In 2002 the European Parliament passed the Financial Conglomerates Directive (FICOD) (2002/87/EC) to provide for the supervision of conglomerated firms and also promote closer coordination between supervisory authorities for the individual sectors and the exchange of information. The main concern was to ensure that firms consisting of banking and insurance entities would be effectively prudentially regulated. The initial directive was very much concerned with commercial organisations that had a significant amount of activity within the financial sector. It was estimated around 58 large firms throughout Europe would be affected by the directive.
Under the original implemented proposals, the most important financial sector – usually banking or insurance – was deemed to be the one with highest proportion of the firm’s balance sheet. The directive then applied supplementary supervision to the following:
- Any regulated entity at the head of the financial conglomerate.
- Any regulated undertaking which has a parent company that is a mixed holding company with its head office in the EU.
- Any other regulated entity in the financial sector.
The effect being that, if a financial firm is part of a conglomerate, in addition to the usual regulation that it is obliged to adhere to the appropriate holding entities and individual financial entities themselves must also abide by these additional regulations.
At the conglomerate level, firms are obliged to ensure they have adequate capital and are not allowed to have multiple gearing of their own funds. That means the parent company is not allowed to borrow funds in order to capitalise their financial entities. Regulated entities and mixed financial holding companies are required to report on significant concentrations of risk and large intra-group transactions (over 5% of a firm’s capital adequacy requirement). Financial conglomerates must have adequate internal control mechanisms to enable all risks to be measured.
A mixture of supervisory authorities is responsible for ensuring coherent cross-sector and cross- border supervision and compliance. However supervision will be led by a coordinator responsible for supplementary supervision of regulated entities of the conglomerate. His/her responsibilities include the coordination and dissemination of information supervisory overview and assessment, as well as assessing compliance with capital adequacy, concentration and intra-group transactions.
Review and Revision
After the 2008 financial crisis it was found that the measures in the directives did not always work as effectively as planned. A review was undertaken, the results of which were published by the European Commission in December 2011. This review included legislative changes and further guidance and these changes were due to be implemented in all EU states by the 10 June 2013.
The review included three main themes:
- First, the scope of application of FICOD, which considers allowing the supervision of regulated and non-regulated entities that were missing in the original scope. The scope of FICOD has been extended to better cover industrial and other conglomerates that have significant financial activity.
- Second, the requirements and powers concerning internal governance requirements and sanctions. Regulatory supervisors have been given powers concerning non-operating holding companies.
- The third theme concerned supervisory empowerment. It was found that during the crisis many regulators lacked the necessary powers needed to ensure proper prudential supervision of the entire conglomerate.
It should be noted that where there are existing rules concerning the key risks for the conglomerate with regards to capital, concentration or intergroup transactions (for example, Solvency II or the Capital Requirements Directive (CRD)), supervisors are not obliged to further implement FICOD if the risks have been already adequately covered from the view point of the whole conglomerate. That being the case, this directive does introduce supplementary rules rather than additional ones. Also, in the case of non-EU conglomerates, regulatory supervisors need to satisfy themselves that these are under equivalent regimes or other measures are taken to ensure they operate safely within the EU.
The key amendments include:
- Amendments to Solvency II and the CRD, to allow insurance holding companies to be mixed financial holding companies.
- The inclusion of asset management companies as part of the threshold test for a conglomerate.
- The addition of alternative investment funds within the scope of FICOD.
- Waivers for smaller groups on the basis of threshold conditions, and the exclusion of participants based on supervisor assessments.
- A new waiver introduced where a firm’s smallest sector does not exceed €6bn.
- Requirements that comprehensive conglomerate-wide stress testing be out in place.
- Guidelines for specific treatment of participations with regard to concentration risk and intra-group transactions.
Under this directive firms have to reappraise the entire risk and management framework of large and complex organisations from the conglomerate-wide standpoint.
This will be a complex task, for example, insurance concerns with banking interest will need to ensure the banking risks and sensitivities are fully considered. This becomes more challenging when one considers non-financial concerns with significant financial business. On top of the controls process and governance issues, firms also need to have not just a bank, investment firm or insurance firm-wide risk and stress testing framework, but one that allows firms to look at all these frameworks together, including non-financial sector risks where relevant. The challenge is clear, and many firms will have put plans in place to address the needs. For those firms that have systems fully in place and working, the benefits will extend far beyond that of simple compliance.
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