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The Supervision of Financial Conglomerates GBV

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					Band 96




Schweizer Schriften
zum Finanzmarktrecht
Herausgegeben von
Prof. Dr. Dieter Zobl
Prof. Dr. Mario Giovanoli
Prof. Dr. Rolf H.Weber




Dr. iur. Valerie Menoud

The Supervision
of Financial Conglomerates
A Study of the Swiss Regulatory Framework
in Light of International Developments




                            Schulthess § 2010
                                                                     Table of Contents



Table of Contents
     Acknowledgements                                                              HI
     Summary of Contents                                                           V
     Table of Contents                                                            VII
     Bibliography                                                                 XV
     Abbreviations                                                               XLV

     Introduction                                                                   1
Parti
Tackling Conglomerates                                                              5
Chapter 1
The Phenomenon of Financial Conglomeration                                          7
    § 1. Background                                                                 9
        I.    The Concept of Conglomeration                                         9
              1. Generic Definition                                                 9
              2. Underlying Financial System Conception                            10
        II.   Universal Banking and Functional Banking Regimes                     11
        HI.   The Parent Concept of "Allfinanz"                                    13
              1. Idea of Allfinanz                                                 13
              2. Bancassurance, Assurbanque, and Assurfmance                       14
     § 2.     Conglomerates as Groups of Companies: Corporate Structure Models     16
        I.    A Matter of Choice                                                   16
        II.   Models                                                               17
              1. Integrated Model                                                  17
              2. Parent-Subsidiary Model                                           19
              3. Holding Company Model                                             21
              4. Horizontal Group Model                                            23
     §3.      Development of Financial Conglomeration                              25
       I.     Motives                                                              25
              1. General Background                                                25
              2. Economic and Regulatory Motivations                               26
              3. Practical Incentives                                              27
        II.   Trends                                                               27
              1. Forces towards Conglomeration                                     27
              2. Conglomeration in Switzerland                                     29
              3. Conglomeration in the European Union                              31
                 a. M&A activities of the 1990s                                    31
                 b. Conglomerates' Structure                                       31
                 c. Facts and Figures                                              33
                 d. Concerns                                                       35
        HI.   Financial Conglomeration and Financial Crises                        35
              1. In General                                                        35
              2. Impact of the 2007-2008 Financial Crisis                          36
              3. Outlook                                                           38
Chapter 2
Supervisory Issues                                                                 41
    § 1. Rationale for Regulating Financial Conglomerates                          43
       I. Issue                                                                    43
       II. Potential Problems                                                      44

                                                                                  VII
Table of Contents

                 1. Double Gearing or Excessive Leveraging                      44
                                                                                44
                 2. Contagion
                                                                                45
                 3. Lack of Transparency
                                                                                46
                 4. Conflicts of Interest
                                                                                46
                 5. Systemic Risks
            III. Sector-based Differences and Common Characteristics            47
                                                                                47
                 1. Differences
                                                                                4
                     a. Banking and Securities Dealing                           ?
                                                                                4
                     b. Banking and Insurance                                    8
                 2. Common Characteristics                                      51
                     a. Fitness and Propriety Tests                             51
                     b. Risk Management                                         52
                 3. Assessment                                                  53
         § 2. Supervisory Answers                                               54
             I. Types of Supervision                                            54
                 1. Stand-alone or Solo-Basis Supervision                       54
                 2. Supervision of Homogenous Financial Groups                  55
                  3. Supervision of Financial Conglomerates                     56
                 4. Mixed-Activities Groups                                     56
             II. Boundaries to Financial Conglomeration                         57
                  1. Generalities                                               57
                  2. Limits Imposed in the Banking Sector                        58
                      a. Secondary Business Activities                           58
                      b. Equity Holdings                                         59
                      c. Technical Skills and Appropriate Organisation           60
                  3. Limits Imposed in the insurance Sector                      61
                      a. Secondary Business                                      61
                                                                                    63
                      b. Equity Holdings
                  4. Comparative Perspective: Situation in the European Union       64
 Chapter 3
 Defining Financial Groups and Conglomerates                                    67
      § 1. Background                                                           69
      § 2. Underlying Notions                                                   71
            I. Notion of "Enterprise"                                               71
             II. Notion of "Group" in Financial Law                                 71
                   1. A Definition Oriented towards Economic Reality                71
                   2. Economic Unity                                                73
                       a. "More than half of the voting rights or capital"          73
                       b. Controlling Influence and Control                         74
                   3. Obligation to Provide Assistance                              78
                       a. A Banking Speciality?                                      78
                       b. Legal Obligation to Provide Assistance                    79
                       c. Factual Obligation to Provide Assistance                  80
          § 3. "Financial Group"                                                    82
              I. Definition                                                         82
              II. Presence of a Bank or a Securities Dealer                         82
                   1. Bank                                                           83
                   2. Securities Dealer                                              85
              III. Primary Activity in the Financial Sector                          87
                    1. Financial Sector                                              87
                    2. Primary Activity                                              88
                    3. Financial Companies                                           90
          § 4. "Financial Conglomerate"                                              93
              I. Definition                                                          93
              II. Supplementary Presence of an Insurance Company                     94


  VIII
                                                                               Table of Contents

        III. Considerable Economic Importance                                                95
     § 5. "Insurance Group"                                                                  97
     § 6. "Insurance Conglomerate"                                                           98


Part II

Supervisory Fundamentals                                                                     99
Chapter 4
International Developments                                                                101
     § 1.        Preliminary Note                                                          103
     § 2.        Basel Committee on Banking Supervision                                    104
        I.       General Remarks                                                           104
        II.      Standards for Effective Consolidated Supervision                          106
                 1. Basel Concordat of 1975                                                106
                 2. Basel Concordat of 1983                                                108
                 3. Minimum Standards                                                      110
                 4. Basel Core Principles and Core Methodology                             111
          III.   Standards for Sensible Minimum Capital Requirements                       114
                 1. Basel Capital Accord of 1988                                           114
                 2. Basel II                                                               116
                     a. Contents                                                           116
                     b. Purpose                                                            118
                     c. Scope of Consolidation                                             119
                     d. Adoption of the framework at National Level                        122
          IV.    Standards for Supervisory Cooperation and Coordination                    122
                 1. Implications of Basel II                                               122
                 2. High-level Principles                                                  123
                 3. Other Cross-border Aspects of Basel II                                 124
     § 3.        Tripartite Group & Joint Forum                                            125
        I.       Tripartite Group of Banks, Securities and Insurance Regulators            125
        H.       Joint Forum                                                               127
                 1. General Remarks                                                        127
                 2. Joint Forum Report                                                     128
                 3. Papers on Intra-Group Exposures and Risk Concentration                 133
                 4. Other Publications                                                     134
     § 4.        International Association of Insurance Supervisors                        137
        I.       Generalities                                                              137
        II.      Principles                                                                138
                 1. Nature and Purpose                                                     138
                 2. Insurance Concordat, December 1999                                     138
                 3. Insurance Core Principles and Methodology, October 2003                139
                 4. Principles on Capital Adequacy and Solvency, January 2002              140
                 5. Principles on Group-Wide Supervision, October 2008                     140
          HI.    Standards                                                                 142
                 1. Nature and Purpose                                                     142
                 2. Supervisory Standard on Group Coordination, October 2000               142
                 3. Supervisory Standard on the Exchange of Information, January 2002      143
        IV.      Guidance Papers                                                           144
        V.       Overarching Standards Setting Papers                                      145
     §5.         International Organisation of Securities Commissions                      147
     § 6.        Synthesis                                                                 149
     §7.         Drawing Lessons from the Banking Crisis                                   150
        I.       Background                                                                150


                                                                                             IX
Table of Contents

        II. Regulatory Revisions under the Authority of the G20                          151
            1. The Washington Summit of November 2008                                    151
            2. The London Summit of April 2009                                           152
            3. The Pittsburgh Summit of September 2009                                   152
            4. The Work of the Financial Stability Forum                                 153
            5. BCBS: Reforming Basel II and Beyond                                       156
            6. The 1AIS and the Insurance Sector                                         157
        HI. Further Steps and Caveat                                                     158

Chapter 5
From Consolidated Supervision to Conglomerate-Wide Supervision                           159
     § 1.     Concepts                                                                   161
        1. Consolidation and Consolidated Supervision                                    161
        11. General Principles of Consolidated Supervision                               162
             1. Abstract Definition                                                      162
             2. Contents of Consolidated Supervision                                     163
             3. Notion of Effective Consolidated Supervision                             164
        III. Consolidation, Consolidated Supervision and Group-wide or
             Conglomerate-wide Supervision                                               165
     § 2.     Historical Background                                                      167
        I. Generalities                                                                  167
        11. Consolidated Supervision of Banking Groups                                   167
             1. Accounting and Capital Adequacy                                          167
             2. Consolidated Risk Supervision                                            169
             3. Economic Unity                                                           171
                a. Supervisory Observations                                              171
                b. Banking Law                                                           171
                c. Company Law                                                           172
                d. De facto Obligation to Provide Assistance                             173
             4. Scope of Consolidation under the Legislation of 1980                     175
        III. Consolidated Supervision of Insurance Groups                                176
        IV. Towards Conglomerate-Wide Supervision                                        178
             1. Credit Suisse Holding: The Rationale for Conglomerate-Wide Supervision   178
                a. Background                                                            178
                b. Supervisory Intervention                                              179
                c. Implications                                                          179
             2. Credit Suisse Group: The Solo-Plus Supervision                           180
             3. Zurich Financial Services: A Pilot Project for Conglomerate-wide
                Supervision                                                              182
      § 3.    Towards the Current Regulatory Framework                                   184
         I. Former Supervisory Practice's Shortcomings                                   184
         II. European Union's Endeavours                                                 186
         HI. Swiss Regulatory Developments                                               187
Chapter 6
Supervisory" System for Monitoring Groups and Conglomerates                              191
      § 1.    Regulatory Framework                                                       193
         I.   Overview                                                                   193
              1. Concept                                                                 193
              2. Banking Law                                                             193
                 a. Banking Act                                                          193
                 b. Banking Ordinance                                                    194
                 c. Banking-Related Circulars and Guidelines                             195
              3. Insurance Law                                                           195
                 a. Insurance Supervision Act                                            195
                 b. Insurance Supervision Ordinance                                      196

X
                                                                         Table of Contents

              c. Insurance-Related Circulars and Guidelines                           196
           4. Securities Law                                                          197
       II. Regulatory Aims                                                            197
           1. Primary Aims                                                            197
           2. Secondary Aims                                                          198
           3. Schematic View                                                          199
     § 2.    Scope of Supervision of Groups and Conglomerates                         200
       I.   Material Scope                                                            200
            1. Approach                                                               200
            2. Personal Scope                                                         200
                a. Principle                                                          200
                b. Implementation                                                     202
            3. Responsible Entity                                                     205
       II. Contents of Supervision                                                    206
       III. Temporal Scope                                                            207
            1. Entry into Force                                                       207
            2. Entry Points                                                           207
       IV. Geographical Scope                                                         209
            1.. Principle                                                             209
            2. Implementation                                                         210
            3. Sharing of Powers                                                      212
     § 3.    Exercise of Group and Conglomerate Supervision                           213
        I. Background                                                                 213
        II. Supervisory Discretion                                                    213
            1. Principle                                                              213
            2. Implementation                                                         214
               a. Methodology                                                         214
               b. Principle of Proportionality                                        215
               c. Prohibition of Arbitrariness                                        216
        HI. Adequate Consolidated Supervision                                         217
        IV. Placement of a Group or Conglomerate under Swiss Lead Supervision         219


Part III
Material Requirements                                                                223
Chapter 7
Quantitative Requirements                                                            225
    § 1. Preliminary Remarks                                                         227
    § 2. Consolidated Financial Statements                                           228
        I.  Obligation to Prepare Consolidated Financial Statements                   228
            1. In Banking Law                                                         228
                a. Principle                                                          228
               b. Exemptions                                                          229
                c. Consolidation Methods                                              231
            2. In Insurance Law                                                       232
        II. International Developments                                                233
     § 3. Capital Adequacy                                                            236
        I. Issue                                                                      236
            1, Basics                                                                 236
               a. Role of Capital                                                     236
                b. Legal Basis                                                        237
        II. Banking Law's Capital Adequacy System versus Insurance Law's Solvency
            System                                                                    239
            1. Banking Capital Requirements                                           240

                                                                                        XI
Table of Contents

                   a. System                                               240
                   b. Consolidated Capital Adequacy Requirements           241
               2. Insurance Solvency Margin System                         243
                   a. System                                               243
                   b. Consolidated Solvency Requirements                   244
               3. Dealing with Conglomerates                               245
                   a. Concern                                              245
                   b. Roadmap                                              246
         III. International Recommendations                                248
               1. Joint Forum                                              248
                   a. Building-Block Prudential Approach                   248
                   b. Risk-Based Aggregation Method                        249
                   c. Risk-Based Deduction Method                          249
                   d. Total-Deduction Method                               250
               2. Basel II                                                 251
                   a. General Remarks                                      251
                   b. Treatment of Investments in Financial Entities       251
                   c. Treatment of Investments in Insurance Undertakings   251
                   d. Treatment of Investments in Commercial Companies     252
               3. European Union                                           253
                    a. Accounting Consolidation Method                     253
                    b. Deduction and Aggregation Method                    253
                    c. Book Value /Requirement Deduction Method            254
         IV. Regulatory Answer for Insurance Conglomerates                 255
               1. Solvency I: Building-Block Prudential Approach           255
                    a. Principle                                           255
                    b. Available Solvency Margin                           258
                    c. Required Solvency Margin                            259
                2. Swiss Solvency Test                                     263
                    a. Principle                                           263
                    b. Internal Models                                      264
                    c. Solvency Requirements                                268
                3. Control and Reporting on Solvency                        269
          V. Regulatory Answer for Financial Conglomerates                  274
                1. Approach                                                 274
                2. Consolidation of Financial Entities                      276
                     a. Scope of Consolidation                              276
                     b. Consolidation Method                                279
                     c. Exemptions                                          280
                3. Taking Insurance Entities into Account                   281
                     a. "Total Deduction" Method                            282
                     b. Conglomerate-Wide Complementary Approaches          283
                4. Deductions at the Level of the Parent Entity             285
                     a. Interests in Financial or Real Estate Companies     286
                     b. Insurance Interests                                 287
                     c. Commercial or Industrial Interests                  288
                5. Control and Reporting                                    288
                     a. Control                                             288
                     b. Reporting                                           289
       § 4. Liquidity Requirements                                          290
          I. Issue                                                          290
                 1. Importance of Liquidity Prescriptions                   290
                2. Group-wide Liquidity Management                          291
          II. International Recommendations                                 293
           III. Regulatory Answer                                           295
                 1. For Insurance Groups and Conglomerates                  295
                 2. For Financial Groups and Conglomerates                  295

 XII
                                                                               Table of Contents

               a. Scope of consolidation                                                       295
               b. Application of Liquidity Prescriptions at the Level of the Group             296
               c. Control and Reporting                                                        296
    § 5.    Intra-Group Transactions and Risk Concentration                                    297
       I.  Intra-Group Transactions                                                            297
           1. Issue                                                                            297
               a. Definition                                                                   297
               b. Motives and Risks                                                            298
           2. International Recommendations                                                    300
           3. Regulatory Answers                                                               301
               a. Legal Basis                                                                  301
               b. "Important" Internal Transactions                                            302
               c. Insurance Groups and Conglomerates                                           302
               d. Financial Groups and Conglomerates                                           304
               e. Intra-Group Transactions as a focus of Risk Management Practices             309
           4. Appraisal                                                                        309
       II. Risk Concentrations                                                                 311
           1. Issue                                                                            311
           2. International Recommendations                                                    312
           3. Regulatory Answers                                                               313
               a. Obligation to Fulfil Risk Diversification Requirements at the Level of the
                  Conglomerate                                                                 313
               b. Risk Aggregation                                                             314
               c. Reporting                                                                    314
               d. Limitations and Supervisory Intervention                                     316
               e. Risk Concentrations as a Focus of Risk Management Practices                  317
    § 6. Drawing Lessons from t h e Crisis                                                     320
           1. Financial Crisis, Large Banks, and the Debate around Capital Adequacy            320
               a. Measures for Financial System's Reinforcement                                320
               b. Capital Adequacy Reform                                                      321
               c. Insurance Solvency Requirements Reform                                       323
           2. Liquidity Prescriptions Reform                                                   323
Chapter 8
Qualitative Requirements                                                                       327
    § 1. Adequate Group Organisation                                                           329
       I. Issue                                                                                329
       II. Regulatory Answers                                                                  331
           1. Legal Basis                                                                      331
           2. Conglomerate's Business Organisation                                             332
               a. Corporate Governance in Financial and Insurance Groups                       332
               b. Organisational Requirements "At the level of the Group or the
                  Conglomerate"                                                                333
               c. Separation of Powers                                                         337
               d. Fitness and Propriety                                                        339
           3. Structure of the Group or Conglomerate                                           343
           4. Risk Management and Internal Control at the Level of the Group or
               Conglomerate                                                                    343
               a. Risk Management Processes and Internal Control System                        343
               b. Internal Audit                                                               345
               c. Audit Committee                                                              346
    § 2. Reporting on t h e Organisation                                                       348
       I. In Banking Law                                                                       348
           1. Group-wide Reporting                                                             348
           2. Banking Subsidiaries' Reporting                                                  350
       II. In Insurance Law                                                                    3S1


                                                                                               XIII
Table of Contents

              1. Group-wide Reporting                                    351
              2. Insurance Subsidiaries' Reporting                       354
              3. Swiss Quality Assessment                                355
              4. Supervisory Search for Information                      356
       § 3. Drawing Lessons from the Crisis                              357
          I. Refining Risk Management Processes                          357
          II. Upgrading Fitness and Propriety Tests                      358


Part IV
Supervisory Issues                                                       361
Chapter 9
Formal Supervision                                                       363
       § 1.    Preliminary Remarks                                       365
       § 2.    Lead Supervisor and Cooperation                           366
          I.   Issue                                                      366
          II.  International Recommendations                              367
          III. Reforms within the European Union                          368
          IV.  Reforms in Switzerland                                     370
       § 3.    "Too-Big-to-Fail" - Breaking-up Large Banks, Groups and
               Conglomerates ?                                           371
          I. Issue                                                       371
          11. International Discussions                                  371
          111. Switzerland                                               373
 Chapter 10
 Outlook                                                                 375




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