the High-Level Expert Group on 
reforming the structure of the EU banking sector also observes in its report20 that capital 
intended to serve as a buffer against certain types of high risk should be available in the 
entities that engage in such high-risk activities. The consolidation approach in the current 
framework does not give any explicit guarantee that this will be case. 

As a separate issue, the eligibility requirements for capital, i.e. the quality of the capital 
buffers, were in justified cases harmonised as far as possible across CRD II and Solvency 
II,  following  the  JCFC’s  Capital  Advice  in  2008.21  However,  Basel  III  re-defined  the 
eligibility of capital and new differences emerged. 

3.2.  Risk concentration — Article 7 

3.2.1.  Current requirements and supervisory powers 

Article  7  of  FICOD  gives  a  lot  of discretion to  supervisors to perform one of the most 
important functions of FICOD: the detection of an excessive build-up of aggregated risks 
across the group. As the 1999 Joint Forum principles pointed out, risk concentrations can 
take many forms, including exposures to individual counterparties, groups of individual 
counterparties  or  related  entities,  counterparties  in  specific  geographical  locations, 
industry sectors, specific products, and service providers. In addition, specific risk types 
can  build  up  if  aggregated  across  the  group,  such  as  market  risk,  interest  rate  risk  and 
operational risk. Article 7 is accordingly drafted in a broad manner, enabling supervisors 
to  limit  certain  concentrations  of  risk,  including  funding  risk.  However,  according  to 
academic  studies  (see  for  example  Blundell-Wignall  2009,  p.  5),  supervisors  have  not 
made use of this possibility. The lack of clarity as to legal addressees may explain this 

19  http://eba.europa.eu/News--Communications/Year/2012/ESAs-consult-on-the-application-of-the-

capital-cal.aspx. 

20  High-Level Expert Group on reforming the structure of the EU banking sector, Final report, Brussels 2 

October 2012, page 95. 

21  https://eiopa.europa.eu/fileadmin/tx_dam/files/consultations/consultationpapers/IWCFCAdvice.pdf. 

15 

 
                                                 
lack  of  intervention,  but  so  may  the  lack  of  clarity  as  to  what  is  possible  with  the 
discretionary powers in Article 7. 

FICOD1 introduced in Article 7 a requirement for ESAs to develop guidelines aimed at 
the  convergence  of  supervisory  practices  and  to  align  the  supervisory  tools  addressing 
risk concentration policy for conglomerates with those applied to insurance groups and 
banking groups, following Article 244 Solvency II and Section 5 of CRD IV (the large 
exposures regime). In an internal study the JCFC has been investigating this specific area 
in relation to European supervisors’ practices, but no guidelines have yet been published. 

Ever since 1999, the Joint Forum has been pointing out how risk concentrations build up 
in the system and what supervisors could do to correct excesses. In all those exercises it 
turned  out  that  the  supervisory  community  still  lacked  sufficient  tools  to  detect  and 
correct risk concentrations.22 

Credit default swaps (CDS) and subprime markets are a case in point. An analysis issued 
by  the  Joint  Forum  in  April  2008  highlights  that  while  CDS  may  allow  effective 
mitigation  of  risk  concentrations,  it  can  at  times  give  rise  to  ‘new’  exposures  or  risk 
combinations  for  firms  (see  Annex  1  for  a  summary)  The  risk  concentrations  observed 
during the crisis starting in August 2007 and continuing into 2008 were: 

– 

– 

– 

– 

– 

excessive exposures to adverse developments in market liquidity conditions, 

exposures to asset pipelines or warehousing, 

exposures to new (institutional) counterparties (e.g. hedge funds), 

legal or reputational risks leading to buy-back decisions, 

basis risks not previously recognised, 

frequency at which, or terms under which, insurance or reinsurance contracts are 

– 
altered. 

3.2.2. 

Inter-related exposures 

The Joint Forum made a number of suggestions on how to better detect the build-up of 
risk  concentrations  (see  Annex  1).  It  noted  that  risk  concentrations  in  most  financial 
conglomerates  are  still  chiefly  identified,  measured  and  managed  within  separate  risk 
categories and within business lines. For instance, credit exposures are considered within 
banking  business  units,  catastrophe  risk  concentrations  within  insurance  business  units 
and  so  on.  It  characterises  this  as  ‘silo  management’.  Though  this  is  the  predominant 
practice,  some  financial  conglomerates  are  striving  for  a  more  ‘horizontal’  (i.e.  across 
risk categories) view of risk concentrations as it is becoming increasingly clear that risk 
concentrations may arise from interrelated exposures across risk categories. 

The  groups  surveyed  in  the  Joint  Forum  exercise  had  started  to  develop  management 
tools  to  acquire  relevant  data  across  the  group and present it to senior cross-group risk 
management committees. The first step within groups taking this approach was typically 

22  This  was  explained  at  the  first  public  hearing  about  the  FICOD  review,  on  8  September  2008: 
http://ec.europa.eu/internal_market/financial-conglomerates/docs/efcc_newsletter_sep2008.pdf. 

16 

 
                                                 
the creation of a risk management structure with an overview of, and responsibility for, 
the group as a whole. This step could yield immediate benefits with a modest investment 
in sophisticated risk measurement tools.23 Against this background of increasing group-
wide  risk  management  structures  and  the  search  for  a  common  measurement 
methodology  to  support  greater  integration,  the  Joint  Forum  experts  have  seen  a 
significant growth in risk transfer markets over the last few years. 

Even without such developments, there are many more ‘second-order effects’ that need 
to be considered in a comprehensive approach to identifying risk concentrations. Second-
order effects are indirect effects on a firm’s exposure(s) caused by a change in economic 
or financial market conditions, from a shock or a change in policy. This can be within a 
risk category or involve contagion from one risk category to another risk category.24 

It is also important to consider how risk mitigation approaches play out under stressful 
market  conditions.  It  is  impossible  to  compile  a  comprehensive  list  of  such  possible 
interactions,  but  the  Joint  Forum  strongly  believes  that  such  hidden  risk  concentrations 
are  best  identified  and  managed  through  stress  testing  and  scenario  analysis.  Hence, 
groups should invest meaningful time in preparing for extreme scenarios and exploring 
unlikely connections between risks. 

The High-Level Expert Group on reforming the structure of the EU banking sector also 
observes major concentrations of risk confined to large complex banking groups, which 
are  not  covered  by  the  current  large  exposures  regime,  nor  sufficiently  captured  by 
current capital requirements.25 The group points to model risk and tail risk as ignored risk 
types in the current framework, which was also observed by the Joint Forum in their Risk 
Aggregation  analyses  (see  Annex  3  for  a  summary  of  the  Joint  Forum’s  study  on  risk 
aggregation models). 

3.3.  Intra-group transactions — Article 8 

3.3.1.  Current requirements and supervisory powers 

Article 8 of FICOD requires regulated entities in a conglomerate to report regularly on 
intra-group  transactions  to  enable  the  supervisor  to  gain  a  deeper  understanding  of  any 
transaction  and  exposure  between  entities  in  a  group.  FICOD1  furthermore  allowed 
Member  States  to  set  quantitative  limits  and  qualitative  requirements  for  intra-group 
transactions.  FICOD1  also  introduced  in  Article  8  a  requirement  for  ESAs  to  develop 
guidelines aimed at the convergence of supervisory practices and to align the supervisory 

23  For instance, the Joint Forum noted an appreciation of the extent to which common exposures net out 
and,  in  addition,  an  appreciation  of  the  extent  to  which  diversification  increases  across  a  broader 
group.  For  example,  interest  rate  risks  between  banking  and  insurance  operations  tend  to  offset  one 
another naturally, whereas equity risks are positively correlated and benefit only from diversification 
effects. One sophisticated method now used by many groups is developing and embedding economic 
capital model frameworks across their enterprises. These approaches can improve the consistency of 
risk  identification,  but  can  also  lead  groups  to  focus  more  heavily  on  the  perceived  benefits  of 
diversification rather than the identification of concentrations. 

24  An example of a second-order effect would be the additional loss arising from the inability of a group 
to liquidate some assets following a sharp decline in the value of those assets. Another example would 
be the additional losses from declines in the value of holdings of bonds issued by airline companies 
due  to  an  increase  in  oil  prices.  Another  would  be  the  additional  losses  incurred  by  the  increase  in 
lapse rates on insurance policies due to a change in interest rate movements. 

25  High-Level Expert Group, final report, page 74. 

17 

 
 
                                                 
tools concerning intra-group  transaction policy  for conglomerates with those applied to 
insurance groups and banking groups, following Article 245 Solvency II. 

3.3.2.  Features of intra-group transactions 

In  their  1999  principles,  the  Joint  Forum  explained  that  intra-group  transactions  and 
exposures (ITEs) can facilitate synergies within different parts of the conglomerate and 
thereby  lead  to  cost  efficiencies  and  profit  maximisation,  improved  risk  management, 
and  more  effective  control  of  capital  and  funding.  Achieving  these  benefits  is  a  major 
goal  of  the  organisational  structures  that  give  rise  to  ITEs.  At  the  same  time,  material 
ITEs  represent  avenues  of  contagion  within  the  conglomerate  and  complicate  the 
resolution of an institution that is failing or has failed. Achieving the appropriate balance 
between  the  benefits  and  risks  of  integrated  groups,  as  exemplified  by  ITEs,  is  an 
important  objective  for  conglomerates  and  for  supervisors,  and  the  appropriate  balance 
may vary across activities and types of ITEs. This is why FICOD Article 8 is drafted in a 
broad manner. 

In order to keep track of potential contagion channels, supervisors need to monitor ITEs. 
ITEs  take  the  form  of  direct  and  indirect  claims  between  entities  within  financial 
conglomerates. ITEs can originate in a variety of ways, e.g. through: 

•  cross-shareholdings; 

•  trading  operations  where  one  group  company  deals  with,  or  on  behalf  of,  another 

group company; 

•  central management of short-term liquidity within the conglomerate; 

•  guarantees, loans and commitments provided to, or received from, other companies in 

the group; 

•  the  provision  of  management  and  other  service  arrangements,  e.g.  pension 

arrangements or back-office services; 

•  exposures  to  major  shareholders  (including  loans  and  off-balance  sheet  exposures 

such as commitments and guarantees); 

•  exposures arising through the placement of client assets with other group companies; 

•  purchases or sales of assets with other group companies; 

•  transfer of risk through reinsurance; and 

•  transactions  to  shift  third-party-related  risk  exposures  between  entities  within  the 

conglomerate. 

In  the  1999  set  of  principles,  the  Joint  Forum  noted  that  a  sound  risk  management 
process for ITEs begins with policies and procedures approved by the board of directors 
or other appropriate body and active oversight by both the board and senior management 
of each regulated entity, in other words with sound internal governance. This guided the 
drafting of FICOD Article 8. 

18 

 
Since then, the Joint Forum has been following the impact of ITEs on financial groups 
and  the  financial  system.  A  general  observation  is  that  the  very  same  transaction  or 
exposure can be beneficial in normal times and contagious in times of stress. A general 
recommendation  with  respect  to  ITEs  is  thus  that  constant  monitoring  of  the  changing 
character of the relationship is crucial in order to detect and control contagion channels 
(for more see Annex 4). The High-Level Expert Group on reforming the structure of the 
EU banking sector confirms the problem of usually beneficial, but potentially contagious, 
intra-group  exposures26  and  suggests  applying  the  large  exposures  limit  for  credit 
institutions  not  only  to  external  parties,  but  also  to  internal,  non-credit-institution 
parties.27 

3.4.  Corporate governance — Articles 9 and 13 

The Joint Forum’s revised 2012 principles describe corporate governance broadly as the 
processes,  policies  and  laws  that  govern  how  a  company  or  group  is  directed, 
administered  or  controlled.  It  defines  the  set  of  relationships  between  a  company’s 
management,  its  board,  its  shareholders,  and  other  recognised  stakeholders.  Corporate 
governance also provides the structure through which the objectives of the company are 
set and the means to attain those objectives and to monitor performance are determined. 

Good  corporate  governance  should  provide  proper  incentives  for  the  board  and 
management  to  pursue  objectives  that  are  in  the  interests  of  the  company  and  its 
shareholders  and  should  facilitate  effective  monitoring.  The  presence  of  an  effective 
corporate governance system within an individual company or group helps to provide the 
degree of confidence necessary for the proper functioning of a market economy. 

Financial conglomerates are often complex groups with multiple business lines and risk 
characteristics  and  comprising  numerous  regulated  and  unregulated  financial  and  other 
entities.  Given  this  inherent  complexity,  corporate  governance  must  carefully  consider 
and  balance  the  combination  of  interests  of  recognised  stakeholders  of  the  ultimate 
parent, and the regulated financial and other entities of the group. The governance system 
should  ensure  that  a  common  strategy  achieves  that  balance  and  that  regulated  entities 
comply  with  regulation  on  both  an  individual  and  an  aggregate  basis.  Establishing  the 
governance system is a fiduciary responsibility of the board of directors. 

FICOD Article 9 contains a requirement for conglomerates to have in place adequate risk 
management  processes  and  internal  control  mechanisms.  Article  13  contains  a  fit  and 
proper  requirement  for  those  who  effectively  direct  the  business  of  a  mixed  financial 
holding company. Omnibus 1 added a living will requirement to Article 9, and FICOD 1 
added a transparency requirement for the legal and organisational structures of groups as 
well  as  a  requirement  for  supervisors  to  make  the  best  possible  use  of  the  available 
governance requirements in CRD and Solvency II. CRD III and the proposal for CRD IV 
included, and Solvency II will include, further strengthening of corporate governance and 
remuneration policy following the lessons learnt during the crisis. 

The  Joint  Forum’s  revised  2012  principles  note  the  need  for  a  comprehensive  and 
consistent  governance  framework  across  the  group  with  ultimate  responsibility  in  the 
hands  of  the  head  of  the  financial  conglomerate.  The  framework  should  include  the 
treatment of conflict of interest, transparency of organisational and managerial structure, 

26  High-Level Expert Group, sections 3.4 and 5.3. 
27 

Idem, pages 74 and 89. 

19 

 
                                                 
suitability of board members, senior managers and key persons in control functions, and 
remuneration policy. 

3.4.1.  Responsibilities  of  the  board  and  senior  management  of  the  head  of  the 

conglomerate; conflict of interest 

De  Vuyst  (2010)  focuses  on  the  accountability  of  the  managers  that  steer  a  financial 
conglomerate. By definition, there is a constant conflict of interest between the group as 
a whole and its individual entities. 

In  order  to  balance  and  ensure  the  soundness  of  the  conglomerate  as  a  whole  and  the 
soundness  of  all  of  its  constituent  entities,  De  Vuyst  (2010)  suggests  applying  the 
Rozenblum  doctrine,  applied  in  some  jurisdictions,  in  a  prudential  setting  as  a  set  of 
governance  requirements.  The  doctrine  basically  builds  on  three  pillars:  (1)  the  group 
should have a common strategy that enforces the common interest, (2) any instruction by 
a parent entity to a subsidiary should not harm the subsidiary’s financial soundness, (3) 
the  benefits  of  the  relationship  should  be  two-way,  i.e.  there  is  a  balance  between  the 
benefits and costs for both sides of the intra-group relationship. Applying this to financial 
conglomerates, the parent entity should, in return for the benefit of steering its licensed 
subsidiaries  and  given  the  guarantee  schemes,  steer  the  subsidiaries  in  such  a  way  that 
the financial soundness of the subsidiaries is at all times ensured. 

Another  layer  of  complexity  in  the  treatment  of  conflict  of  interest  stems  from  the 
existence  of  different  business  sectors  in  a  financial  conglomerate,  where  conflict  of 
interest may arise between the insurance side and the banking side of the conglomerate. 
Internal control and governance should also capture this potential conflict of interest.    

A.O. Laeven (2009), Westman (2011) and Esty (1998) observe that the ultimate parent 
entity’s managers are bound by the instructions of the owners of the group. They have an 
incentive  to  follow  the  instructions  of  these  owners,  as  the  latter  can  hire  or  fire  them. 
The  incentive  to  ensure  the  subsidiaries’  individual  soundness  may  be  less  disciplining 
than the incentives provided by the owners. For these managers, the problem of looking 
after subsidiaries is less pressing than the problem of following the owners’ instructions, 
because  the  depositors  and  policy  holders  of  the  individual  banks  and  insurers  in  the 
conglomerate  benefit  from  guarantees  provided  by  their  governments.  Westman  (2011) 
suggests  increasing  the  monitoring  incentives  for  the  (supervisory)  board,  especially  in 
banks where the safety net reduces the monitoring incentives of depositors. Esty (1998) 
suggests extending the liability of owners. 

The High-Level Expert Group on the structure of the EU banking sector, pointing to the 
studies listed above, also underlined the crucial role of the board and management in a 
complex  group  and  suggests  strengthening  governance  and  control  requirements  for 
boards  and  management,  and  making  those  requirements  enforceable  by  competent 
authorities.28 

3.4.2.  Complexity and business structures 

Lumpkin (2010) argues that the greater financial and economic impacts associated with 
problems  at  larger  institutions  require  a  holistic  approach  that  combines  transparency, 
governance,  regulation  and  supervision.  Confirming  the  main  recommendation  of  the 

28 

Idem, section 5.5.5. 

20 

 
                                                 
Joint Forum’s DNSR report, he asserts that, to be effective, the supervision of financial 
groups needs to fully capture and treat all risks and entities in the group, including any 
unregulated companies. Furthermore, the threat of failure is a core component of market 
discipline,  Lumpkin  says,  because  participants  have  incentives  to  protect  their  own 
interests  only  if  they  are  not  fully  protected.  He  advises  incentivising  behaviour 
consistent  with  the  longer-term  view  of  the  institution  as  a  going  concern;  a 
strengthening  of  the  accountability  of  managers  would  be  part  of  such  behavioural 
incentives. 

Blundell-Wignall  et  al.  (2009)  argue  differently:  group  structures  should  be  simplified, 
and a non-operating holding company (NOHC) structure should distinguish between the 
different kinds of business a conglomerate operates in. In their view, this is the only way 
to ensure that volatile investment banking functions do not dominate the future stability 
of the commercial banking and financial intermediation environment that is so critical for 
economic  activity.  An  NOHC  structure  allows  for  the  protected  capitalisation  of  the 
separate  silos  and  legal  separation  of  the  capital  pools  for  subsidiaries,  without  which, 
they claim, contagion risk cannot properly be addressed. Comparing state-aided and non-
state-aided  banks,  which  were  subject  to  the  exact  same  rules  but  were  operating  in 
businesses with very different risk profiles, they find that every other structure gives too 
much leeway for risky activities impacting on crucial financial intermediation activities. 
Resolution mechanisms for smaller, legally separate entities would be more credible than 
those  required  for  the  large  complex  groups  that  needed  to  be  rescued  by  their 
governments. As in Lumpkin’s argument (2010), it is the threat of failure that disciplines 
the group; the necessary simplified structure is a consequence of the necessary discipline. 
This  is  in  line  with  Westman’s  (2011)  observation  that,  for  mixed  groups,  no  credible 
threat can be found. 

3.4.3.  Living wills 

A powerful mechanism to promote responsible behaviour is to ensure that the managers 
of  financial  institutions  and  their  counterparties  are  aware  of  the  possibility  of  their 
failure, and therefore the need to be concerned about risk. The threat of failure — market 
exit  —  is  a  core  component  of  market  discipline;  it  keeps  all  participants  honest 
(Lumpkin 2010, p. 131). This is why a living will requirement was added to Article 9 in 
Omnibus  I.  The  Bank  Recovery  and  Resolution  framework29  would  roll  out  this 
requirement to the entire banking sector and thus add to credibility. 

The  living  will  concept  was  introduced  when  the  awareness  of  ‘too  big  to  fail’  hit  our 
economies. It is important to note, however, that ‘too big to fail’ has much less to do with 
size  than  with  structure,  as  Blundell-Wignall  et  al.  (2009)  pointed  out.  These  authors 
argue that systemic impact stems from two factors: the potential interruption of financial 
intermediation in an economy to the extent that the economy would suffer significantly, 
and  the  connections  of  counterparties  to  the  failing  firm  to  an  extent  that  would  also 
impact  the  financial  intermediation  function  in  the  economy.  In  particular,  those  firms 
that  engage  relatively  more  in  derivative  instruments  are  more  interconnected  with 
counterparties and thus expose an economy to systemic risks. 

29  Commission  proposal  for  a  Directive  of  the  European  Parliament  and  of  the  Council  establishing  a 
framework  for  the  recovery  and  resolution  of  credit  institutions  and  investment  firms  and  amending 
Council  Directives  77/91/EEC  and  82/891/EC,  Directives  2001/24/EC,  2002/47/EC,  2004/25/EC, 
2005/56/EC, 2007/36/EC and 2011/35/EC and Regulation (EU) No 1093/2010. 

21 

 
                                                 
The ESAs, in their advice, also note that group risks and resolution issues have less to do 
with  size  than  with  complexity.  They  underline  that  even  in  small  conglomerates 
apparently  non-correlated  risks  might  interact  to  produce  negative  effects  especially  in 
times of stress. 

3.5.  Summary 

3.5.1.  Capital — Article 6 

The  regulatory  technical  standard  (RTS)  for  Article  6(2)  FICOD  is  expected  to  deal 
sufficiently  with  the  inconsistent  use  of  methods  to  calculate  capital  for  the  purpose  of 
regulatory capital requirements and to ensure that only transferable capital is counted as 
available for the regulated entities of the group. What needs to be addressed is the lack of 
insight  into  the  availability  of  capital  at  conglomerate  level.  This  could  be  done  by 
requiring  supervisory reporting and market disclosure of capital on an individual or sub-
consolidated basis in addition to the consolidated level.  

3.5.2.  Risk concentrations and intra-group transactions — Articles 7 and 8 

Articles  7  and  8  on  risk  concentrations  and  intra-group  transactions  already  impose 
reporting  requirements  on  undertakings.  Combined  with  the  potential  extension  of 
supervision to unregulated entities and identification of the entity ultimately responsible 
for  compliance  with  FICOD  requirements,  including  the  reporting  obligations,  these 
requirements should provide an adequate framework of supplementary supervision with 
regard to risk concentrations and intra-group transactions. 

The  guidelines  to  be  developed  by  ESAs  should  ensure  that  the  supervision  of  risk 
concentration and intra-group transactions is carried out in a consistent way. 

Given the Joint Forum recommendations referred to in section 3.2.2 above, applying the 
large exposures regime at the level of the conglomerate could be considered, along with 
the need to tailor it to fit the context of conglomerates. 

3.5.3.  Corporate governance — Articles 9 and 13 

FICOD, CRD and Solvency II contain or will contain requirements for regulated entities 
with  respect  to  their  governance  and  remuneration.  The  living  will  requirement  in 
FICOD1 would be strengthened by the Bank Recovery and Resolution Framework. 

What these frameworks do not yet cover is the enforceable responsibility of the head of 
the  group  or  the  requirement  for  this  legal  entity  to  be  ready  for  any  resolution  and 
ensure  a  sound  group  structure  and  the  treatment  of  conflicts  of  interest.  This  is  also 
discussed in section 2.2 above concerning the legal addressees of the requirements. The 
Bank  Recovery  and  Resolution  Framework  would  require  the  preparation  of  group 
resolution plans covering the holding company and the banking group as a whole.   

22 

 
4.  SUPERVISORY TOOLS AND POWERS  

4.1.  The  current  regime  and  the  need  to  strengthen  supervisory  tools  and 

powers 

4.1.1.  Supervisory powers under FICOD 

FICOD contains a number of tools and powers for supervisors together with enforcement 
measures: 

•  Article  14  enables  supervisors  to  access  any  information  relevant  for  supervisory 
purposes. There are views expressed by legal experts that this provision could actually 
be more useful than perceived. According to these views, if necessary for the sake of 
financial  stability,  this  power  even  overrides  the  ordinary  rule  in  company  law  that 
information cannot be shared with minority owners (or their supervisors) if not shared 
with the other owners. 

•  Article  16  empowers  the  coordinator  to  take  measures  with  respect  to  the  holding 
company, and supervisors of regulated entities to act against these entities, upon non-
compliance  with  requirements  concerning  capital,  risk  concentrations,  intra-group 
transactions  and  governance  (Articles  6-9).  The  Article  only  refers  to  ‘necessary 
measures’ to rectify the situation but does not specify such measures. Omnibus I gave 
ESAs the possibility to develop guidelines for measures in respect of mixed financial 
holding companies, but these guidelines have not yet been developed. 

•  Article 17 requires Member States to provide for penalties or corrective measures to 
be imposed on mixed financial holding companies or their effective managers if they 
breach the provisions implementing FICOD. The Article also requires Member States 
to confer powers upon supervisors to avoid or deal with the circumvention of sectoral 
rules by regulated entities in a financial conglomerate.   

The wording of Article 16 and the lack of guidelines has led to a situation where is no 
EU-wide enforcement framework specifically designed for financial conglomerates. As a 
result, the supervision of financial conglomerates is sectorally based with differences in 
national  implementation.  The  ESAs  point  out  furthermore  that  the  strengthened 
sanctioning regime in the CRD IV proposal may create an uneven playing field between 
financial  conglomerates  depending  on  whether  they  are  bank  or  insurance-led.  At  the 
same time, according to the ESAs, most national supervisory authorities consider that the 
measures  available  for  sectoral  supervision  are  also  appropriate  for  the  supervision  of 
financial conglomerates. Strengthening the supervision of financial conglomerates could 
be achieved by improving the actual use of the instruments.   

As to the Article 17 requirement that Member States must provide for credible sanctions 
to make the requirements credibly enforceable, no such sanctioning regime is known for 
conglomerates.  This  may  be  due  to  the  lack  of  correspondence  between  breaches  at 
conglomerate level and authorisation powers at individual level. Generally, regarding the 
sanctioning regimes of the Member States, the Commission survey30 revealed differences 
in  the  availability  of  sanctioning  powers,  the  form  and  substance  of  available 
instruments, the level of application, and the actual use of enforcement powers. 

30  http://ec.europa.eu/internal_market/consultations /docs/2010/sanctions/COM_0716_en.pdf. 

23 

 
                                                 
4.1.2.  Enhancing enforcement to cover the ultimately responsible entity 

As discussed in chapters 2.2 and 2.3 above, the setting of requirements at the level of the 
group should be accompanied by clear identification of an ultimately responsible entity 
in a financial group, which should be in charge of controlling risks on a group-wide basis 
and be responsible for regulatory compliance with group requirements. To give effect to 
these responsibilities, the ESAs’ view is that supervisors should be given more power to 
enforce  compliance  by  this  entity.  Also,  discussions  with  those  applying  the  Directive, 
Member State experts and supervisors, reveal that imposing group-wide requirements on 
a  group  of  entities  would  be  meaningless  without  powers  over  the  entity  that  controls 
these entities. If the responsibility to meet group-wide requirements needs to be imposed 
on a parent entity, specific additional powers are necessary with respect to these parent 
entities.  Currently,  there  are  different  approaches  in  the  Member  States.  Some 
supervisors can impose measures directly on non-regulated holding companies whereas 
others apply enforcement measures only through the regulated entities. 

The  ESAs  recommend  developing  an  enforcement  regime  covering  the  ultimately 
responsible  entity  and  its  subsidiaries,  in  order  to  ensure  that  the  group-wide 
requirements  are  enforceable.  This  would  imply  a  dual  approach  with  enforcement 
powers  with  respect  to  the  top  entity  for  group-wide  risks  and  with  respect  to  the 
individual  entities  for  their  respective  responsibilities.  Corrective  measures  should  be 
directed at the entity responsible for the breach concerned. 

Furthermore, the ESAs argue, the supervisor should have a minimum set of informative 
and investigative measures available with regard to MAHCs and MAIHCs. Supervisors 
should  be  able  to  impose  sanctions  on  MAHCs  or  MAIHCs  if  these  entities  do  not 
provide  the  requested  information.  Moreover,  when  an  intermediate  financial  holding 
company  has  been  established,  supervisors  should  be  able  to  impose  sanctions  on  this 
intermediate financial holding company. 

4.1.3.  Supervisory responsibilities; existing supervisory coordination provisions 

Both the determination of a coordinator in Article 10 and the list of coordinating tasks in 
Articles  11  and  12  are  widely  appreciated  and  since  2002  have  been  copied  into  the 
banking and insurance group frameworks. The substance of those provisions thus seems 
relevant;  in  particular,  the  group-structure  provisions  seem  even  more  relevant  today. 
These  provisions  were  even  strengthened  in  the  Omnibus  I  and  FICOD1  exercises,  by 
adding  the  gathering  and  distribution  of  information  on  the  transparency  of  group 
structures  as  a  further  important  task  for  the  coordinator  and  the  relevant  competent 
authorities. 

However, as noted above, this list of tasks for the coordinator and the relevant competent 
authorities  is  not  supported  by  any  requirement  other  than  the  requirement  to  Member 
States  to  provide  for  credible  sanctions  and  measures  with  respect  to  the  holding 
company  in  Article  17.  The  question  is  then  whether  information  exchange  and 
coordination are sufficient as obligations for coordinating supervisors in the light of the 
objective of the Directive. 

The Joint Forum revised 2012 principles reveal that the responsibilities of the head of a 
financial  conglomerate  should  be  mirrored  by  the  responsibilities  of  the  authority 
supervising it. This is necessary because a holding company as such is not authorised, so 

24 

 
the  rule  of  ‘licenser  supervises  licensee’  is  not  applicable  to  the  head  of  a  group  of 
licences if that head is a holding company. 

The Joint Forum notes that, in order to develop and maintain a sound understanding of 
the  operations  of  a  financial  conglomerate,  supervisors  should  have  the  following 
responsibilities (quoting from the principles, non-exhaustive list): 

(i) 

(ii) 

To review the consistency of the financial conglomerate’s own assessment of its 
risks at sector and aggregate level; 

To have sufficient interaction with the board and senior management of the head 
of  the  financial conglomerate,  the board and senior management of the ultimate 
parent, and the boards and senior managements of material and relevant entities 
within the financial conglomerate; 

(iii)  To  understand  the  broader  risks  to  which the financial  conglomerate is exposed 

from the environment in which it operates; 

(iv) 

(v) 

To  have  a  forward-looking  assessment  of  the  sources  of  risk  to  the  financial 
conglomerate; 

To  impose  sanctions  or  corrective  action  to  be  taken  by  the  financial 
conglomerate  or  its  constituent  entities,  such  as  restricting  current  or  future 
activities,  suspending  dividends  to  shareholders  of  relevant  entities  within  the 
financial conglomerate, and other measures to prevent capital from falling below 
the required levels; 

(vi) 

To possess both an ability and willingness to take timely action when appropriate. 

These responsibilities are broadly covered by FICOD Articles 11 and 12. 

4.2.  The possibility to introduce mandatory stress testing 

The possibility to require conglomerates to carry out stress tests might be an additional 
supervisory tool to enhance the early and effective monitoring of risks in conglomerates. 
FICOD1  introduced  the  possibility  (though  not  an  obligation)  for  the  supervisor  to 
perform  stress  tests  on  a  regular  basis.  In  addition,  when  EU-wide  stress  tests  are 
performed, the ESAs may take into account parameters that capture the specific risks of 
financial conglomerates. 

The  Joint  Forum’s  revised  2012  principles  recognise  that  supervisors  should  require, 
where  appropriate,  financial  conglomerates  to  periodically  carry  out  group-wide  stress 
test and scenario analyses for their major sources of risk. 

The ESAs recognises that it could be useful to strengthen risk management with a group-
wide perspective on the basis of specific ESA guidelines as indicated in FICOD Article 
9(6) or through stress tests at group-wide level in accordance with FICOD Article 9b. 

25 

 
References 

Blundell-Wignall, A., G. Wehninger and P. Slovik (2009), The Elephant in the room: the 
need to deal with what banks do, In Financial Market Trends, 2009(2), pp. 1-26 

Boot, Arnoud W.A. (2011), Destabilising market forces and the structure of banks going 
forward, in The Future of Banking, edited by Thorsten Beck, CEPR VoxEU.org eBook, 
pp. 29-34 

De Haas, R., Van Lelyveld, I. (2006) Foreign Banks and Credit Stability in Central and 
Eastern Europe: Friends or Foes? Journal of Banking and Finance 30 (7), 1927–1952. 

De  Haas,  R.,  Van  Lelyveld,  I.  (2010),  Internal  Capital  Markets  and  Lending  by 
Multinational Bank Subsidiaries. Journal of Financial Intermediation 19 (1), 1–25  

De  Haas,  R.  &  Van  Lelyveld,  I..  &    (2011),  Multinational  Banks  and  the  Global 
Financial Crisis, Weathering the Perfect Storm?, DNB working paper nr 332 

De Vuyst, Veerle (2010), Internal governance bij financiele conglomeraten, Antwerpen, 
Intersentia 

European  Business  Organisation  Law  Review  (EBOR)  I  (2000)  165-264;  ‘Corporate 
Group  Law  for  Europe’,  Forum  Europaeum  Konzernrecht,  Stockholm  (Corporate 
Governance Forum) 2000 

Gouvin,  E.  (1999)  Of  Hungry  Wolves  and  Horizontal  Conflicts:  Rethinking  the 
Justifications for Bank Holding Company Liability, in University of Illinois Law Review 
988 e.v. 

Gruson,  Michael  (2004),  Consolidated  and  supplementary  supervision  of  financial 
groups  in  the  European  Union,  Working  paper  series  No  19,  Institute  for  Law  and 
Finance, Frankfurt 

High-Level Expert Group on reforming the structure of the EU banking sector, “Liikanen 
Group” Brussels, 2 October 2012 

Hutter, Bridget M. (2005), The Attractions of Risk-based Regulation: accounting for the 
emergence of risk-ideas in regulation, ESRC Centre for Analysis of Risk and regulation, 
Discussion paper No 33, LSE, March 2003 

Joint Forum (2008), Credit risk transfer 

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26 

 
 
Laeven, Luc (2011), Bank governance and regulation, in The Future of Banking, edited 
by Thorsten Beck, CEPR VoxEU.org eBook, pp. 49-55 

Levine,  Ross  (2010),  BIS  working  papers  No  329,  The  governance  of  financial 
regulation: reform lessons from the recent crisis 

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Financial Market Trends, Volume 2010 — issue 2, pp. 105-136 

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finance,  in  The  transformation  of  the  European  financial  system,  Second  ECB  banking 
conference (2003) 

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paper Ministry of Finance, Finland 

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profitability in banks with different strategies, Journal of Banking and Finance 35 (2011), 
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of  the  European  Union,  in  K.  Hopt  a.o.  Unternehmensgruppen  in  mittel-  und 
osteuropäischen Ländern, Tübingen, Mohr Siebeck 

27 

 
ANNEX 1 — RISK CONCENTRATIONS, CRISIS LESSONS 

The Joint Forum report on risk concentrations31 included an analysis of how the largest 
complex  groups  across  the  globe  currently  deal  with  this  kind  of  group  risk  and  the 
lessons learned from the crisis. Below is an impression of the report: 

The market events of the second half of 2007 and the rise of risk concentrations 

In  this  section,  the  focus  is  on  the  emergence  of  risk  concentrations  within  financial 
conglomerates as the market conditions initially precipitated by credit quality problems 
in  the  US  subprime  mortgage  market  developed  during  the  latter  half  of  2007,  and  the 
challenges or difficulties this posed to firms’ management processes. 

The risk measurement methods and valuation approaches that are key to the credit risk 
transfer markets were called into question in the latter half of 2007. For OTC derivatives 
and  securitisation  products,  the  valuation  process  is  fundamental  to  understanding  the 
risks of these positions. The reliance of firms on liquid markets to value their positions 
may  have  led  some  to  neglect  more  fundamental analysis of the risk of such positions. 
Consequently,  the  subsequent  valuation  difficulties  affected  the  assessments  by  some 
financial  conglomerates  of  their  potential  exposures  in  businesses  across  trading  book 
activities, investment portfolios, warehousing and counterparty exposures. 

The  risk  characteristics  of  credit  risk  transfer  products  (e.g.  ABS  CDOs)  differ  from 
those  of  single-name  bonds  or  loans.  Investments  in  these  products  can  affect  the  risk 
characteristics  of  firms’  credit  portfolios.  There  are  a  number  of  factors  to  consider  in 
assessing  these  effects.  First,  through  the  pooling  of  collateral,  (higher  grade) 
securitisation  notes  can  represent  significant  exposures  to  systematic  risk  even  while 
reducing specific risk. Second, if defaults become more correlated (which is the case for 
a  systemic  credit  event),  the  probability  that  the  losses  will  affect  the  higher-rated 
tranches  increases.  Third,  a  risk  feature  called  negative  convexity  can  be  present  in 
credit-structured products. This implies that a widening of credit spreads has a stronger 
impact on prices than a narrowing, and that prices decline at an increasing rate the more 
spreads widen. The correlation and negative convexity features reinforce one another, in 
that as the number of defaults increases the decline in ABS prices gains in speed, and as 
negative  convexity  increases  the  prices  decline  further.  Fourth,  securitisation  products 
and investment strategies often incorporate additional leverage. In general, these features 
increase the ‘extent’ and ‘speed’ of a systemic event during a period of price decline. In 
addition, a feature that comes into play in a portfolio context is the dependency between 
securitisation notes. In general, compared to common single-name bonds and loans, the 
dependencies  between  securitisation  notes  are  relatively  stronger.  It  is  clear  that  these 
characteristics  of  relatively  higher  exposure  to  systematic  risk,  stronger  correlated 
exposures,  significant  negative  convexity  and  high  leverage  may  quickly  lead  to 
concentrated exposures to systematic factors. Risk management approaches that did not 
fully  recognise  these  risk  characteristics  were  not  able  to  capture  the  potential  risk 
concentrations within the firm stemming from their credit securitisation exposures. 

31  http://www.bis.org/publ/joint19.htm. 

28 

 
                                                 
A systematic credit event, which first showed up in the US subprime mortgage market, 
quickly  spread  through  other  markets,  affecting  many  different  business  lines  within 
financial conglomerates: 

The  sharp  rise  in  default  rates  for  US  subprime  mortgages,  coupled  with  tremendous 
uncertainty  surrounding  the  valuation  and  risk  measurement  approaches  to  ABS  and  a 
loss  of  confidence  in  credit-rating  agency  ratings,  led  to  a  drop  in  investor  demand  (as 
investors could not confidently quantify the risks of these products and as CDOs, CLOs, 
SIVs  and  conduits  were  experiencing  difficulties).  These  developments,  in  turn,  led  to 
the  almost  complete  absence  of  market  liquidity  for  asset-backed  commercial  paper. 
Several originating companies encountered difficulty funding their mortgage loans, and 
started to draw  down the back-up lines of credit provided by their respective banks. In 
addition, for the firms originating the assets and structuring the ABS, these events led to 
an unexpected build-up of concentrated exposures from assets in the warehouse pipeline, 
since  the  assets  could  not  be  transferred  and  had  to  be  taken  on  the  books  at  the  same 
time that liquidity support for similar assets was being drawn down.   

he  lack  of  confidence  in  the  ability  of  market  participants  to  determine  the  quality  of 
some  assets  and  the  increased  risk  aversion  among  investors  led  to  significant 
deterioration  in  the  market  liquidity  of  the  ABCP  markets.  This  in  turn  led  to  soaring 
rates  on  ABCP  and  the  restructuring  of  CP  funding  with  overnight  or  very  short-term 
debt  (generally  one  week  and  under).  The  shortening  of  ABCP  funding  maturities 
increased  the  funding  concentrations  of  firms  in  short-term  maturities,  making  them 
increasingly exposed to sudden liquidity events. 

The  funding  difficulties  (i.e.  the  difficulty  of  rolling  over  commercial  paper)  required 
some issuers to sell a portion of their assets to their liquidity providers or sponsors, while 
others drew on their back-up lines of credit or tried to extend the maturity of their CP or 
medium-term  notes.  In  sum,  the  market  events  severely  affected  the  off-balance  sheet 
banking  conduits,  including  SIVs.  For  the  sponsoring  firms  or  the  banks  providing 
liquidity  facility  lines,  this  systematically  led  to  a  further  build-up  of  exposures  to 
(structured) credit assets and put pressure on their liquidity positions. 

The  credit  event,  coupled  with  the  deterioration  in  market  liquidity  and  the  subsequent 
rise in risk aversion, led to large declines in the value of ABS and the underlying assets. 
Under these circumstances, the degree of risk mitigation provided by initial margins and 
collateral  may  have  been  less  than  firms  anticipated,  due  to  the  dynamics  of  the  initial 
price  shocks,  the  consequent  increases  in  haircuts  and  the  further  price  declines  due  to 
the sale of collateral in illiquid markets. The additional collateral requirements led to a 
further deterioration in the liquidity situation of several firms. 

The hedging of credit risk exposures was also limited by the market events and proved 
difficult  to  manage.  Even  the  effectiveness  of  some  of  the  more  common  hedges  for 
structured credit products, such as traded reference indices or particular credit tranches, 
were called into question. For instance, the hedging of subprime mortgage exposures via 
the  ABX  index  proved  to  be  quite  difficult.  Nevertheless,  in  some  cases,  reference 
indices were the only hedging instruments that maintained their liquidity, forcing firms to 
switch  their  hedges  from  instruments  that  lost their liquidity to these  reference  indices. 
This  often  led  to  significant  increases  in  basis  risk.  Additionally,  the  stress  events  also 
showed that some model-based valuation methods may not have fully captured the entire 
risk  profile  of  exposure  under  these  market  conditions,  giving  rise  to  additional 
unexpected basis risk. As some hedging strategies proved inadequate or had to be altered 

29 

 
in  the  midst  of  a  market  liquidity  squeeze,  some  firms  were  exposed  to  unexpected 
concentrated risk exposures and basis risk. 

The  liquidity  squeeze,  combined  with  the  higher  sensitivity  to  credit  risk  and  elevated 
concerns about financial institutions’ exposure to structured credit products and liquidity 
facilities, spread to the interbank markets. Firms that were still relatively liquid were not 
willing to supply funds in the interbank market, due to their own contingent exposures or 
due  to  the  uncertainty  regarding  the  financial  health  of  their  interbank  counterparties. 
These uncertainties resulted in steep increases in short-term interest rates for some firms, 
making  interbank  term  funding  extremely  expensive  or  even  impossible  in  some  cases. 
This again forced certain firms’ funding towards short-term (often overnight) maturities, 
heightening  their  sensitivity  to  unexpected  liquidity  events.  In  addition,  firms  that 
increased their reliance on the interbank markets to meet the additional liquidity demand 
(and thus may have been concentrated in these markets) saw an ultimate liquidity source 
being constrained. 

The  extensive  downgrading  of  ABS  has  also  put  enormous  pressure  on  monoline 
insurance  companies,  as  some  financial  guarantors  have  guaranteed  large  amounts  of 
AAA rated (and super-senior) CDO tranches. This pressure has the potential to affect the 
entire  ABS  spectrum,  bringing  further  price  declines  in  particular  for  the  already 
weakened higher-grade notes. The deterioration in the credit ratings for ABS could have 
second-order implications, as, for instance, institutional investors that are only allowed to 
hold  highly  rated  paper could be forced to sell in the event of a downgrade, leading to 
additional  price  pressure.  Additional  second-order  effects  may  also  include  pressure  in 
the US municipal finance market as municipalities may find it more difficult to obtain the 
bond  insurance  needed  to  obtain  their  desired  credit  rating  and  borrowing  costs.  Thus, 
firms might have unexpected second-order,  concentrated exposures to certain monoline 
insurance  companies,  either  directly  or  as  a  result  of  agreements  to  fund  or  buy  back 
certain positions in the event of multi-notch downgrades of assets. 

While the credit risk transfer markets have provided financial institutions with increased 
opportunities  to  more  actively  manage  the  portfolios  of  risks  that  they  hold,  the  recent 
market  turmoil  also  demonstrates  that  these  activities  can  also  lead  to  additional  risk 
exposures that are sometimes difficult to measure and manage. As recent events indicate, 
the greater a firm’s reliance on the risk transfer markets — whether for an originate-to-
distribute business, for the securitisation of assets, as an alternative funding source, or for 
the hedging of risk exposures and the extended use of collateral to manage counterparty 
risk  —  the  more  dependent  it  is  on  the  existence  of  liquid  markets.  Additionally,  risk 
transfer markets can deepen the link between market liquidity and funding liquidity risk 
and  may  create  significant  exposures  across  risk  categories  (i.e.  market,  credit  and 
liquidity  risk).  Recent  events  also  show  that  different  business  activities  across  a 
financial  conglomerate  may  be  affected  at  the  same  time,  possibly  compounding  the 
exposures  in  the  different  businesses  (and  increasing  the  potential  of  contagion  to 
unaffected activities). The interactions between risk exposures can give rise to the rapid 
growth  of  ‘unexpected’  risk  positions  at  the  same  time  that  they  become  increasingly 
difficult to measure and manage. 

The  market  events  of  the  second  half  of  2007  and  integrated  risk  management 
approaches 

30 

 
 
the  extent  of 

the  exposures  and 

Risk  concentrations  are  determined  by 
the 
interdependencies  between  these  exposures.  Recent  market  events  have  shown  that  the 
magnitude  of  the  risk  exposures  and  their  simultaneous  realisation  across  much  of  the 
global  financial  system  were  not  fully  anticipated.  The  report  discussed  how  risk 
methods may have missed certain risk characteristics of the credit risk transfer products 
and thereby may have missed the potential concentrated exposures that can arise during 
systemic  events.  It  also  summarised  how  the  credit  event  spread  through  the  markets, 
affecting  the  different  activities  of  financial  conglomerates  and  leading  to  a  number  of 
risk  concentrations.  Economic  capital  models  generally  lack  the  flexibility  to  fully 
integrate  the  rich  interdependency  structures  between  exposures  and  tend  not  to 
incorporate  the  second-order  effects.  Scenario  stress  testing  is  regarded  as  a  more 
appropriate  tool  to  capture  the  dependencies,  the  second-order  effects,  and  the 
simultaneous realisations due to contagion. However, in the Joint Forum interviews with 
firms,  the  majority  indicated  that  they  had  not  conducted  any  stress  tests  or  scenario 
analysis that had detected and prepared their institutions for the potential ramifications of 
this  financial  shock.  In  general,  stress  tests,  for  instance,  did  not  adequately  capture 
(systemic) market shocks, had optimistic assumptions as to asset marketability (via loan 
sales or securitisation), underestimated or ignored the risks of extending liquidity support 
to conduits and SIVs, and ignored potential contingent risks from reputational issues. 

In  general,  the  scenario  stress  tests  of  the  financial  conglomerates  do  not  consider 
systemic  shocks  or  events;  rather,  they  mainly  look  at  name-specific  events.  Systemic 
shocks are often considered to have an extremely low probability of occurrence, so are 
usually  considered  to  be  too  severe  to  be  practical  for  the  purposes  of  stress  testing. 
However,  while  standard  distributions  may  allot  an  extremely  low  probability  to  these 
systemic  shocks  occurring,  recent  experience  may  give  a  different  picture  of  their 
likelihood.  Moreover,  many  firms  question  the  feasibility  of  predicting  the  actual 
development of particular shocks. While the precise timing, triggers and development of 
a systemic shock are hard to predict exactly, accurately predicting specific market events 
is  not  necessary  to  incorporate  systemic  risk  within  a  scenario.  Thorough  analysis  and 
understanding of the economic and financial environment, coupled with views on further 
market  developments,  the  identification  of  how  different  risk  factors  could  potentially 
play  out,  the  identification  of  the  drivers  of  potential  market  dislocations,  the  ways  in 
which  contagion  may  spread,  and  the  firm’s  own  behaviour  during  these  events,  will 
increase  the  preparedness  and  robustness  of  financial  conglomerates  to  cope  with  such 
turmoil events. 

The events in the latter half of 2007 clearly showed how positions can suddenly become 
concentrated  because  of  the  actions  of  other  market  participants.  In  reality,  market 
participants  sometimes  initially  overreact  to  certain  events  (which  may  be  due  to 
information  gaps  and  asymmetries),  which  can  lead  to  a  drying-up  of  market  liquidity. 
Even  so,  the  limited  number  of  financial  conglomerates  that  reported  the  inclusion  of 
market  liquidity issues in their stress tests tended to see market liquidity risk only as a 
material issue in markets with a limited number of dealers. Overall, these conglomerates 
saw the exposure of the entire group to these narrow markets to be rather limited. Recent 
market events, however, have shown that the issue of market liquidity is not restricted to 
highly  concentrated  markets  and  that  risk  concentrations  may  quickly  arise  in  financial 
conglomerates when broader market liquidity dries up. 

Firms  should  also  consider  how  different  market  structures  (that  originally  may  be 
intended to protect individual positions) may lead to or reinforce a systemic event. For 
instance,  the  market  triggers  present  in  different  CDOs  reinforced  the  initial  price 

31 

 
declines  in  ABS.  Common  investment  rules  forced  some  market  participants  to 
simultaneously  exit  certain  positions,  with  these  asset  sales  leading  to  further  price 
declines  (and  to  potential  second-order  effects).  The  liquidity-constrained  SIVs  were 
particularly prone to second-order effects: fire sales had the potential to trigger a domino 
effect spreading to other SIVs holding similar assets. This reduction in asset value could 
set  off  certain  triggers,  forcing  the  SIVs  in  turn  to  sell  assets  to  meet  their  liquidity 
requirements. The market volatility also led to some firms’ VaR models breaching their 
limits,  which  dampened  risk  appetite.  In  general,  besides  a  firm’s  own  management 
actions, firms should also consider the potential reactions of market participants to stress 
events in their scenarios (for instance when determining the severity of such scenarios). 
In  particular,  the  self-reinforcing  behaviour  due  to  certain  market  structures  should  be 
incorporated into scenario stress tests. 

The 2007 market events also showed the importance of legal and reputational risk issues. 
Several financial conglomerates faced the threat of legal action by various investors for 
the losses suffered on their ABS investments. To avoid some of these legal actions and 
the  associated  reputational  risk,  several  firms  bought  back  ABS,  incurring  additional 
unexpected  losses.  Firms  that  sponsored  or  provided  liquidity  support  to  off-balance 
sheet conduits also felt obligated, in some cases, to buy back or consolidate assets even 
though  they  had  no  legal  obligation  to  do  so,  often  for  reputational  reasons.  Similarly, 
some firms that manage money market funds had to reimburse their clients, after freezing 
withdrawals,  when  clients  started  to  redraw  from  money  market  funds  that  invested  in 
ABCP or other CRT products. 

32 

 
 
 
ANNEX 2 — SPECIAL PURPOSE ENTITIES 

Below is an impression of the Joint Forum SPE report.32 

Features 

An SPE is a legal entity created at the direction of a sponsoring firm (which may also be 
referred to as the sponsor, originator, seller, or administrator). The sponsor is typically a 
major bank, finance company, investment bank or insurance company. An SPE can take 
the form of a corporation, trust, partnership, corporation or a limited liability company. 
An  SPE  is  a  vehicle  whose  operations  are  typically  limited  to  the  acquisition  and 
financing  of  specific  assets  or  liabilities.  In  this  respect,  a  distinction  should  be  drawn 
between  asset  securitisations  and  liability  securitisations.  Asset  securitisations  are 
usually undertaken by banks and finance companies, and typically involve issuing bonds 
that are backed by the cash flows of income-generating assets (ranging from credit card 
loans).  Liability  securitisations  are  usually 
receivables 
undertaken by insurance companies, and typically involve issuing bonds that assume the 
risk  of  a  potential  insurance  liability  (ranging  from  a  catastrophic  natural  event  to  an 
unexpected claims level on a certain product type). 

to  residential  mortgage 

securities 

securities 

The  application  of  SPEs  across  financial  sectors and to different asset classes  is broad. 
For  example,  these  structures  are  employed  in  programmes  for  residential  mortgage-
(CMBS), 
(RMBS),  commercial  mortgage-backed 
backed 
collateralised  debt  obligations  (CDOs),  collateralised  loan  obligations  (CLOs),  asset-
backed  commercial  paper  (ABCP),  and  structured 
investment  vehicles  (SIVs). 
Repackaging  vehicles  are  another  significant  business  that  involves  SPEs,  one  which 
permits clients to acquire tailored exposure to a variety of asset classes and risk profiles 
through a single instrument. For example, an investor seeking a structured return might 
request  that  a  financial  institution  structure  a  transaction  that  combines  otherwise 
unrelated  credit  components  (exposure  to  one  or  more  corporate  entities),  interest  rate 
components  (fixed,  floating,  inflation-linked,  etc.)  and  maturity  components  (bullet, 
scheduled  maturity,  etc.)  that  are  not  currently  available  ‘packaged  together’  in  the 
marketplace. 

In contrast to asset securitisations, institutions in the insurance sector have used SPEs in 
products  that  transfer  exposures  to  liabilities,  such  as  bonds  that  transfer  catastrophic 
event risk to the capital markets. Additionally, financial guaranty providers have created 
transformer structures that incorporate credit default swaps to provide the equivalent of 
guaranty insurance. 

A defining feature common to many SPEs is that of bankruptcy remoteness, whereby an 
SPE’s  assets  are  isolated  from  any  creditors  of  its  sponsoring  firm  should  the  latter  go 
into  bankruptcy.  This  feature  can  be  achieved  through  a  variety  of  methods,  including 
limiting  the  SPE’s  purpose,  indebtedness,  assets,  and  other  liabilities  (or  non-financial 
obligations),  as  well  as  by  ensuring  through  its  corporate  governance  process  that 
decisions regarding bankruptcy will be made from the point of view of the SPE itself (not 
its sponsor or other affiliate). A ‘true sale’ of assets from the sponsor’s balance sheet to 
such a bankruptcy-remote SPE should ensure that the recourse of investors to assets held 
as  security  in  the  SPE  is  unlikely  to  be  successfully  challenged.  In  the  US,  the  legal 

32    http://www.bis.org/publ/joint23.pdf 

33 

 
                                                 
separateness  of  SPEs  is  considered  fairly  well  established.  However,  bankruptcy 
remoteness  may  be  harder  to  achieve  in  certain  jurisdictions,  or  may  be  less  certain 
where securitisation is a  relatively recent development.  These  factors may  explain why 
the use of SPEs is not as prevalent in such jurisdictions. 

In some jurisdictions, most transactions involving SPEs are treated as on-balance sheet, 
while  similar  transactions  in  other  countries  will  appear  off-balance  sheet.  This 
distinction  between  on-  and  off-balance  sheet  treatments  for  accounting  purposes, 
however, does factor into how transparent these vehicles have been in the international 
financial system. 

Motivations 

SPEs  and  the  securitisation  transactions  that  employ  them  can  be  viewed  as  a  way  of 
disaggregating  the  risks  of  an  underlying  pool  of  exposures  held  by  the  SPE  and 
reallocating these risks to those parties most willing to take on those risks. This purpose 
is  therefore  a  motivating  factor  for  both  originators  and  investors.  Originating  or 
sponsoring institutions can use SPEs for risk management purposes, such as to transfer 
credit,  interest  rate,  market,  event,  or  insurance  risks  to  other  parties.  Originators  may 
also use SPEs to access additional sources of funding and liquidity, or to reduce funding 
costs.  Smaller  institutions  may  use  SPE  structures  to  pool  exposures  and  thereby  gain 
greater and more cost-effective access to the capital markets. In some cases, sponsoring 
firms  may  be  motivated  to  use  SPEs  to  achieve  off-balance  sheet  accounting  treatment 
for assets, leading to improved financial and capital ratios for the firm. 

Generally, off-balance sheet treatment is easier to achieve under US GAAP than under 
IFRS. However, recent  changes  to  US accounting rules relating to SPEs effective from 
2010 will significantly reduce the ability of certain transactions to qualify for off-balance 
sheet treatment. 

Regulatory  capital  also  serves  as  an  important  motivating  factor  for  engaging  in 
transactions involving SPEs. In particular, differences between the Basel I and Basel II 
regulatory  capital  frameworks  present  different  incentives  to  enter  into  particular 
transactions.  These  differences  manifest  themselves  along  two  dimensions.  One  is  the 
difference in treatment for on-balance sheet loans, and the second relates to differences 
in the treatment of retained exposures in securitisation transactions. 

Investors  may  be  motivated  to  purchase  securities  issued  by  SPEs  to  gain  exposure  to 
new  asset  classes  or  possibly  to  avoid  regulatory  and  internal  limits,  such  as  those 
relating  to  name  concentrations  or  credit  quality.  In  the  case  of  synthetic  transactions, 
investors may find it beneficial that they would not have to fund credit exposures at the 
outset. 

The  relative  importance  of  these  motivating  factors  may  vary  across  jurisdictions.  For 
example, European financial firms generally have less ability to remove assets from their 
balance sheets by using SPEs. However, this is offset by the fact that risk-based capital 
requirements are not as closely tied to accounting in Europe. In contrast, while US firms 
currently  can  more  easily  remove  assets  from 
the  US 
implementation of Basel I required more capital for certain exposures than in Europe. 

their  balance  sheets, 

Risk transfer 

34 

 
Vehicle  types  that  tend  to  achieve  a  high  level  of  risk  transfer  for  originators  include 
CDO/CLOs, SIVs (with notable exceptions), and RMBS structures. In contrast, high risk 
retention  (implying  a  need  for  potential  credit  support  on  the  part  of  the  sponsor  or 
originator)  is  generally  more  likely  with  programmes  such  as  covered  bonds,  certain 
ABCP conduits, and credit card securitisations. The current market crisis has highlighted 
several areas  where  firms may have misestimated the degree of risk transfer associated 
with certain SPE structures. Several factors will determine the level of risk transfer. One 
factor is whether the originator has retained a position in the capital structure and, if so, 
what position. The issue becomes more complex given that tranches initially retained at 
deal  inception  can  be  subsequently  sold  or  else  transformed  through  re-securitisation 
processes.  Originating  firms  also  have  an  asymmetric  informational  advantage  in 
knowing more about the exposures than investors, which could potentially allow them to 
structure a deal to most efficiently transfer risk away from themselves. 

Another  important  risk  element  relates  to  the  existence  of  triggers  in  many  structured 
finance  transactions,  such  as  early  amortisation  triggers  in  revolving  securitisation 
structures and market value triggers in SIVs. Triggers may potentially be interrelated (as 
could happen in the case of re-securitisations, resulting in two layers of triggers) or else 
highly  correlated  (leading  to  procyclical  effects).  Beyond  these  contractual  elements, 
considerations  of  factors  such  as  reputational  risk  and  franchise  risk  could  lead 
originators to provide non-contractual support to investors in SPEs. 

Due Diligence and Risk Management 

Market participants interviewed suggest that originating firms may, in instances, conduct 
different  levels  of  credit  due  diligence  on  assets  depending  on  whether  they  intend  to 
retain  the  related  risks  on  their  own  balance  sheets  or  transfer  them  to  an  SPE.  In 
particular,  CDO  assets  that  are  specifically  originated  or  purchased  (and  temporarily 
warehoused)  to  be  sold  to  an  SPE  may  undergo  a  less  rigorous  credit  underwriting 
process compared to credits that the originator intends to retain. On the other hand, most 
ABCP  conduit  sponsors  seem  to  apply  the  same  level  of  due  diligence  whether  or  not 
assets  are  intended  for  an  SPE,  subjecting  them  to  comparable  concentration  and 
exposure caps. In between these two extremes are receivables such as small-and-medium 
enterprise (SME) and leveraged loans, where origination practices vary by institution and 
vehicle. 

For  ongoing  risk  management  purposes,  many  sponsoring  firms  will  maintain  a  single 
database  that  aggregates  both  on-balance  sheet  exposures  and  off-balance  sheet  (SPE) 
exposures. This is fairly common for credit card securitisations, where originators view 
risks on a ‘managed asset’ basis. However, firms may exclude certain vehicles from this 
aggregated  risk  analysis,  if  they  judge  those  exposures  to  have  been  materially 
transferred. CDO transactions, thought to be done at a greater arm’s length, and SIVs are 
two types of vehicles more commonly omitted from such management information and 
modelling. 

In  contrast,  some  firms  either  do  not  perform  aggregated  risk  management  analysis  to 
include  SPEs,  or  else  do  so  infrequently  (for  instance,  semi-annually).  Firms  may  also 
not consider the breadth of roles they may play in relation to an SPE on an ongoing basis. 
For  instance,  a  bank  could  have  a  liquidity  facility,  swap,  and  reserve  fund  linked  to  a 
single SPE, but each of these elements could be analysed separately by different business 
units without the firm necessarily rolling up its overall exposure to this SPE. 

35 

 
Several  market  participants  interviewed  noted  that,  until  the  market  disruptions,  some 
senior  managers  were  unaware  of  the  full  extent  of  their  firm’s  overall  linkage  to  and 
obligations (explicit or implicit) toward their SPEs. There is no clear pattern that larger 
institutions  understood  the  risks  better  than  smaller  ones.  In  fact,  senior  managers  at 
small firms — particularly those operating in a niche or monoline sector which rely on 
SPEs in their funding strategy — may have an enhanced understanding of these entities. 

It  was  also  observed  that  some  investors  did  not  seem  to  have  conducted  adequate 
independent  due  diligence  to  understand  the  risk  profiles  of  SPE  transactions  that  they 
had  invested  in.  Geographic  distinctions  were  noted  for  certain  sub-sectors  of  the 
securitisation markets. For instance, investors in US RMBS transactions seemed unaware 
primarily  of  issues  surrounding  credit  quality  and  asset  performance.  In  contrast, 
European  SPE  investors  were  more  surprised  by  structural  features  of  the  transactions 
and their inability to access analytics and modelling resources for bonds held 

Lessons learnt 

The  monitoring  of  the  changing  character  of  intra-group  relationships  is  particularly 
relevant for relationships with special purpose entities (SPE), as was shown in the Joint 
Forum’s SPE report.  

The number and complexity of SPE structures increased significantly before the financial 
crisis in conjunction with the growth of markets for securitisation and structured finance 
products, but have declined since then. The use of SPEs has been proven to be beneficial 
for the risk management of a financial group. SPEs have been used for many years and 
have contributed to the operation of the global financial markets by providing financing 
opportunities for a wide range of securities to meet investor demand. 

While the use of SPE structures yields benefits and may not be inherently problematic in 
and of itself, the crisis has illustrated that poor risk management and a misunderstanding 
of the risks of SPE usage can lead to failures. In cases where parties to SPEs possessed a 
comprehensive  understanding  of  the  associated  risks  and  possible  structural  behaviours 
of  these  entities  under  various  scenarios,  they  have  effectively  engaged  in  and  reaped 
benefits  from  their  SPE  activities.  On  the  other  hand,  it  is  unclear  that  the  poor  credit 
quality  of  assets  sold  into  SPEs  can  be  attributed  to  the  existence  of  these  structures, 
which were simply the legal form in which such assets were held to issue bonds backed 
by them. Nonetheless, it is important to address why some of the recent failures in SPE 
usage occurred. 

While  recent  market  events  have  resulted  in  a  dramatic  reduction  in  the  issuance  of 
securities  using  SPEs,  since  these  structures  provide  institutions  and  investors  with  a 
variety  of  uses  and  benefits,  they  are  likely  to  continue  to  be  used  for  financial 
intermediation and disintermediation going forward. It is accordingly important to ensure 
that they are properly regulated and their usage supervised. 

To  that  end,  the  Joint  Forum  recommended  supervisors  to  develop  skills  in  the  areas 
below.  The  application  of  the  intra-group  transaction  provisions  of  Article  8  FICOD 
would then be more effective, especially if their scope were enlarged (see section 2.1). It 
should be noted that this intra-group problem is not specific to financial conglomerates, 
but inherent to complex groups in general. It may be a question that has to be tackled at 
the sectoral legislative levels. The Joint Forum recommended the following: 

36 

 
1. 
Supervisors should ensure that market participants assess all economic risks and 
business purposes of an SPE throughout the life of a transaction, distinguishing between 
risk transfer and risk transformation, and are particularly aware that over time the nature 
of these risks can change. Supervisors should ensure that such assessment is ongoing and 
that management has sufficient understanding of the risks. 

2. 
Market participants should be able to assess and manage risk factors that increase 
transaction complexity, such as the structural features of an SPE, including triggers and 
the roles of parties involved. 

3. 
Firms  and  supervisors  should  ensure  that  the  governance  of  an  SPE  is 
commensurate with the complexity of the structure and the degree of active intervention 
and discretion required of the parties participating in the SPE. 

4. 
Firms should monitor on an ongoing basis the quality of transferred exposures in 
relation to the risk profile of the firm’s remaining portfolios and the impact on its balance 
sheet  components,  and  supervisors  should  where  appropriate  assess  systemic 
implications of risk dispersion to transferees. 

Firms  should  have  the  capability  to  aggregate,  assess  and  report  all  their  SPE 

5. 
exposure risks in conjunction with all other firm-wide risks. 

6. 
If at inception or at any point throughout the life of an SPE there is a likelihood or 
evidence  of  support  by  the  financial  firm,  including  non-contractual  support,  then  the 
activities  of  that  SPE  should  be  aggregated  with  those  of  the  institution  for  both 
supervisory assessment and internal risk management purposes. 

Supervisors  should  support  market  participants’  efforts 

towards  greater 
7. 
standardisation  of  definitions,  documentation,  and  disclosure  requirements  for  SPE 
transactions  and  provide  for  the  communication  of  any  material  divergence  from  these 
standards to investors in individual transactions. 

8. 
Supervisors  should  regularly  oversee  and  monitor  the  use  of  SPE  activity,  and 
assess the implications for regulated firms of the activities of SPEs, in order to identify 
developments  that  can  lead  to  systemic  weakness  and  contagion  or  that  can  exacerbate 
procyclicality. 

37 

 
ANNEX 3 — ECONOMIC CAPITAL MODELS 

Following  up  on  the  risk  aggregation  exercise  described  in  Annex  1,  the  Joint  Forum 
investigated economic capital models and found that these are no panacea either. If not 
designed for their purpose, and if used for other purposes, they could even give rise to 
compounding  risks.  The  Joint  Forum  found  that  risk  aggregation  models  (RAMs)  are 
used  to  provide  information  to  support  decisions  contributing  to  the  resilience  of 
complex  firms.  RAMs  are  used,  for  instance,  to  support  decisions  on  capital  allocation 
and  capital  adequacy  and  solvency.  They  are  also  used  to  support  risk  management 
functions  (including  risk  identification,  monitoring  and  mitigation).  The  Joint  Forum 
found that, despite recent advances, RAMs in current use have limitations. They are not 
adapted  to  support  all  the  functions  and  decisions  for  which  they  are  now  used.  As  a 
result, firms using them may not see clearly or understand fully the risks they face.   

Some  of  the  firms  surveyed  were  addressing  these  issues.  For  instance,  some  were 
starting  to  address  the  assessment  of  tail  events.  Some  were  moving  away  from  using 
basic  ‘Value  at  Risk’  (VaR)  measures  of  the  risk  of  independent  extreme  events  to 
measures  such  as  ‘Expected  Shortfall’  (which  is  more  sensitive  to  ‘tail  event’ 
probabilities) and ‘Tail VaR’ (which accounts for both the probability and severity of an 
extreme event). Use was also being made of scenario analysis and stress testing. Firms 
faced a range of practical challenges in using RAMs with cost and quality implications. 
These included managing the volume and quality of data and communicating results in a 
meaningful  way.  Despite  these  issues,  the  Joint  Forum  found  there  was  little  or  no 
appetite for fundamentally reassessing or reviewing how risk aggregation processes were 
managed. 

To address the limitations noted, the Joint Forum suggested that firms should consider a 
number  of  improvements  to  the  RAMs  they  currently  use.  Firms  making  these 
improvements would be able to see and understand the risks they face more clearly. This 
would  require  significant  investment.  FICOD  Articles  7  and  9  enable  supervisors  to 
specify the use and application of the risk concentration provisions in this way, but the 
Joint Forum did not observe that they did. The improvements were the following: 

Firms should reassess risk aggregation processes and methods according to their 

(i) 
purpose and function and, where appropriate, reorient them; 

(ii)  Where  RAMs  are  used  for  risk  identification  and  monitoring  purposes,  firms 
should take steps to ensure they are more sensitive (so as to be able to identify change 
quickly), granular (so as to be able to drill down to identify and analyse the risk positions 
that cause changes), flexible (so as to be flexible enough to reflect changes in portfolio 
characteristics  and  the  external  environment);  and  clear  (so  as  to  be  able  to  see  and 
understand the sources of risk and their effect on the firm); 

Firms  should  consider  changes  to  methodologies  used  for  capital  and  solvency 
(iii) 
purposes  to  better  reflect  tail  events.  This  includes  attributing  more  appropriate 
probabilities  to  potential  severe  ‘real-life  events’,  and  conducting  robust  scenario 
analysis and stress testing; 

Firms should consider better integrating risk aggregation into business activities 

(iv) 
and management; 

38 

 
 
(v) 
Firms should consider improving the governance of the risk aggregation process, 
particularly the areas in which expert judgment enters this process. This could be done by 
enhancing the transparency of such judgment and its potential impact on risk outcomes, 
and the controls that surround the use of judgment. 

Furthermore,  the  Joint  Forum  recommended  that  supervisors,  on  their  part,  should 
recognise and communicate to firms the risks posed by the continued use of RAMs. In 
doing  so,  they  should  highlight  the  benefits  of  appropriately  calibrated  and  well-
functioning RAMs for improved decision making and risk management within the firm. 
Supervisors should work with firms to implement these improvements. 

39 

 
ANNEX  4  — 
CONTAGION CHANNELS 

INTRA-GROUP  TRANSACTIONS  AND  EXPOSURES  TURNING 

INTO 

Van Lelyveld & De Haas (2006, 2010) have shown the benefits of multinational banks 
for  emerging  countries  in  several  studies.  However,  using  data  on  the  48  largest 
multinational  banking  groups  to  compare  the  lending  of  their  199  foreign  subsidiaries 
during  the  2008-2009  recession  with  lending  by  a  benchmark  group  of  202  domestic 
banks, they found the opposite. Contrary to earlier, more contained crises, parent banks 
were not a significant source of strength to their subsidiaries during the 2008-09 crisis. 
As a result, multinational bank subsidiaries had to cut back credit growth about twice as 
fast as domestic banks. This was in particular the case for subsidiaries of banking groups 
that relied more on wholesale market funding. Domestic banks were better equipped to 
continue  lending  because  of  their  greater  use  of  deposits,  a  relatively  stable  funding 
source during the crisis. They conclude that while multinational banks may contribute to 
financial stability during local crisis episodes, they also increase the risk of ‘importing’ 
instability  from  abroad  (De  Haas  &  Van  Lelyveld,  2011).  The  very  same  intra-group 
relationships  that  are  beneficial  in  one  period  of  time  could  be  contagious  in  another 
period of time. 

The  Joint  Forum  performed  a  similar  investigation  in  2011,  looking  for  potential 
contagion  channels  in  groups,  when  authorities  were  increasingly  focused  on  ways  to 
ensure banks and other financial entities can be wound down in an orderly manner during 
periods of distress. Investigating a representative group of conglomerates across the G20 
countries, the Joint Forum found the following: 

1. 
Intra-group  support  measures  can  vary  from  institution  to  institution,  driven  by 
the  regulatory,  legal  and  tax  environment,  the  management  style  of  the  particular 
institution and the cross-border nature of the business. Authorities should be mindful of 
the complicating effect of these measures on resolution regimes and the recovery process 
in the event of failure. 

2. 
The  majority  of  respondents  surveyed  indicated  that  centralised  capital  and 
liquidity  management  systems  were  in  place.  According  to  proponents,  this  approach 
promotes the efficient management of a group’s overall capital level and helps maximise 
liquidity  while  reducing  the  cost  of  funds.  However,  the  respondents  that  favoured  a 
‘self-sufficiency’  approach  pointed  out  that  centralised  management  can  potentially 
increase  the  contagion  risk  within  a  group  in  the  event  of  distress  at  any  of  the 
subsidiaries.  The  use  of  such  systems  impacts  the  nature  and  design  of  intra-group 
support  measures,  with  some  firms  indicating  that  the  way  they  managed  capital  and 
liquidity within the group was a key driver in their decisions on intra-group transactions 
and the support measures they used. 

Committed  facilities,  subordinated  loans  and  guarantees  were  the  most  widely 

3. 
used measures. This was evident across all sectors and participating jurisdictions. 

4. 
Internal  support  measures  generally  were  provided  on  a  one-way  basis  (e.g. 
downstream  from  a  parent  to  a  subsidiary).  Loans  and  borrowings,  however,  were 
provided  in  some  groups  on  a  reciprocal  basis.  As  the  groups  surveyed  generally 
operated  across  borders,  most  indicated  support  measures  were  provided  both 
domestically  and  internationally.  Support  measures  were  also  in  place  between  both 
regulated and unregulated entities and between entities in different sectors. 

40 

 
5. 
The  study  found  no  evidence  of  intra-group  support  measures  either  a)  being 
implemented  on  anything  other  than  an  arm’s  length  basis,  or  b)  resulting  in  the 
inappropriate transfer of capital, income or assets from regulated entities or in a way that 
generated capital resources within a group. However, this does not necessarily mean that 
supervisory  scrutiny  of  intra-group  support  measures  is  unwarranted.  As  this  report  is 
based  on  industry  responses,  further  in-depth  analysis  by  national  supervisors  may 
provide  a  more  complete  picture  of  the  risks  potentially  posed  by  intra-group  support 
measures. 

6. 
While  the  existing  regulatory  frameworks  for  intra-group  support  measures  are 
somewhat limited, firms do have certain internal policies and procedures to manage and 
restrict  internal  transactions.  Respondents  pointed  out  that  the  regulatory  and  legal 
framework  can  make  it  difficult  for  some  forms  of  intra-group  support  to  be  provided 
while  supervisors  aim  to  ensure  that  both  regulated  entities  and  stakeholders  are 
protected  from  risks  arising  from  the  use  of  support  measures.  For  instance,  upstream 
transfers  of  liquidity  and  capital  are  monitored  and  large  exposure  rules  can  limit  the 
extent  of  intra-group  interaction  for  risk  control  purposes.  Jurisdictional  differences  in 
regulatory setting can also pose a challenge for firms operating across borders. 

Based  on  the  survey,  and  independently  of  remaining  concerns  and  information 
7. 
gaps,  single-sector  supervisors  should  be  aware  of  the  risks  that  intra-group  support 
measures  may  pose  and  should  fully  understand  the  measures  used  by  an  institution, 
including its motivations for preferring certain measures over others. In order to obtain 
further insight into the intra-group support measures put in place by financial institutions 
within their jurisdiction, national supervisors should, where appropriate, conduct further 
analysis in this area. 

Also, the ESAs note in their advice the anecdotal evidence from JCFC discussions during 
the recent crisis that banking-led financial conglomerates have used their ability to draw 
down liquidity from the insurance entities within the group to the benefit of the financial 
conglomerate, contrasting with the restricted liquidity sources available for pure banking 
groups. More in general, it has been observed that the financial conglomerates that fared 
better  during  the  crisis  were  mostly  those  that  did  not  have  exotic  business  models. 
Rather, those that were affected by the crisis ran into serious difficulties predominantly 
because of the risks of business complexity and contagion. Systemic impacts, the ESAs 
observed,  impaired  (or  even  nullified)  the  smooth  functioning  of  emergency/resolution 
practices. 

41 

 
ANNEX 5 — DEFINITION OF GROUP 

FICOD defines ‘group’ in Article 2(12) as a group of undertakings consisting of a parent 
undertaking,  its  subsidiaries  and  the  entities  in  which  the  parent  undertaking  or  its 
subsidiaries  hold  a  participation,  or  undertakings  linked  to  each  other  by  a  relationship 
within the meaning of Article 12(1) of Directive 83/349/EEC,33 including any subgroup. 
The  definition  of  group  does  not  distinguish  between  regulated  and  non-regulated 
entities.  The  definition  of  financial  conglomerate  specifies  that  there  must  be  at  least  a 
regulated  insurer  and  a  regulated  credit  institution  in  the  same  group,  but  does  not 
exclude non-regulated entities either. 

CRD (2006/48) does not define a ‘group’, as that would be outside its objective, which is 
to ensure the soundness of banking licenses on an individual and a consolidated basis. If 
the  CRD  needs  to  refer  to  a  group  setting,  it  refers  to  Directive  83/349  relationships. 
Some Member States define a banking group as ‘a financial holding company plus all its 
subsidiaries, most of which are credit institutions’. 

Solvency II defines ‘group’ in Article 212(1)(c) as follows: 

‘ “group” means a group of undertakings that: 

(i)  consists  of  a  participating  undertaking,  its  subsidiaries  and  the  entities  in  which  the 
participating undertaking or its subsidiaries hold a participation, as well as undertakings 
linked to each other by a relationship as set out in Article 12(1) of Directive 83/349/EEC; 
or 

(ii)  is  based  on  the  establishment,  contractually  or  otherwise,  of  strong  and  sustainable 
financial  relationships  among  those  undertakings,  and  that  may  include  mutual  or 
mutual-type associations, provided that: 

–  one  of  those  undertakings  effectively  exercises,  through  centralised  coordination,  a 
dominant  influence  over  the  decisions,  including  financial  decisions,  of  the  other 
undertakings that are part of the group; and 

– the establishment and dissolution of such relationships for the purposes of this Title are 
subject to prior approval by the group supervisor; 

where the undertaking exercising the centralised coordination shall be considered as the 
parent undertaking, and the other undertakings shall be considered as subsidiaries;’ 

Solvency  II  thus  defines  ‘group’  in  the  widest  sense,  therefore  enabling  insurance 
supervisors to detect risks coming from any relevant entity, regulated or not. 

FICOD1  restricted  the  scope  of  the  transparency  requirement  to  ‘all  regulated  entities, 
non-regulated  subsidiaries  and  material  branches  of  the  group’  and  thus  excluded  only 
the participations of financial groups, which were assumed to have a temporary character 
in many cases. 

33  Seventh Council Directive of 13 June 1983 on consolidated accounts (83/349/EEC). 

42 

 
                                                 
ANNEX 6 — THE JOINT FORUM’S REVISED 2012 PRINCIPLES AND THE EU FRAMEWORK 

Following up the report on the differentiated nature and scope of regulation (DNSR) 
as endorsed by the FSB, the Joint Forum suggests revised or new principles in the 
following five areas. 

The Joint Forum notes that the principles should be applied, on a group-wide basis, 
to a financial conglomerate, defined for the purpose of this framework as any group 
of companies under common control or dominant influence, including any financial 
holding company, which conducts material financial activities in at least two of the 
regulated banking, securities or insurance sectors. 

Jurisdictions  should  consider  the  application  of  the  Principles  to  other  financial 
groups  which  conduct  activities  in  one  of  these  regulated  sectors  while  also 
conducting  material  activities  in  any  other  financial  sector,  where  these  financial 
activities  are  not  subject  to  comprehensive  group-wide  supervision  under  the 
sectoral frameworks. 
FICOD  confines  the  application  of  the  supplementary 
provisions  to  groups  that  meet  the  quantitative  thresholds  only.  This  excludes  the 
supplementary supervision of some groups that the Joint Forum definition without 
any thresholds would capture. The issue is discussed in the review.  

1. Supervisory powers (Joint Forum principles 1-4) 

Observing  that  the  facilitating  role  of  the  coordinating  supervisor  in  the  1999 
framework  appeared  to  have  played  quite a minor part in times of high stress, the 
Joint Forum suggests in the revised principles that it may be worthwhile exploring 
whether  supervisors  should  be  empowered  to  approach  the  head  of  a  financial 
conglomerate and impose corrective measures on this head if deemed necessary. 

In European legislation, supervisory provisions apply to authorised entities but not 
to the holding company as a stand-alone entity, even though this holding company 
may  have  an  important  role  as  the  head  of  a  group  of  authorised  entities,  being 
responsible  for  group-wide  policies.  Due  to  the  lack  of  coordinated  European 
legislation  in  this  area,  the  head  of  a  financial  conglomerate  may  not  be 
systematically  supervised  if  the  head  is  not  itself  a  regulated  entity.  This  is 
addressed in the review. 

2. Supervisory responsibilities (Joint Forum principles 5-9) 

The  Joint  Forum  observes  that  the  regulatory  framework  up  to  now  has  assumed 
that the resources, skills and systems of supervisory authorities would be sufficient 
to  implement  the  agreed  rules,  e.g.  the  Basel  agreements.  However,  the  Financial 
Sector  Assessment  Programmes  carried  out  by  the  International  Monetary  Fund 
revealed  that  countries  could  be  aware  of  the  necessary  supervisory  programmes, 
but  were  sometimes  simply  not  able  to  implement  them  because  the  basic 
preconditions  were  not  fulfilled.  For  example,  they  had  no  ready-to-use  set  of 
prudential standards against which to assess firms’ behaviour (other than the capital 
ratio),  including  standards  for  group  risks  and  triggers  for  corrective  action.  This 
could be addressed by adding the same set of basic preconditions to the three sets of 
Core  Principles  of  the  Basel  bodies  BCBS,  IOSCO  and  IAIS.  However,  this 

43 

 
 
approach  is  also  included  in  the  Joint  Forum’s  revised  principles  for  financial 
conglomerate supervision. 

including 

standards, 

In  Europe,  prudential 
those  governing  supervisory 
responsibilities,  are  set  out  in  sectoral  legislation  and  supplemented  by  FICOD. 
Their  consistent  implementation  is  ensured  by  supervisory  coordination  and 
common  standards  and  guidelines  to  be  developed  by  ESAs.  The  European 
framework  for  supervision  of  financial  undertakings  requires  Member  States  to 
provide  supervisors  with  the  necessary  tools  to  enforce  compliance.  The  review 
observes that existing tools could be used more effectively and that an enforcement 
regime applying to the ultimately responsible entity may need to be established. 

 3. Governance (Joint Forum principles 10-14) 
The  Joint  Forum  suggests  that  a  supervisor  should  be  able  to  require  a  legal  and 
organisational  group  structure  that  is  consistent  with  the  group’s  overall  strategy 
and risk profile and is well understood by the board and senior management of the 
head  company.  Also,  the  Joint  Forum  suggests  imposing  an  explicit  responsibility 
on  the  head  of  the  conglomerate  to  define  and  implement  a  group-wide  strategy. 
Finally,  the  Joint  Forum  suggests  that  the  remuneration  requirements  should  no 
longer be limited to regulated entities only, but should apply to any employee of the 
financial conglomerate. 

The  European  framework  for  supervision  of  financial  undertakings  requires 
authorised  entities  to  have  a  sound  governance  framework  in  place.  FICOD1 
(2011/87) requires that supervisors, through the ESAs, find common frameworks to 
enforce sound governance systems in financial conglomerates. The review notes the 
need  for  the  comprehensive  application  of  a  group-wide  set  of  governance 
requirements, especially as regards the duties of the parent entity that controls and 
steers the regulated entities in the group, and the main counterparty for the group in 
the market. 

4. Capital adequacy and liquidity (Joint Forum principles 15-20) 

The  Joint  Forum  observes  that  financial  conglomerates  should  calculate  capital 
adequacy on a group-wide basis and have in place group-wide capital management 
policies as well as liquidity management policies. 

The  European  prudential  framework  stipulates  that  the  level  of  required  capital 
buffers  against  sector-specific  risks  is  to  be  addressed  within  the  sector-specific 
frameworks.  However,  the  supplementary  framework  should  ensure  that  the 
allocation of capital across the legal entities of the group as a whole is such that the 
required capital buffer is indeed available at all times when an unexpected loss hits 
a regulated entity. 

Qualitative  liquidity  requirements  are  already  in  place  for  credit  institutions,  and 
Solvency II will set out requirements for undertakings to identify and manage any 
kind  of  risks  including  liquidity  risks.  FICOD’s  provisions  on  intra-group 
transactions  also  cover  a  broad  spectrum  of  transactions  and  exposures  and  could 
therefore capture liquidity swaps and similar potential liquidity problems. 

The  problem  of  the  inconsistent  use  of  methods  to  calculate  available  capital  in 
conglomerates  was  signalled  with  Omnibus  I  in  October  2010,  which  invited  the 

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ESAs  to  draft  a  Binding  Technical  Standard  for  the  calculation  of  consolidated 
capital  in  a  conglomerate.  This  invitation  was  changed  into  a  requirement  in  the 
CRD  IV  proposal.  The  standard  was  published  for  consultation  by  the  ESAs  in 
September 2012 and is expected to harmonise the methods of calculating available 
capital. However, the review observes that supervisors sometimes lack insight into 
the availability of capital at the level of the conglomerate. This could be addressed 
by requiring the reporting and market disclosure of capital on an individual or sub-
consolidated basis in addition to reporting at the consolidated level of the regulated 
entity. 

5. Risk management (Joint Forum principles 21-29) 

The  1999  Joint  Forum  framework,  as  well  as  the  2002  FICOD,  included  several 
provisions  to  deal  with  group  risks,  especially  risk  concentration  and  intra-group 
contagion. The Joint Forum has published many additional analyses and guidelines 
to illustrate, clarify and strengthen the application of these provisions. 

The  Joint  Forum  suggests  introducing  more  detailed  policy  requirements  to  deal 
with contagion and risk concentration. 

The  review  observes  that  FICOD  provides  several  tools  to  enable  supervisors  to 
assess  and  control  risk  concentrations  and  contagion.  FICOD  already  provides  for 
risk  reporting  and  management  requirements  for  undertakings.  These,  combined 
with  the  observed  need  to  extend  the  scope  of  supervision  to  unregulated  entities 
and  identification  of  the  ultimately  responsible  entity  for  compliance  with  FICOD 
requirements,  should  ensure  an  adequate  framework  for  the  supplementary 
supervision of risk management. 

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