Notes of the meeting held at the European Parliament
Solvency II
The European Union should seize the opportunity to take the lead in establishing a solvency regime for insurance companies which could set the standard for the world. This was one of the key messages which emerged from the Graham Bishop European Finance Forum which took place in the European Parliament buildings on June 12th.
Graham Bishop opened the forum by pointing out that the proposed Solvency II Directive for insurance companies broke new ground in the supervision and regulation of insurance companies, but it also raised controversial issues of principle, relating in particular to the question of accepting the idea of a lead regulator which would test the political will behind the aim of establishing a single EU insurance market. He added that Solvency II would be the first Directive that was developed from the outside in accordance with the Lamfalussy Process of extensive pre-legislative consultation. It would call on the European Parliament to provide a genuine “framework Directive” and resist lobbyist pressures for including too much detail in Level 1 of the legislation.
Karel Van Hulle, Head of the Commission's Insurance and Pensions Unit, outlining the shape of the process which will lead to the new Directive said that the existing insurance legislation, which he characterised as “Solvency 1,” had a fundamental weakness, namely that there was no early warning structure in place to alert supervisors that a company was running into serious financial difficulty.” Solvency 1 does not look at the individual risk positions of companies,” he said, which is odd because insurance is about risk management.
Solvency II involves recasting the existing fourteen (14) insurance directives, to gouge out the old heart of existing insurance regulation and replace it with a single piece of principles-based legislation to create a new solvency regime with new, modern legislative drafting.
Like the Basle II based Capital Requirements Directive in banking, Solvency II would have three pillars: a new capital regime, a quality of management assessment and a disclosure based market discipline structure.
The new Solvency II early warning system would involve establishing a standard formula-e for solvency capital requirements (SCR) which, when breached, would trigger automatic intervention by supervisors to assess what was wrong. The goal would be to ensure that intervention requirements would be harmonised so that no matter which national supervisors were involved, intervention would be triggered in the same way in every EU country. There would also be a minimum capital requirement (MCR), and if this were breached regulators would be required to stop the company concerned from doing business.
Although the regulatory formula-e would be the same, insurance companies would be able to develop a full internal model for establishing their capital needs, thereby going beyond what is presently possible for banks under the Capital Requirements Directive.
Mr. Van Hulle stressed that another big difference is that Solvency II has been built from the bottom up. It is the result of three waves of calls for advice addressed to CEIOPS, which resulted in a “tsunami” of replies. The advice developed by CEIOPS had been widely consulted with stakeholders. As the Solvency II Directive will be a Lamfalussy Directive, it will require further implementing measures which will be issued by the Commission in close cooperation with CEIOPS, which will again produce draft advice, with the Member States through the European Insurance and Occupational Pensions Committee (EIOPC) and under the scrutiny of the European Parliament.
He expects the Commission to approve the final draft of the Directive on July 10th. Publication of the proposed Directive will follow promptly, and will be accompanied by an extensive impact assessment report, including a cost/benefit analysis and a series of reports: by CEIOPS on the implications for supervisors; by the European Central Bank on financial stability issues; by DG Ecfin on macro economic aspects; by the CEA/AISAM and ACME on insurance products and markets; and by Finuseon the implications for consumers.
He stressed that the Commission saw the timing as urgent since Solvency II presented the EU with the opportunity to design a modern solvency regime “which we can export to the rest of the world.” Already, he said, the Commission had had meetings with Chinese, Japanese and South Korean officials to discuss the project.
Peter Skinner (MEP and Rapporteur on the Directive), responding, said that Solvency II would be one of the most demanding pieces of legislation the Parliament had had to deal with under the new Lamfalussy and comitology procedures. He said the ECON committee of the Parliament had already been working closely with the other EU institutions and industry representatives in order to produce “good law” which would allow the insurance industry to expand and protect policyholders. But, he stressed, the Parliamentary committees would expect to get involved in the details of difficult issues such as supervisory cooperation, the calibration of capital adequacy and securitisation. He hoped that members would exert self discipline in the interests of the EU in general, and not try to protect national interests and firms.
He said that he expected that in the autumn the QIS 3 exercise would be published. This would provide detailed information on how to calibrate the standard and minimum capital requirements and this would raise the crucial issue of how to fit capital adequacy/solvency models on these foundations. He said that he expected Parliament’s committees to get into discussions about the details of how internal capital adequacy models would fit with QIS 3.
Graham Bishop wondered, in relation to the timescale, whether there was a risk that Solvency II could be amongst the last issues voted on in the April 2009 plenary, the last before the next parliamentary elections. Karel Van Hulle suggested that this timeline was too pessimistic and that a vote might take place in 2008. Peter Skinner agreed.
In the following discussion, industry representatives stressed that they too wanted the legislation to be a high level principles text, not too detailed and hoped that Parliament and the Commission would work closely together to achieve this. Concerns were expressed about the scope for disputes.
Karel Van Hulle said that his dream would be that national delegations would concentrate on the main issues and would not start a discussion about the details; that the industry would be united in their position and that would not be too much controversy between big and small insurers and mutuals. But he admitted this would be expecting a lot. The key controversial issues would be the further development of the standard formula following the conclusions of QIS 3, the relationship between the MCR and the SCR as well as issues relating to the supervision of groups which involved accepting the reality of group and cross-border structures, and how to organise the interplay between group and solo insurers.
One participant said that he thought the waves of calls for advice had created awareness amongst national supervisors and others of the complexities of the proposal and the differences between different national regulatory regimes. Karel Van Hulle added that insurance supervision is generally less harmonised than banking supervision, and that Solvency II was therefore asking for a big leap forward in supervisory convergence and co-operation. One participant added that there is strong industry support for economic risk-based supervision. Graham Bishop asked whether any member state or major interest group was explicitly against the project. Karel Van Hulle responded that he was not aware of any Member State opposing Solvency II. It is indeed difficult for Member States to oppose this reform which is generally felt to be needed and to be in the interest of all stakeholders, but there will be plenty of argument about some of the detail. Peter Skinner added that Parliament would hope to see the home/host supervisory debate resolved before the Parliament had to vote on the Directive. If it were not, Parliament itself might have a view. He added that issues of reciprocity with third countries are also involved, not least with the United States.
Hedge funds and private equity
Graham Bishop opened the discussion by remarking that public policy issues such as the ballooning of the money supply as a result of leveraged lending, corporate governance questions resulting from the high profile activity of small shareholders in a few large companies like Deutsche Boerse and ABN-Amro are all contributing to the intense debate surrounding the impact of financial innovation. Claims by Internal Market Commissioner Charlie McCreevy that there are “no chinks in the regulatory armour,” in relation to private pools of private capital are also part of the controversy.
Niall Bohan, Head of Unit in the Asset Management section said the issues raised by hedge funds and private equity, two very different forms of investment vehicle, are extremely complex. There are a lot of perceptions and not a lot of facts available. He said the defining qualities of hedge funds is that they have high leverage, trade very quickly in volume and are still mainly bought by institutional investors.They have been growing very rapidly but still only have around $1.5 trillion of assets under management, representing about 4% of the global asset management industry.
But there are signs that more retail investors are being sold these products and that traditional investment management firms are now using hedge fund techniques. He identified four policy issues which the Commission is currently analysing; “retailization” of the product, the role of active funds in pressuring for corporate restructuring, potential for market abuse including insider trading, and the vulnerability of the financial system as a whole to a hedge fund shock.
He stressed that the Commission is not in denial about these issues, that it is examining what checks and balances are in place, pointing out that the funds are not, strictly speaking “unregulated.” He said that on some issues, market abuse rules and rules about small investor transparency when acting in concert, regulatory rules are already in place.
As for financial stability, the G8 has concluded that regulating the 15/20 prime brokers who service hedge funds and making sure they are sound is the most fruitful way forward at this stage. He added that rather than just focus on hedge funds, the Commission sees that what the IMF calls “ the triangle of vulnerability,” the credit risk transfer market, credit derivatives and hedge funds, should be the focus of concern and that here the crucial issues revolve around the credit risk transfer and derivatives markets not the hedge funds themselves. He expected a ratcheting up of supervisory control of credit derivative markets.
Wolf Klinz MEP responded that it is too early to say whether or not adequate checks and balances are in place. The markets have not yet been really tested. He pointed out that another distinguishing characteristic of hedge funds is that they act in the face of management opposition which is not usually the case with private equity. Private equity funds also invest for four to seven years, hedge funds are short-termist and highly leveraged. He agreed that formal regulation is not at present the way forward and wondered why the British and U.S. authorities are so opposed to a voluntary code of conduct for the industry. One participant intervened to dispute this saying that a former Bank of England governor is currently working to try and devise a hedge fund code of conduct in London.
Portuguese Presidency
Ceu Pereira, Financial Attaché, Portuguese Permanent Representation, discussing its priorities in its forthcoming Presidency of the EU said that pushing forward with Solvency II was clearly a high priority, along with the implications of the Inter Institutional Monitoring Group’s final report on the Lamfalussy process. Inevitably, continued vigilance regarding hedge funds would be a feature. Financial stability and the future of clearing and settlement, which were likely to be prominent features of the informal Ecofin in September with Ecofin conclusions expected in October, are also high on its agenda. The Presidency was also keen to see the SEPA Directive made a reality in terms of transposition and in terms of getting a critical mass of private sector support.
Graham Bishop closed the meeting by thanking all the speakers.
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Date of next meeting: Provisionally set for 16th October, and asset management is expected to be a major subject.
© Graham Bishop
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