Jul112014

Collateral for bank support, an additional risk to the euro crisis?

COLLATERAL FOR BANK SUPPORT,

AN ADDITIONAL RISK TO THE EURO

CRISIS?

President Klaas Knot of the Dutch Central Bank (DNB) has expressed clear concerns regarding the collateral accepted by the seven central banks in the eurozone. ‘I would have preferred it otherwise; I would have preferred we had not done this at all. As a central banker, I am naturally not enthusiastic about this,’ he stated.

In December and February, the ECB provided banks with three-year loans totalling €1000 billion. During this operation, the collateral requirements were relaxed, increasing the risk exposure.

Collateral

Until recently, central banks only accepted market-traded collateral, such as government bonds and corporate bonds. ‘It turned out that a significant portion of the banks we wanted to help could not participate in the LTRO (three-year ECB loans, ed.) Their collateral was not good enough,’ Knot explained. He emphasised that he agreed with the support in principle.

This situation primarily affected banks in Southern Europe, which lend substantial amounts to small and medium-sized enterprises (SMEs). To accommodate these banks, central banks would also accept bundled SME loans, Knot explained.

‘Those loans had to meet the same quality standards as other collateral,’ the DNB president noted. Under pressure from seven central banks, the collateral requirement was further lowered, allowing individual SME loans to be accepted as collateral.

Plasterk: ‘Stupid’

PvdA Member of Parliament Ronald Plasterk criticised Knot for exposing the ECB’s internal divisions in this manner, as he expressed on Twitter.

‘What purpose does Knot serve by showcasing that the ECB is internally divided?’ Plasterk questioned. ‘If you are going to inject money, don’t suggest that you might change your mind next month. #stupid’

Risks

The question arises whether the risks borne by these seven central banks might eventually fall on the eurosystem if problems arise in one of these countries. If this happens, will the reduction in the collateral requirement exacerbate the current euro crisis? And perhaps more importantly, should the ECB be open and transparent about this, or should it present a united front to project stability?

Jul102014

Statusupdate Solvency II

Status Update: Solvency II

General

Since the beginning of 2012, negotiations have been underway to finalise the content of the Omnibus II directive and the Level 2 implementing measures. The definitive agreement on the Omnibus II directive is expected shortly. The definitive agreement on the Level 2 implementing measures is expected in the autumn. The focus lies on the risk-free curve, capital requirements, and own funds, as well as transitional measures.

Pillar Developments
Additionally, there are developments per pillar:

Pillar I: Parallel Run and Risk-Free Term Structure

From 2011, Dutch insurers that fall within the scope of Solvency II must calculate their solvency (2011 and 2012) in accordance with the expected Solvency II measures (SCR and MCR) and report on this (Pillar 3) to the DNB. This is known as the parallel run.

A part of this reporting (and the calculation of the SCR) is the countercyclical premium, known as the CCP. A proposal has been developed for this CCP, using the formula from QIS5 as a basis. Two scenarios have been developed, with the countercyclical premium ranging between 75% (Scenario 1) and 100% (Scenario 2). In the definitive directive, more clarity will be created on this.

Pillar II: ORSA

The outcomes of the roundtable sessions held by the DNB regarding ORSA were positive. Bottlenecks include setting up mandatory key functions (Internal Audit, Risk Management, Actuarial Function, and Internal Control) and implementing IT systems. A frequently discussed aspect here is proportionality. Where the risk profile of the insurer must be chosen as the starting point. For example, an insurer with a low risk profile can make different choices in filling these bottlenecks (and other aspects of the directive) compared to an insurer with a high risk profile.

Pillar III: Consultation

Regarding Pillar III, the reporting requirements, the consultation period for several aspects (including reporting templates and National States) has closed, and the comments are currently being processed. More will follow on this later.

Jul102014

The potential impact of Solvency II

The Potential Implications

of Solvency II

Solvency II will have far-reaching consequences not only for insurers but also for the capital market.

Insurers, pension funds, and consultants have been anticipating the implementation of Solvency II for some time. In brief, Solvency II demands a more comprehensive risk management framework and higher capital requirements for European insurers.

The introduction of Solvency II, initially planned for January 2013 but likely to be delayed, is intended to make insurers more stable and protect policyholders. Insurers taking on greater risks will also be required to hold more capital. The implementation will have significant repercussions for insurers, necessitating substantial changes. UK regulators estimate that the costs of implementation in the UK alone will exceed £2 billion, with an additional £250 million annually for compliance costs for insurers.

Major insurers welcome the increased investment and attention to risk management activities. However, smaller insurers may struggle to meet the capital requirements and stricter risk management standards. Consequently, a BASIC version of the directive has been introduced. The question remains as to how the regulator will handle this.

There is also criticism of the stricter requirements, particularly regarding who will bear the costs of this transition—will it be the policyholders?

The portfolios of insurers will change, with the new rules discouraging risky investments such as equities and private equity. With the current low-interest rates, there is uncertainty about whether sufficient income can be generated in the future. Banks will also be affected by the stricter requirements, as they are significant investors in insurers.

If the business and risk models of insurers show strong similarities, there could be simultaneous buying and selling of stocks, potentially leading to significant market fluctuations, according to a major European insurer.

Additionally, the competitive position relative to other countries may deteriorate, especially if the United States does not implement similar measures to Solvency II, as noted by another major European insurer. However, an insurance market characterised by great stability and certainty, partly due to Solvency II, could also derive competitive advantage from this development.

Jul102014

COSO due for renewal

The widely adopted COSO (Committee of Sponsoring Organizations of the Treadway Commission) risk framework, frequently utilized in the implementation and auditing of standards such as ISAE 3402 or ISO 27001, is due for a comprehensive update.

ICIF – the new model

Due to strong market changes, the COSO II ERM framework was outdated. A framework was needed that was responsive to, and took into account, current market conditions while being flexible enough to be applicable to a wide range of organisations: Internal Control – Integrated Framework (ICIF). The framework is also expected to enable organisations to meet rapidly changing market demands without incurring more risk.

The biggest changes are the minimisation of the COSO cube (the number of components has been reduced). In addition, the model has moved to a ‘principle-based structre’ where 17 principles form the foundation for the model. Also, given recent developments, the new model has placed more emphasis on the IT component.

From late 2011 to March 2012, the committee solicited feedback from the market on the framework. This feedback is currently being critically assessed by the committee and will largely be incorporated into the final version of the framework.

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