European joint committee highlights chinks in Europe’s financial armour

Banking union more likely, as the Joint Committee of the European Supervisory Authorities publishes its first look at the European financial systems’ vulnerabilities, which include ongoing macroeconomic woes and the fragmentation of the eurozone.

The Joint Committee’s Report on Risks and Vulnerabilities in the European Union’s (EU) Financial System outlined a number of leading threats to the European financial services industry.

Key challenges outlined by the committee were “weak macroeconomic outlook and consequently a deterioration for financial institutions’ asset quality and profitability; the low interest rate environment; risk of further fragmentation of the single market ; increased reliance on collateral; lack of confidence in financial institutions’ balance sheet valuations and risk disclosure; and loss of confidence in financial benchmarks.”

The committee indicated that only a concerted effort by European states would help to diminish the threat posed by European financial vulnerabilities and help resuscitate confidence in the Continent’s financial sector.

The Joint Committee recommended that EU political leaders should press ahead with the formation of a banking union, including a single supervisory mechanism. EIOPA indicated it is committed to supervisory convergence and the development of EU-wide practices.

Bermuda:Re spoke with the team at EIOPA about the committee’s findings and the role of regulatory measures can play in steadying the ship in Europe.

What role can Solvency II play in restoring European confidence in its financial institutions?

The Solvency II framework was designed with the objective of  increasing policyholder protection. It incorporates the latest international developments in risk-based supervision, actuarial science and risk management. The main benefit of Solvency II is that it provides greater risk sensitivity, as well as a completely different way of looking at, and managing, the risks faced by insurers. Besides this, among the other benefits of Solvency II are such important elements as enhanced group supervision; use of (partial) internal models and undertaking specific parameters; common reporting framework; reliable disclosure; enhanced protection of consumers; international competitiveness of EU undertakings and financial stability.

How damaging have delays to the Solvency II process been?

The current regime (Solvency I) lacks risk sensitivity, restricts the proper functioning of the single market, includes sub-optimal arrangements for the supervision of groups and does not ensure accurate and timely intervention of supervisors. Solvency I also does not properly capture a number of key risks including significant market and credit risk as  reflected in EIOPA Risk Dashboard of September 2012. Furthermore, the Solvency I regime is not forward-looking, contains very few qualitative requirements regarding risk management and governance and does not provide supervisory authorities with adequate information on the undertaking's risks.

If we have to continue supervision on this basis, there is a huge danger that supervisors will not be able to identify and analyse risks correctly and will not be able to take the necessary supervisory actions in time, which may have serious consequences for policyholder protection.

Some re/insurers would argue that greater supervision will act as a drag on their business operations. Is further Europe-wide regulation and coordination the solution to the current woes of the continent?

We need to see things clearly: it is not supervision that has a negative impact on business, but economic reality. Even without the introduction of Solvency II, the problems would persist. The objective of Solvency II is to promote a  better understanding of the risks faced, which in  turn will help companies to better manage these risks and therefore, to make better decisions. This will create benefits for those undertaking the project. For this reason it is crucial to put in place  a risk sensitive system in this economic and financial environment.

Hasn’t Europe-wide regulation that ignores the particular nuances of individual markets proved one of the major stumbling blocks of regimes such as Solvency II? How is EIOPA trying to allay such fears with the banking union and greater regulatory convergence?

There is no perfect regulatory regime and Solvency II is not perfect either. Regulatory systems are based on reference points. We should remember that Solvency II is built upon a European average. So it cannot necessarily reflect exactly the risks of typical British insurers for example. But a clear advantage of Solvency II is that we have - besides the standard formula approach - the possibility for undertakings to use partial models or internal models and also applying specific parameters for the calculation of solvency capital requirements. These models bring capital calculations closer to the risk profile of the undertaking.

The duty of EIOPA is to make sure that the supervisory authorities in all the 27 EU Member States understand the principles of risk based supervision embodied in Solvency II in a convergent way and apply it consistently. That’s why we are developing guidelines for the preparation phase for Solvency II.

The guidelines define areas where we want supervisors to ensure that undertakings are prepared: governance, risk management, pre-application of internal models, elements related to the Own Risk and Solvency Assessment (ORSA), the information to be provided to supervisors. The objective of these guidelines is to help markets and supervisors to have a clear idea of how to prepare for the new regime.

For example, there is a need to prepare the systems and processes that are necessary for participants to deliver high quality data to  supervisors and the market. So by our guidelines we are not anticipating Solvency II, but in order to ensure particpants are in a good shape when Solvency II is applied, we expect national supervisors to start implementing these elements in a consistent way and to request from participants that they prepare themselves in these areas. It is a win-win situation for both companies and supervisors.