Explanatory Memorandum to COM(2001)213 - Supplementary supervision of credit institutions, insurance undertakings and investment firms in a financial conglomerate - Main contents
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This page contains a limited version of this dossier in the EU Monitor.
| dossier | COM(2001)213 - Supplementary supervision of credit institutions, insurance undertakings and investment firms in a financial conglomerate. |
|---|---|
| source | COM(2001)213  |
| date | 24-04-2001 |
The Lisbon Council has taken a strong commitment to integrate European financial markets by 2005 at the latest. A single financial market will be a key factor in promoting the competitiveness of the European economy, lowering the cost of capital for large and small companies. An integrated market, properly regulated and prudentially sound, will also deliver major benefits to consumers, through increased security against institutional default. The vehicle to achieve this integrated market is the Financial Services Action Plan. The Financial Services Action Plan announces a proposal for a directive on the prudential supervision of financial conglomerates at the beginning of 2001.
The EU's single financial market goes hand in hand with prudential soundness and financial stability. Steady EU-led convergence in regulatory requirements, underpinned by common ground-rules and pragmatic means of implementing and applying the EU Directives for a single market for financial services has already contributed greatly to achieving this goal. However, the heightened tempo of consolidation in the industry, and the intensification of links between financial markets call for careful consideration of structures for containing and supervising institutional and systemic risk, in particular where they arise in cross-sector groups combining insurance companies, banks and investment firms ('financial conglomerates'). In some Member States the importance of financial conglomerates is significant (e.g. in the Benelux and Scandinavian countries), and some of the biggest actors in the financial markets are financial conglomerates. In other Member States their importance is less important or even marginal; however this could change in the future. As reliable figures on the significance of financial conglomerates are lacking (among other things due to the absence of harmonised definitions), a mapping exercise is currently under way at the initiative of the Commission's services in order to assess the real importance of financial conglomerates in the EU.
Combined financial operations may also create new prudential risks or exacerbate existing ones. Capital requirements must therefore be adequate and proportionate to meet the risks undertaken in financial groups that straddle traditional sectoral boundaries. Where appropriate, inconsistencies between sectoral legislation that gives rise to loopholes and opportunities for regulatory arbitrage should be removed. The Union should strive to maintain the highest standards of prudential regulation for its financial institutions. These standards must be kept up-to-date with market developments and capital requirements must accurately reflect the risks run by banks, insurance undertakings and securities firms in the Union. The EU has been at the international forefront of these developments - as explained some of the biggest financial groups in the Union are financial conglomerate type groups - and has contributed to the work and recommendations of the G-10 Joint Forum on Financial Conglomerates.
The aim of this Directive is therefore to ensure the stability of European financial markets, to establish common prudential standards for the supervision of financial conglomerates throughout Europe, and to introduce level playing fields and legal certainty between financial institutions. In doing so, the Directive will implement the recommendations of the G-10 Joint Forum on Financial Conglomerates. It will also meet the recommendations of the Brouwer group on stability in the financial sector which were endorsed by the Ecofin Council in Lisbon.
Contents
- a) The need for a European legal framework for financial conglomerates
- b) The approach of the Directive
- 2. DESCRIPTION OF ARTICLES
- Articles 2 and 3 - Definitions
- Articles 4 - Scope of the supplementary supervision
- Articles 7 to 13 - Measures to facilitate supplementary supervision
- Articles 16 and 17 - Comitology
- Articles 18 to 25 - Amendments of sectoral legislation
The existing European legal framework for the supervision of financial institutions is incomplete. Homogeneous groups of financial institutions are already covered by EU-directives for specific prudential purposes. Directive 2000/12/EC relating on the taking up and pursuit of the business of credit institutions and Directive 93/6/EEC on the capital adequacy of investment firms and credit institutions provide for the consolidation of banking groups, investment firm groups and bank/investment firm groups, whereas Directive 98/78/EC on the supplementary supervision of insurance undertakings in insurance groups applies additional group supervision over insurance groups.
'Heterogeneous' financial conglomerate type groups combining institutions from the different sectors are only covered to a limited extent, and basically a comprehensive set of rules on the prudential supervision of financial conglomerates is lacking. The present EU prudential framework shows important overlaps and lacunae in respect of the regulation of financial conglomerates.
Lacunae exist as:
(i) certain types of financial groups are not captured by the existing directives (e.g. horizontal groups), and
(ii) important prudential issues that are regulated in sectoral directives aiming at the supervision of banking groups, investment firm groups and insurance groups, are not regulated at the level of financial conglomerate type groups (e.g. the elimination of multiple gearing of regulatory capital).
Overlaps in the existing legislative exist because:
(iii) inconsistencies occur in the treatment of similar prudential questions, and
(iv) the same financial group can be covered by different sectoral directives (e.g. a mixed-activity insurance holding company can be a financial holding company in the sense of the banking directive).
These differences lead to important prudential deficiencies in the regulatory framework that is designed to ensure financial stability, and competitive distortions in otherwise highly competitive markets. They hinder the development of a single financial market based on a level playing field, leaving authorities and financial firms in uncertainty over concepts, and definitions.
Some Member States have acknowledged the imperfection of the present EU legislative framework for financial conglomerates and have either introduced or are planning to introduce national legislative measures on their own accord to address the supervisory concerns arising from the group structures described above. Some have complemented legislation with bilateral agreements, pending future European legislation on financial conglomerates. Measures that have been introduced by Member States to date vary in their scope and approach.
In view of the increasing cross-border dimension of financial conglomerate type groups (some of them are active on a global basis), the need to maintain level playing fields across the EU and the need to protect the financial stability of the EU financial system, there is therefore a need to address the most pressing issues arising in such structures. This will enhance legal certainty and clarity for regulators, supervisors and the market, and will make an important contribution to the stability of the EU financial system. To ensure that the stability of integrated European financial markets will be well protected, a common legal framework is needed to address these issues. The need for an appropriate prudential framework for financial conglomerates has also been agreed by other international fora. In particular the Joint Forum on financial conglomerates, representing supervisory authorities from the three afore-mentioned financial sectors of the major financial markets, has recently issued a number of recommendations with regard to the supervision of Financial Conglomerates (February and December 1999).
The proposal seeks to introduce specific prudential legislation for financial conglomerates. Furthermore, it takes the first necessary minimum steps to align the directives for homogeneous financial groups and for financial conglomerates (i.e. eliminating some of the major inconsistencies) in order to ensure a minimum equivalency in the treatment of these groups. The harmonisation between sectoral rules is however not the major objective of this directive and can only be achieved by stages.
A central issue is to ensure that the objectives of separate supervisors to ensure the capital adequacy of the entities for which they have regulatory responsibility should not be impaired as a result of the existence of cross-sector financial conglomerates. This requires measures to prevent situations in which the same capital is used simultaneously as a buffer against risk in two or more entities in the same financial conglomerate ('multiple gearing') and situations where a parent issues debt and down streams the proceeds as equity to its regulated subsidiaries ('excessive leveraging'). In developing capital adequacy assessment methods, the existence of capital adequacy rules in each sector is recognised, as is their effectiveness and reasons for the differences. Sectoral capital adequacy approaches are therefore taken as given as they reflect the different nature of business undertaken by each sector, differing risks to which they are exposed and different approaches to risk management and assessment by supervisors and/or firms. This also means that the directive will not pre-empt the ongoing discussion on the review of the solvency requirements in the banking sector.
The proposal introduces effective EU-legislation to address the supervisory concerns about intra-group transactions and risk exposures in a financial conglomerate. As it is not yet feasible to introduce quantitative limits in this area, an adequate and effective regulatory approach for intra-group transactions and risk exposures should be built on the following three pillars:
* an internal management policy with effective internal control and management systems;
* reporting requirements to supervisors; and
* effective supervisory enforcement powers.
The cross-sector developments demonstrate the clear need to introduce co-ordination arrangements between supervisors to ensure an efficient and adequate supervision of cross-border financial conglomerates. The benefits of appointing a co-ordinator authority for a financial conglomerate will be:
* to avoid underlaps in the prudential supervision of a financial conglomerate which will enhance financial stability;
* to avoid duplication of supervision, which are burdensome and costly for supervisors and the supervised entities of a group;
* to achieve simplification of procedures and supervisory efforts.
The role and responsibilities of the co-ordinator(s) depend heavily on the specific circumstances of a financial conglomerate, such as the legal framework and the risk profile of the institution involved. Rules regarding the appointment of the co-ordinator(s), as well as any further arrangements or obligations with regard to his tasks are framed in as flexible terms.
Co-operation between the supervisors involved and information sharing is a precondition for effective supervision. None of the supervisory measures proposed in this report will function effectively in the absence of a proper flow of information from the entities within a financial conglomerate to the supervisors and between supervisors themselves.
Article 1 - Objective
The Directive applies to credit institutions, insurance undertakings and investment firms, i.e. regulated entities, that have their head office in the EU. Where such entities are part of a financial conglomerate, they are submitted to supplementary prudential supervision to the extent and in the manner prescribed in the Directive. Furthermore, in order to avoid major unlevel playing field amongst regulated entities of different financial sectors, the Directive introduces some amendments to the sectoral prudential regulation.
Article 2 introduces and defines the main concepts on which this Directive is based. As the Directive enters into hitherto unregulated areas, there is a need to introduce and define concepts that do not yet exist in current legislation. The most important are the definitions of a financial conglomerate and mixed financial holding company. These definitions are essential to define the scope of application of the directive: i.e. whether a particular group is a financial group with homogeneous financial activities, which on a group-wide basis will continue to be covered by the existing sectoral directives referred to in section I of this memorandum; or a mixed group with both financial and non-financial activities, which are submitted to some limited supervision by the existing sectoral directives referred to; or a predominantly financial group with heterogeneous financial activities ('financial conglomerates'), which are covered by this new Directive. Two thresholds are introduced: a first one distinguishes financial vs non-financial groups (50%-threshold referred to in Article 2 i (a)); a second threshold distinguishes between homogeneous groups and financial conglomerates (10%-threshold referred to in Article 2 i (d)). These latter thresholds are further defined in Article 3.
Another core concept of this Directive is the definition of a group (Article 2 i and (12)). In order to include all relevant groups, no matter how they are structured, a broad definition is used based on the concept of close links as introduced in the past by the so-called post-BCCI Directive. However, the concept of close links has been further elaborated, in order to cover other groups that are relevant for realising the objectives of the Directive. E.g. it includes groups of entities between which there are no capital links but that are managed on a unified basis and for which accounting legislation gives Member States the possibility to require consolidated annual accounts.
When introducing rules on the supplementary supervision of regulated entities that are part of a financial conglomerate (see Article 1), the Directive makes a distinction whether the head or parent undertaking in the financial conglomerate is based in theCommunity or not, providing for a different - but in principle equivalent - regime.
As some groups are not covered by the definitions under Article 2, but do have financial entities with substantial activities in the financial markets the supervision of which would respond to the objectives of the Directive, the Directive introduces a basis for competent authorities to submit also these special group structures to supplementary supervision, on the condition that well defined conditions are met.
For the sake of completeness and in order to avoid any possible moral hazard, the Directive also states that the inclusion of unregulated entities in the group-wide supplementary supervision does not mean that these entities are subject to supervision on a stand-alone basis.
Article 5 and 6 - Capital adequacy, intra-group transactions and risk concentration Articles18 i, 19 i, 23 i and 25 i - Management
The Directive introduces a series of quantitative and qualitative rules with regard to the supervision of regulated entities in a financial conglomerate. They relate in particular to capital adequacy, intra-group transactions and risk concentration, as well as the management. Regulated entities in a financial conglomerate also have to meet requirements on the suitability of their shareholders. However, there is no need to introduce new specific legislation in this latter field as the current sectoral rules provide for a sufficient legal basis that allows to capture financial conglomerate structures.
Regulated entities which are at the head of a financial conglomerate, or are part of a financial conglomerate the parent undertaking of which is a mixed financial holding company that has its head office in the Union, are subject to supplementary supervision as regards their solvency position, the prevention of multiple gearing of regulatory own funds within the group (Article 5), as well as the level of risk concentration and intra-group transactions (Article 6).
In section 1 of this explanatory memorandum, it is explained that the existing capital adequacy rules in each sector are recognised (see pt. I, b). The Directive provides for different technical methods to calculate the solvency position at the level of a financial conglomerate. These methods are not new, but are already to some extent applied in sectoral supervision in accordance with the sectoral rules. Furthermore, the Joint Forum on Financial Conglomerates has tested the appropriateness and the equivalency of these methods (see the Joint Forum document Supervision of financial conglomerates, February 1999). The Directive also requires financial conglomerates to have in place an adequate capital adequacy policy at group level.
As regards risk concentration at the level of the group, the Directive does not provide for quantitative limits as in some of the sectoral legislation. It was not possible to agree on a common approach across sectors without a further thorough study about the advantages and possible disadvantages. The introduction of such limits in the longer term should however not be excluded (see also recital i of the Directive). In the meanwhile, the Directive prescribes that financial conglomerates should have appropriate risk management processes in place as regards their intra-group transactions and risk concentration, and that competent authorities may introduce quantitative limits where deemed necessary taking into account the Directive's objectives.
Furthermore, as regards the fit and proper requirements for the management of the regulated entities in a financial conglomerate, there is a need to take into account recent market developments. In particular with regard to financial conglomerates, there is a tendency to manage them along the different business lines of conglomerates instead of the traditional legal entity based approaches. However, as the fit and proper regulatory requirements relate to the management of regulated entities, which are covered by the sectoral rules, it is appropriate to amend the sectoral rules (in this regard, see Chapter IV).
These articles provide for several measures in order to facilitate supplementary supervision. They eliminate legal impediments preventing entities within a financial conglomerate to exchange information. They also relate to the co-operation and information exchange among the competent authorities involved in the supervision of regulated entities in a particular financial conglomerate. One important provision is the identification of the competent authority responsible for exercising the supplementary supervision (the co-ordinator). Its appointment also aims at facilitating the co-operation amongst the supervisors involved and clarifying each other's role when carrying out the supplementary supervision. In particular, the Directive provides for criteria in order to facilitate the identification of the most appropriate competent authority as the co-ordinator, as well as his tasks. Other articles relate to on-the-spot verification of information that has been reported to the competent authorities and the organisation of the co-operation with third country authorities.
Article 14 - Parent undertakings outside the Community.
This Article provides for the verification by competent authorities whether regulated entities that have their head office in the Community but belong to a non EU group, are equally supervised as regulated entities being part of an EU group. If not, the Directive provides for the application by analogy of the rules that apply to the latter type of financial conglomerates. They may also require the creation of a European sub-holding to which they apply on a subgroup-wide basis the provisions on the supplementary supervision.
To facilitate a timely adaptation of the technical provisions in the regulation on financial conglomerates to take into account rapid developments in the financial markets, in order to preserve financial stability as well as European regulated entities' level playing field in global financial markets, the Directive provides for the creation of a specific Committee that will assist the Commission. The Committee will comply with the Comitology Decision (1999/468/EC). The budgetary impact of the creation of this new Committee is expected to be neutral, as it replaces an existing consultative body (the Mixed Technical Group on Financial Conglomerates).
To avoid regulatory arbitrage between the sectoral supervisory regimes and the financial conglomerate regime as well as overlap and underlap between the different supervisory regimes, there is need to amend and to supplement to a minimum level the sectoral regulations (see pt.
1).
For these reasons, sectoral definitions of participation, related undertaking, financial holding company, insurance holding company, mixed-activity holding company and mixed-activity insurance holding company have been amended . Also, the existing sectoral rules regarding the consultation with competent authorities have been brought in line , as well as the rules on the on-the-spot verification and on the deduction of own funds instruments in other financial entities in order to eliminate multiple gearing. Finally, the sectoral supervisory rules regarding intra-group transactions with mixed-activity holding companies and their subsidiaries have been further clarified.