What is a financial conglomerate?
A financial conglomerate is a corporate group with significant activities in both:
- banking and/or investment services on the one hand; and
- insurance (including reinsurance) on the other.
These sub-sectors are collectively referred to as the ‘financial sector’ within a conglomerate. Some conglomerates, of course, also have significant non-financial activities.
The banking/investment sector is widely defined. It includes a number of activities not regulated as such in the UK, including financial leasing and the financing of commercial transactions. It has recently been expanded under the Markets in Financial Instruments Directive to cover, for instance, investment research and financial analysis.
The Financial Conglomerates Directive
The Financial Conglomerates Directive (FCD) created a distinct European regime for the supervision of financial conglomerates. It was aimed at bancassurance groups and insurance groups with significant banking and asset management activities. It was required to be effective for financial years beginning on 1 January 2005 or later. It also made significant changes to the pre-existing separate regimes for the supervision of insurance groups and banking/investment groups.
The FCD sets out a complex mechanism for identifying a financial conglomerate. In simplified terms financial sector activities should exceed 40 per cent of the total activities of the conglomerate. The smallest financial sub-sector (whether insurance or banking/investment) should exceed 10 per cent of the financial sector balance sheet total.
Even where a sub-sector within the financial sector does not reach this threshhold the conglomerate will generally be supervised as such if the balance sheet total of the smaller sub-sector exceeds €6bn. In that event, however, the supervisors concerned may, under article 3.3 of the FCD, agree to disapply the directive regime in whole or in part. Where the FCD is disapplied, the group as a whole will in most cases be supervised as an insurance group or a banking/investment group. Sometimes separate parts of the group may also be supervised in their own right (see below).
The prudential requirements applied under the FCD cover:
- maintenance of capital adequacy across the conglomerate;
- the reporting and regulation of risk concentrations;
- the reporting of intra-group transactions; and
- the regulation of internal control mechanisms and risk management processes.
Sub-conglomerates and sub-groups
Financial conglomerates and other regulated groups must be supervised as such even if they are sub-groups within a wider financial group.
Article 18 of the FCD covers the position where the headquarters of a financial conglomerate are based outside the European Economic Area (EEA). In that event EEA regulated entities within the group may nonetheless be supervised by reference to their membership of the conglomerate.
Measures available to the relevant European regulators include requiring the conglomerate to create an intermediate European holding company. Measures such as these will, however, only be taken to the extent that conglomerate supervision in the non-EEA state concerned is considered not to be equivalent to European standards. The Commission has determined that the US and Swiss regimes are broadly equivalent, subject to some reservations.
The lead supervisor
The FCD contains a mechanism for identifying a lead supervisor for each conglomerate. The lead supervisor has primary responsibility for supervising the conglomerate although it will consult with other relevant supervisors under arrangements set out in the Helsinki Protocol.
The UK regime
The UK implementation of the directive regime applies only to conglomerates for which the FSA is the lead supervisor. In general either the FSA’s insurance or banking/investment capital adequacy rules are applied across the conglomerate, depending on which is the most important sub-sector (see Chapter 3 of the FSA’s General Prudential Sourcebook (GENPRU)). These two distinct sets of rules may sometimes produce quite different results. The operation of the insurance rules is constrained by directives dating back to the 1970s, whereas the banking regime has recently been updated under Basel II.
The list of conglomerates
All European financial conglomerates in the EEA are identified in a list published and regularly updated (most recently in November 2007) by the Commission. It includes a separate list of non-EEA conglomerates with European operations. Apart from non-EEA conglomerates, the only seven UK lead supervised conglomerates (out of a European total of 68) are now:
- Co-operative group;
- Julian Hodge Bank Group;
- Lloyds TSB;
- Old Mutual; and
- Standard Life.
Some other UK groups originally identified in 2005 as conglomerates are no longer listed as such. They will therefore be supervised either as insurance or banking/ investment groups. In some cases this seems to have arisen because of the application of the article 3.3 exemption. In other cases it may have been because of changes in internal organisation or M&A activity. Details of the process by which financial conglomerates are identified or excluded from the regime are not in the public domain. Some groups may be quite near to the borderline.
The Commission’s list shows that in other EEA jurisdictions some leading insurance groups and bancassurance groups have developed into conglomerates. A number of these are sub-conglomerates.
Review of the FCD
Article 20 of the FCD provides for some of its more technical rules to be adapted and updated where appropriate. Changes to the directive are under consideration. The Commission has also been working with the European Financial Conglomerates Committee (EFCC) and the Interim Working Committee on Financial Conglomerates (IWCFC). The scope of this work covers:
- establishing the extent to which conglomerate supervision in third countries (particularly the US and Switzerland) is equivalent;
- achieving fuller harmonisation of member states’ practices; and
- creating more harmonisation across the different sub-sectors.
In relation to conglomerate capital the IWCFC recommends:
‘that the principles and requirements for eligibility should be the same for both banks and insurance companies. Differences between the two sectors should not occur unless they reflect specificities. This has strong industry support and it is recommended that this harmonisation should occur no later than the implementation of Solvency II’.
Issues for review
The EFCC raises specific issues for response by the industry and proposes a roundtable on 8 September 2008. The issues include whether any difficulties have arisen from applying the definitions in article 2 of the FCD, which determine whether a group is a financial conglomerate.
The scope of the proposed roundtable seems wide enough to cover questions arising from the ‘credit crunch’, including possibly increased emphasis on supervision by reference to liquidity.
The Solvency II project proposes a major reform of the European framework for the supervision of insurers and insurance groups. It does not cover the FCD, although it will apply to solo insurers and insurance groups within conglomerates.
The proposed Solvency II directive gives supervisors considerable discretion and flexibility in the application of group supervision to sub-groups within a larger insurance group. There is no similar flexibility in the FCD. Arguably there should be. This is, however, outside the scope of the Commission’s review and in any event could not be achieved within the FCD’s limited comitology provisions.
Solvency II also proposes a new group support regime for insurance groups that meet specified requirements. Such groups would maintain their Solvency Capital Requirement (SCR) primarily at group rather than solo level. This might (if the regime delivers the desired results) give them much more flexibility in capital management. The group would, however, be required to provide a guarantee of group support for its members.
The question has arisen whether such a regime might also be applied across banking groups and financial conglomerates. The UK Treasury and the FSA argue in a recent discussion paper that it should not. They rely on significant differences in the risks applying to insurance business on the one hand and banking business on the other.
Bancassurance groups in the UK
A number of leading bancassurance groups in the UK do not now qualify as conglomerates. The FSA has been focusing on the prudential approach to their holdings in insurance companies. A consultation paper on this topic was due to appear in June 2008 but has been deferred, probably until the new year. Currently investments by banking groups in insurance companies are not consolidated. The possibility of applying a different approach is under consideration.