EU Financial Conglomerates Directive To Be Revised

by Ulrika Lomas, LawAndTax-News.com, Brussels

18 August 2010

Following the experience of the recent financial crisis, the European Commission (EC) is proposing a revision to the Financial Conglomerates Directive (FCD) to improve supervision of financial groups that are active in one or more country and operate in both insurance and banking business.

Such groups, the EC says are often large and complex and, due to their size, are often of systemic importance to the European economy: either for one or more member states or for the European Union (EU) as a whole.

Currently, supervision in EU is mainly done at the national level. Every legal entity wanting to operate in the banking sector in an EU member state needs authorisation from the national financial supervisor, and needs to comply with the relevant banking regulation. It is the same for entities that want to operate in the insurance sector: such entities need to be authorized as insurance companies and must comply with the relevant insurance regulation.

Supervision rules also allow for a group of authorised banking entities to be subject to consolidated banking supervision. Similarly, in the insurance sector, a group of authorised insurance entities can be subject to insurance group supervision.

However, financial conglomerates are often active in both banking and insurance business and operate in several EU member states. The existing FCD gives national financial supervisors additional powers and tools to watch over these firms. More specifically, it requires supervisors to apply supplementary supervision on these conglomerates, in addition to the specific banking and insurance supervision.

Such supplementary supervision can include making sure that capital is not used twice or more within a conglomerate, and that group risks are recognised. The latter may relate to the risks of contagion, management complexity, risk concentration and conflicts of interest.

Nevertheless, when the EC evaluated the effectiveness of the current FCD, it found that supplementary supervision could not be carried out on certain financial groups because of their legal structure which meant that national financial supervisors were obliged to choose either banking or insurance supervision under the sector-specific directives. The main objective of the FCD’s revision is to correct this unintended consequence of the current rules.

Under the proposed amendments, both sector-specific (banking and insurance) supervision and supplementary supervision could be applied on a conglomerate's parent entity, also if it concerns a holding company. Banking supervision would therefore remain applicable even if the banking group acquires a significant stake in an insurance business. By the same token, insurance supervision would also remain applicable if the insurance group acquires a significant stake in a banking business.

When justified by potential group risks as a whole, financial supervisors will be allowed to identify a group as a financial conglomerate and apply supplementary supervision. The identification process of financial conglomerates should allow for risk-based assessments, in addition to existing definitions relating to size ("quantitative indicators"). Under the current rules, balance sheet figures are determinative when identifying conglomerates.

However, financial supervisors should also be allowed to waive a group from supplementary supervision if the supervisor assesses the group risks to be negligible, even if the small group meets the quantitative indicators. This should enable supervisors to allocate their resources to the supplementary supervision of larger and systemically important conglomerates.

With the proposal now passing to the European Parliament (EP) and the EU member states for consideration, the EC hopes to see the changes enter into force in 2011.

As regards financial conglomerates operating in several EU countries, closer coordination between national financial supervisors is also thought to be required, particularly through the new European financial supervision authorities. The proposals regarding those authorities are currently being negotiated between the Council and the EP.

The new European Banking Authority and the new European Insurance and Occupational Pensions Authority are to form a joint committee to oversee cooperation and coordination between national supervisors in the case of financial conglomerates. As a follow up to this proposal, the committee is also expected to look into extending the scope of supplementary supervision to non-regulated entities, such as special purpose vehicles (SPVs).

SPVs, where assets are stored off groups' balance sheets, caused problems during the crisis when it became clear that contagion and risk concentration originated also from non-regulated parts of financial conglomerates. It is the EC's intention to continue to work on this issue, and present further amendments to the FCD in due course.

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