The G20 first called for something to be done about systemically important financial institutions (‘SIFIs’), and the risk they pose by being ‘too big to fail’, at the Pittsburgh Summit in September 2009.
It was not until 20 October 2010, however, that the Financial Stability Board (‘FSB’) published‘Reducing the moral hazard posed by systemically important financial institutions’, which established the ‘SIFI Framework’ that would form the basis of subsequent policy.
The SIFI Framework defines G-SIFIs (global systemically important financial institutions) as
Institutions of such size, market importance, and global interconnectedness that their distress or failure would cause significant dislocation in the global financial system and adverse economic consequences across a range of countries.
While the G-SIFI concept was originally concerned with banks, the SIFI Framework document first proposed extending the regime to insurers and other financial institutions. This led to the category of G-SIFIs later being further broken down into global systemically important banks (‘G-SIBs’), insurers (‘G-SIIs’)1 , and non-bank, non-insurance G-SIFIs (‘NBNI’).
The SIFI Framework set out the key elements of the new regime to reduce moral hazard risk among the G-SIFIs:
G-SIFIs should have higher loss absorbency, beyond the Basel III minimum standards;
resolution of a G-SIFI should be a viable option; this will involve
effective cross-border collaboration between regulators; and
appropriate recovery and resolution planning;
national supervisors should be able to apply proportionate – i.e. stricter – supervision to (G)- SIFIs; and
the above elements should be applied consistently across different national jurisdictions.
This was followed in November 2011 by ‘Global systemically important banks: Assessment methodology and the additional loss absorbency requirement’ from the Basel Committee on Banking Supervision (‘BCBS’), setting out the methodology by which regulators might determine which firms are G-SIBs. The first G-SIBs were identified using these criteria later that same month.
1. Confusingly, some EU documents (e.g. the Capital Requirements Directive) use ‘G-SII’ to refer to ‘global systemically important institutions’.
Insurance: assessment methodology
What is a G-SII?
As noted above, in 2010 the FSB proposed to extend the (originally banking-focused) G-SIFI concept to insurance firms as well; and on 18 July 2013 the International Association of Insurance Supervisors (‘IAIS’) published ‘Global Systemically Important Insurers: Initial Assessment Methodology’.
This methodology was inspired by the earlier BCBS methodology for banks, sharing
similarities to the approach developed by the BCBS for G-SIBs. For example, there is considerable overlap in the categories of indicators. However, insurers vary widely from banks in their structures and activities and consequently in the nature and degree of risks they pose to the global financial system. Thus, the particular indicators selected for identifying G-SIIs reflect different drivers of possible negative externalities.
Unlike banks, “size alone is less important for traditional insurers”, and the “activities that might make an insurer a G-SII […] are generally related to their [non-traditional, non-insurance] activities and any interconnectedness generated from those activities.”
The assessment methodology is based around 20 indicators, which are arranged into five categories3:
- Global activity
- Non-traditional and non-insurance (‘NTNI’) activities
with interconnectedness and NTNI activities given the greatest weighting.
What is a non-traditional, non-insurance (‘NTNI’) activity?
The special treatment of NTNIs is at the heart of the IAIS policy measures described below. Whereas “traditional insurance business” is based around “the concept of the insurability of risks, in particular the insured events’ accidental nature, random occurrence and the applicability of the law of large numbers”2,
involve financial features such as leverage, liquidity or maturity transformation, imperfect transfer of credit risks (i.e. ‘shadow banking’), credit guarantees or minimum financial guarantees. […] Other products of concern include those where the liabilities are significantly correlated with financial market outcomes, such as stock prices, and the economic business cycle.
Financial activities conducted outside of a licensed insurance entity are also categorised as non-insurance.
The IAIS has provided a set of principles for identifying NTNI activities2:
- products that provide credit guarantees to financial products such as securities, mortgages and other traded or non-traded instruments - whether principal or interest - can be considered NTNI;
- policies or products that expose the insurer to substantial market and liquidity risk and require a more complex risk management practice by the insurer in order to hedge those risks and may require substantial, complex, and dynamic use of derivatives, can be considered NTNI; and
- investment and funding or other capital market activities that result in maturity or liquidity transformation, leverage or imperfect transfer of credit risk, such as repo and securities lending, beyond that justified by the scope and scale of conducting traditional insurance activities, can be considered NTNI.
The IAIS has also provided a list of examples of traditional and NTNI insurance products.2
Who are the G-SIIs?
Using the IAIS’ methodology, the FSB (in consultation with IAIS) identified the first nine G-SIIs in July 2013:
- Allianz SE
- American International Group, Inc.
- Assicurazoni Generali S.p.A.
- Aviva plc
- Axa S.A.
- MetLife, Inc.
- Pin An Insurance (Group) Company of China, Ltd.
- Prudential Financial, Inc.
- Prudential plc
G-SIIs will be determined on an annual basis each November, beginning in November 2014. Entities may be either added to or removed from the list.
According to Lloyd’s, the FSB and IAIS are expected to designate a number of reinsurers as G-SIIs by the end of 2014.
Insurance: policy measures
At the same time as the IAIS published its assessment methodology (see above), it also published ‘Global Systemically Important Insurers: Policy Measures’, a framework for insurers developed “in line with” the FSB’s SIFI Framework.
The main points of the IAIS policy measures are described below.
Backstop capital requirements
IAIS are in the process of developing straightforward, backstop capital requirements (‘BCRs’) for all G-SII group activities (including any non-insurance subsidiaries)4. This was the subject of apublic consultation in December 2013.
IAIS published an update on their work on 18 March 2014, including some details on how the BCR might be calculated. In particular, “to address the lack of comparability between insurance liabilities in differing jurisdictions, Current Estimates of Liabilities will be a proxy measure for insurance liabilities”.
Julian Adams, Deputy Head of the UK’s Prudential Regulation Authority, provided a further update on IAIS’ work in a speech on G-SIIs to the Geneva Association on 24 March 2014.
Adams noted the IAIS has “enter[ed] the field testing phase”, “request[ing] insurers’ best estimate of liabilities on four different bases in order to test the impact of various valuation approaches”. He reiterated that the “use of best or current estimate by all firms in determining the value of an insurer’s liabilities is essential” for achieving global consistency.
A second public consultation on BCR is expected to take place after the field testing has ended.
Higher loss absorbency
In addition to the BCR described above, there will also be an additional requirement for G-SIIs conducting NTNI activities to have higher loss-absorbency capacity (‘HLA’).
NTNI activities are seen as a major source of risk, both for the interconnectedness they introduce between the insurance and other sectors, but also because these activities often lack the longer timeframe associated with traditional insurance business; hence the new HLA requirements for NTNI activities, which are intended to reduce the probability of G-SII failure.
The IAIS will develop the HLA requirements by the end of 2015. In the meantime, the IAIS policy measures indicate the main factor in determining the level of HLA is whether NTNI activities have been effectively separated from traditional insurance business (see below):
- where NTNI business has been separated, HLA figures may be calculated based on those NTNI activities, and the HLA requirement applied to the separate NTNI entity; but
- where NTNI business has not been separated, HLA figures may be calculated based on the NTNI activities of the entire consolidated group (including the parent company) – which will inevitably be a higher figure.
HLA capacity requirements should be met by the highest quality capital, sufficient to cover all losses on a going-concern basis. The assessment of HLA may take into account any other capital requirements already imposed on the G-SII.
Recovery and resolution
The FSB anticipates that G-SIIs and their supervisors should apply the standards contained in their October 2011 document ‘Key Attributes of Effective Resolution Regimes for Financial Institutions’ (‘Key Attributes’).
For banks, the ‘Key Attributes’ will be incorporated into EU law by the recently-agreed (Bank) Recovery and Resolution Directive; the corresponding5 ‘Recovery and resolution framework for financial institutions other than banks’, however, has not progressed beyond a Commission consultation in October-December 2012.
According to the IAIS, the distinctive elements of insurance sector resolution include:
- the need to separate NTNI activity from traditional insurance business;
- the possible use of portfolio transfers and run-off arrangements; and
- the existence of policyholder protection and guarantee schemes or similar.
The main aspects of the IAIS recovery and resolution policy are:
- national authorities will be required to establish Crisis Management Groups (‘CMGs’) for G-SII firms made up of “supervisory authorities, central banks, resolution authorities, finance ministries and [those] responsible for guarantee schemes of jurisdictions that are home or host to entities of the group that are material to its resolution”6;
- CMGs will carry out resolvability assessments of G-SIIs "that evaluate the feasibility of resolution strategies and their credibility in light of the likely impact of the firm’s failure on the financial system and the overall economy" and, in particular:
- the extent to which critical financial services can continue to be performed
- the nature and extent of intra-group exposures; and
- the firm’s capacity to deliver detailed, accurate, and timely information to support resolution;
- all G-SIIs will be required to produce recovery and resolution plans (‘RRPs’), including liquidity risk management plans;
- the development of institution-specific cross-border co-operation agreements among resolution authorities.
Enhanced supervision requirements
The IAIS’ policy on enhanced supervision requirements is based on its own ‘Insurance Core Principles, Standards, Guidance and Assessment Methodology’ framework for insurance supervisors, published in October 2011, and the FSB’s series of recommendations and progress reports on ‘Intensity and Effectiveness of SIFI Supervision’ in 2011-12.
The new requirements are mainly focused on group-wide supervision carried out by group-wide supervisors (‘GWS’) “since G-SIIs are most likely to take the form of a group”. GWS should have direct powers over holding companies.
GWS must require G-SIIs to have adequate arrangements for liquidity risk management for the whole group, and particularly for any NTNI carried out in that group.
Further, GWS should oversee the development and implementation of a Systemic Risk Management Plan (‘SRMP’). This is something distinct from an RRP (see above).
IAIS has provided guidance for GWS on what SRMPs should include. The G-SII should describe in the SRMP how it will “manage, mitigate and possibly reduce its systemic risk”; this should include in particular the “effective separation” of systemically-important NTNI activities from traditional insurance business “where feasible and appropriate”.
Where this is done:
- the separate entity carrying on NTNI activities must be structurally self-sufficient; e.g. a restriction or prohibition on parental guarantees or cross-default clauses;
the separate NTNI entity must also be financially self-sufficient, e.g. no capital or funding subsidies, multiple gearing or double leverage;
any necessary remaining interconnectedness between the NTNI entity and the remainder of the group should be ‘addressed by the application of other consequential measures” (e.g. increased capital requirements); and
the separate NTNI entity should be supervised by the GWS (and, if applicable, any other direct supervisory authority).
More broadly, IAIS expect enhanced supervision to mean “tailored regulation, greater supervisory resources and bolder use of existing supervisory tools compared to the supervision of non-systemically important insurers”.
- July 2014: first nine G-SIIs to have completed their SRMPs.
- Mid-2014: national supervisors to have established CMGs for the first nine G-SIIs and reported back on the status of CMGs and resolution planning.
- November 2014 (date of the G20 summit in Brisbane) IAIS to have developed the BCR.
- End of 2014: G-SIIs/CMGs to have developed RRPs.
- End of 2014: list of reinsurers designated as G-SIIs to be announced by FSB/IAIS.
- End of 2014: FSB members to have reported back to the FSB on their respective plans to implement the Key Attributes in the non-bank financial sector. (In the EU, this will include the progress of the ‘Recovery and resolution framework for financial institutions other than banks’ described above.)
- End of 2015: IAIS to have developed a detailed proposal for the HLA requirements. By this date the FSB also expects its members to have fully implemented the Key Attributes into national law.
- July 2016: the first assessment of the implementation of SRMPs for the first nine G-SIIs to have taken place.
Timetable for newly designated G-SIIs
Deadlines following designation as a G-SIFI/G-SII:
- Immediately: enhanced supervision measures begin to apply; start developing SRMP
- 6 months: establishment of a CMG
- 12 months: develop a recovery plan and resolution strategy, and review this with the CMG #
- 18 months: agreement of an institution-specific cross-border co-operation agreement, and development of an operational resolution plan; and
- 24 months: CMG to conduct resolvability assessment.