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International Association of Risk and Compliance Professionals (IARCP)
1200 G Street NW Suite 800 Washington, DC 20005-6705 USA Tel: 202-449-9750 www.risk-compliance-association.com

Top 10 risk and compliance management related news stories and world events that (for better or for worse) shaped the week's agenda, and what is next

Dear Member, This week I will start from a really

interesting approach to risk management:
“There are essential parts of the valuation framework still under political discussions”

What? Politicians in actuarial roles? Who said that?
The European Insurance and Occupational Pensions Authority (EIOPA) that was established in consequence of the reforms to the structure of supervision of the financial sector in the European Union. This phrase is at the top of the "I wish I had the guts to say it" list for a supervisor. Congratulations EIOPA. Read more at Number 4 below. Welcome to the Top 10 list.

_____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com

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Chairman Ben S. Bernanke

U.S. Monetary Policy and International Implications
At the "Challenges of the Global Financial System: Risks and Governance under Evolving Globalization," A High-Level Seminar sponsored by Bank of Japan-International Monetary Fund, Tokyo, Japan

The new UK Regulator: The Financial Conduct Authority
The Financial Conduct Authority (FCA) will be the new regulator whose vision it is to make markets work well so consumers get a fair deal. It will be responsible for requiring firms to put the well-being of their customers at the heart of how they run their business, promoting effective competition and ensuring that markets operate with integrity. The FCA will start work in 2013, when it will receive new powers from the Financial Services Bill that is currently going through parliament.
_____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com

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Cyber Experts Engage on DARPA’s Plan X
Proposers’ Day dialogue cements program approach When the team behind DARPA’s Plan X mapped out where it wanted to go with research in the development of cyber capabilities and platforms, it knew the DARPA approach to problem solving included soliciting input from the leading experts in the field.

Technical Specifications for the Solvency II valuation and Solvency Capital Requirements calculations (Part I)
This technical specification is a working document proposed by EIOPA to be used by insurance and reinsurance undertakings participating in any quantitative assessment to be undertaken until new update is available.

International Association of Insurance Supervisors

IAIS Releases Proposed Policy Measures for Global Systemically Important Insurers

Public consultation to continue through 16 December 2012 Basel – The International Association of Insurance Supervisors (IAIS) today released its proposed policy measures for global systemically important insurers, or G-SIIs.

_____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com

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President's Summary of Outcomes from the Experts’ meeting on Corruption
The Financial Action Task Force (FATF) convened, in collaboration with the G20 Anti-Corruption Working Group, an Experts Meeting on Corruption.

Lim Hng Kiang: What’s next for hedge funds?
Keynote address by Mr Lim Hng Kiang, Minister for Trade and Industry and Deputy Chairman of the Monetary Authority of Singapore, at the SkyBridge Alternative (SALT) Conference, Marina Bay Sands

Gill Marcus: Why education is important to the South African Reserve Bank
Address by Ms Gill Marcus, Governor of the South African Reserve Bank, at the Partners in Performance 2012 Celebration Lunch at the Maths Centre, Braamfontein
_____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com

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Andrew G Haldane: The Bank and the banks

Speech by Mr Andrew G Haldane, Executive Director, Financial Stability, Bank of England, at Queen’s University, Belfast

Proposal for a Directive of the European Parliament and of the Council on criminal sanctions for insider dealing and market manipulation (MAD)
State of play and orientation debate

_____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com

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Chairman Ben S. Bernanke At the "Challenges of the Global Financial System: Risks and Governance under Evolving Globalization," A High-Level Seminar sponsored by Bank of Japan-International Monetary Fund, Tokyo, Japan

U.S. Monetary Policy and International Implications
Thank you. It is a pleasure to be here. This morning I will first briefly review the U.S. and global economic outlook. I will then discuss the basic rationale underlying the Federal Reserve's recent policy decisions and place these actions in an international context.

U.S. and Global Outlook
The U.S. economy has faced significant headwinds, and, although the economy has been expanding since mid-2009, the pace of our recovery has been frustratingly slow. The headwinds include the effects of deleveraging by households, the still-weak U.S. housing market, tight credit conditions in some sectors, spillovers from the situation in Europe, fiscal contraction at all levels of government, and concerns about the medium-term U.S. fiscal outlook. In this environment, households and businesses have been quite cautious in increasing spending. Accordingly, the pace of economic growth has been insufficient to support significant improvement in the job market; indeed, the unemployment rate, at 7.8 percent, is well above what we judge to be its long-run normal level.
_____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com

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With large and persistent margins of resource slack, U.S. inflation has generally been subdued despite periodic fluctuations in commodity prices. Consumer price inflation is running somewhat below the Federal Reserve's 2 percent longer-run objective, and survey- and market-based measures of longer-term inflation expectations have remained well anchored. The global economic outlook also presents many challenges, as you know. Fiscal and financial strains have pushed Europe back into recession. Japan's economy is recovering from last year's tragic earthquake and tsunami, and it continues to struggle with deflation and persistent weak demand. And in the emerging market economies, the rapid snap-back from the global financial crisis has given way to slower growth in the face of weak export demand from the advanced economies. The soft tone of global activity is yet another headwind for the U.S. economy. Looking ahead, economic projections of Federal Open Market Committee (FOMC) participants prepared for the Committee's September meeting called for the economic recovery to proceed at a moderate pace in coming quarters, with the unemployment rate declining only gradually. FOMC participants generally expected that inflation was likely to run at or below the Committee's inflation goal of 2 percent over the next few years. The Committee also judged that there were significant downside risks to this outlook, importantly including the potential for an intensification of strains in Europe and an associated slowing in global growth.
_____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com

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Federal Reserve's Recent Policy Actions
All of the Federal Reserve's monetary policy decisions are guided by our dual mandate to promote maximum employment and stable prices. With the disappointing progress in job markets and with inflation pressures remaining subdued, the FOMC has taken several important steps this year to provide additional policy accommodation. In January, the Committee noted that it anticipated that economic conditions were likely to warrant exceptionally low levels of the federal funds rate at least through late 2014--a year and a half later than in previous statements. In June, policymakers decided to continue through year-end the maturity extension program (MEP), under which the Federal Reserve purchases long-term Treasury securities and sells short-term ones to help depress long-term yields. At its September meeting, with the data continuing to signal weak labor markets and no signs of significant inflation pressures, the FOMC decided to take several additional steps to provide policy accommodation. It extended the period over which it expects to maintain exceptionally low levels of the federal funds rate from late 2014 to mid-2015. Moreover, the Committee clarified that it expects to maintain a highly accommodative stance of monetary policy for a considerable period after the economic recovery strengthens. The FOMC coupled these changes in forward guidance with additional asset purchases, announcing that it will purchase agency mortgage-backed securities (MBS) at a pace of $40 billion per month, on top of the $45 billion in monthly purchases of long-term Treasury securities planned for the remainder of this year under the MEP.

_____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com

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The FOMC also indicated that it would continue to purchase agency MBS, undertake additional asset purchases, and employ other tools as appropriate until the outlook for the labor market improves substantially in a context of price stability. The open-ended nature of these new asset purchases, together with their explicit conditioning on improvements in labor market conditions, will provide the Committee with flexibility in responding to economic developments and instill greater public confidence that the Federal Reserve will take the actions necessary to foster a stronger economic recovery in a context of price stability. An easing in financial conditions and greater public confidence should help promote more rapid economic growth and faster job gains over coming quarters. As I have said many times, however, monetary policy is not a panacea. Although we expect our policies to provide meaningful help to the economy, the most effective approach would combine a range of economic policies and tackle longer-term fiscal and structural issues as well as the near-term shortfall in aggregate demand. Moreover, we recognize that unconventional monetary policies come with possible risks and costs; accordingly, the Federal Reserve has generally employed a high hurdle for using these tools and carefully weighs the costs and benefits of any proposed policy action.

International Aspects of Federal Reserve Asset Purchases
Although the monetary accommodation we are providing is playing a critical role in supporting the U.S. economy, concerns have been raised about the spillover effects of our policies on our trading partners. In particular, some critics have argued that the Fed's asset purchases, and accommodative monetary policy more generally, encourage capital flows to emerging market economies.
_____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com

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These capital flows are said to cause undesirable currency appreciation, too much liquidity leading to asset bubbles or inflation, or economic disruptions as capital inflows quickly give way to outflows. I am sympathetic to the challenges faced by many economies in a world of volatile international capital flows. And, to be sure, highly accommodative monetary policies in the United States, as well as in other advanced economies, shift interest rate differentials in favor of emerging markets and thus probably contribute to private capital flows to these markets. I would argue, though, that it is not at all clear that accommodative policies in advanced economies impose net costs on emerging market economies, for several reasons. First, the linkage between advanced-economy monetary policies and international capital flows is looser than is sometimes asserted. Even in normal times, differences in growth prospects among countries--and the resulting differences in expected returns--are the most important determinant of capital flows. The rebound in emerging market economies from the global financial crisis, even as the advanced economies remained weak, provided still greater encouragement to these flows. Another important determinant of capital flows is the appetite for risk by global investors. Over the past few years, swings in investor sentiment between "risk-on" and "risk-off," often in response to developments in Europe, have led to corresponding swings in capital flows. All told, recent research, including studies by the International Monetary Fund, does not support the view that advanced-economy monetary policies are the dominant factor behind emerging market capital flows.
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Consistent with such findings, these flows have diminished in the past couple of years or so, even as monetary policies in advanced economies have continued to ease and longer-term interest rates in those economies have continued to decline. Second, the effects of capital inflows, whatever their cause, on emerging market economies are not predetermined, but instead depend greatly on the choices made by policymakers in those economies. In some emerging markets, policymakers have chosen to systematically resist currency appreciation as a means of promoting exports and domestic growth. However, the perceived benefits of currency management inevitably come with costs, including reduced monetary independence and the consequent susceptibility to imported inflation. In other words, the perceived advantages of undervaluation and the problem of unwanted capital inflows must be understood as a package--you can't have one without the other. Of course, an alternative strategy--one consistent with classical principles of international adjustment--is to refrain from intervening in foreign exchange markets, thereby allowing the currency to rise and helping insulate the financial system from external pressures. Under a flexible exchange-rate regime, a fully independent monetary policy, together with fiscal policy as needed, would be available to help counteract any adverse effects of currency appreciation on growth. The resultant rebalancing from external to domestic demand would not only preserve near-term growth in the emerging market economies while supporting recovery in the advanced economies, it would redound to everyone's benefit in the long run by putting the global economy on a more stable and sustainable path.

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Finally, any costs for emerging market economies of monetary easing in advanced economies should be set against the very real benefits of those policies. The slowing of growth in the emerging market economies this year in large part reflects their decelerating exports to the United States, Europe, and other advanced economies. Therefore, monetary easing that supports the recovery in the advanced economies should stimulate trade and boost growth in emerging market economies as well. In principle, depreciation of the dollar and other advanced-economy currencies could reduce (although not eliminate) the positive effect on trade and growth in emerging markets. However, since mid-2008, in fact, before the intensification of the financial crisis triggered wide swings in the dollar, the real multilateral value of the dollar has changed little, and it has fallen just a bit against the currencies of the emerging market economies.

Conclusion
To conclude, the Federal Reserve is providing additional monetary accommodation to achieve its dual mandate of maximum employment and price stability. This policy not only helps strengthen the U.S. economic recovery, but by boosting U.S. spending and growth, it has the effect of helping support the global economy as well. Assessments of the international impact of U.S. monetary policies should give appropriate weight to their beneficial effects on global growth and stability.

_____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com

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The new UK Regulator: The Financial Conduct Authority
The Financial Conduct Authority (FCA) will be the new regulator whose vision it is to make markets work well so consumers get a fair deal. It will be responsible for requiring firms to put the well-being of their customers at the heart of how they run their business, promoting effective competition and ensuring that markets operate with integrity. The FCA will start work in 2013, when it will receive new powers from the Financial Services Bill that is currently going through parliament. The Journey to the FCA sets out how we will approach our regulatory objectives, how we intend to achieve a fair deal in financial services for consumers and where we are on this journey.

Changes to authorisations
The UK regulatory structure will be changing in 2013, when the FSA will split into two regulatory bodies the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA).
_____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com

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In April 2012, Supervision adopted the internal-twin peaks structure, and now Authorisations are implementing a similar structure, with assessments carried out by both the Prudential Business Unit (PBU) and the Conduct Business Unit (CBU). This change will only affect firms that will be dual regulated in future. The application submission process will not change and we will continue to seek to meet our statutory deadlines. What will change is how the application is processed internally. There will be a CBU case officer and a PBU supervisor responsible for each application and they will coordinate to minimise duplication or the impact on applicant firms and individuals. The final decision will need to be agreed by both the PBU and the CBU to ensure a single FSA decision during transition to the new regulatory structure. These changes will allow us to start to deliver, as far as possible, a model that will mirror the future authorisation procedures in the PRA and the FCA.

What is happening to the FSA Handbook?
At legal cutover, the FSA Handbook will be split between the FCA and the PRA to form two new Handbooks, one for the PRA and one for the FCA. Most provisions in the FSA Handbook will be incorporated into the PRA’s Handbook, the FCA’s Handbook, or both, in line with each new regulator’s set of responsibilities and objectives. Users of the Handbook will be able to access the following online: 1. The PRA Handbook, displaying provisions which apply to PRA-regulated firms
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2. The FCA Handbook, displaying all provisions which apply to FCA-regulated firms; and 3. To support the transition, a central version which will show the provisions of both Handbooks, with clear labels indicating which regulator applies a provision to firms. The new Handbooks will reflect the new regulatory regime (for example, references to the FSA will be replaced with the appropriate regulator), and in some areas more substantive changes will be made to reflect the existence of the two regulators, their roles and powers. (This is likely to include such aspects as the future processes for permissions, passporting, controlled functions, threshold conditions and enforcement powers.) The more substantive changes will be consulted on before the PRA and the FCA acquire their legal powers. Changes to the FSA Handbook as a result of EU legislation and FSA policy initiatives will continue throughout this work. After acquiring their powers, the FCA and the PRA will amend their own suites of policy material as independent bodies in accordance with the processes laid down in the Financial Services Bill, including cooperation between them and external consultation.

What does this mean for firms?
This approach to the Handbooks for the FCA and the PRA has been planned to ensure a safe transition for firms and the new regulators as the new regime is introduced. Firms will have a new regulator or regulators, and will consequently need to assess how the new Handbooks of these bodies will apply to them. Dual regulated firms will need to look to both the PRA and the FCA Handbooks, and FCA regulated firms to the FCA Handbook.

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When will the changes be in the Handbook?
We expect to publish the new Handbooks before legal cutover. This will allow firms and others time to adjust to the application of the new Handbooks before the FCA and the PRA are fully operational. The new Handbooks will not be available in detail before this. Alongside the publication, we will publish material on how to interpret the application of the Handbooks, where this is not dealt with in the Handbooks themselves. The FSA will continue to make changes to its Handbook in accordance with the normal procedure, until the new bodies acquire their legal powers. The FSA Handbook will remain in force until the FCA and PRA acquire their legal powers.

_____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com

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Launch of the Journey to the FCA
Speech by Martin Wheatley - Managing Director, FSA, and CEO Designate, FCA at the Launch of the Journey to the FCA event Good morning. I would like to thank the Minister Greg Clark for joining us today, for his supportive words – and for demonstrating the Government’s commitment to working alongside us to deliver better conduct regulation. I would also like to thank Thomson-Reuters for hosting this morning. Today is a big step forward on the road to becoming the new regulator, and I am glad that you are all here to join us as we launch the Journey to the FCA. The FCA offers a huge opportunity for the regulator and firms to start afresh, and work in partnership to reset how we deal with conduct in financial services. We see it as the role of the regulator to not only make the relevant markets work well but also to help firms get back to putting their customers at the heart of how they do business. Regulation has a huge impact on the people and businesses that rely on financial services, and we should never forget this. We have approached the creation of the FCA in a thoughtful and considered way, as the document we are sharing with you today shows. We will regulate one of our most successful industries, central to the health of our economy and a provider of two million UK jobs. This makes our job an important one, and it will mean that we carry out our work in a way that is as open and accountable as possible. We spent the summer engaging with consumer organisations, and 500 firms from all areas of financial services, as we developed our thinking on the FCA. This allowed us to gather useful feedback and we will continue this open working in the FCA.
_____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com

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We aim in the Journey to the FCA to demonstrate what our new organisation will mean for the firms we regulate and the consumers we are here to help protect. I encourage you all to read it, and to give us your views. We are clear about the type of regulator we want to become, and we want to work with all of our stakeholders to get there and deliver regulation that works better. You have not yet had a chance to read the document, so let me explain a bit more about what the FCA is going to be about. The FCA has been set up to work with firms to ensure they put consumers at the heart of their business. Underlining this are three outcomes: 1. Consumers get financial services and products that meet their needs from firms they can trust. 2. Firms compete effectively with the interests of their customers and the integrity of the market at the heart of how they run their business. 3. Markets and financial systems are sound, stable and resilient with transparent pricing information. Reforming regulation is not just good for consumers, it will also be good for firms. The industry’s standing has suffered as the mis-selling scandals and other problems have taken their toll. This has damaged the reputation of firms across the industry, whether directly involved or not. We need to work with you to put that right. While much of what we will do is new, we will also build on what has worked well under the FSA. We will keep up our policy of credible deterrence, pursuing enforcement cases to punish wrongdoing. And our markets regulation will continue to promote integrity and carry on the FSA’s fight against insider dealing, which has secured 20 criminal convictions since 2009.
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We will continue to keep unauthorised firms from trying to take advantage of consumers. We will set high expectations for those firms that want to enter financial services, while still allowing innovation and good ideas to flourish. And we will take forward a strong interest in the fair treatment of customers – an agenda that has been around for many years, but is still key to the FCA. There will, however, be important changes, and our approach will be more forward-looking, better informed, and we will have a greater appetite to get things done. A new department will act as the radar of our new organisation – combining better research into what is happening in the market, and analysis of the risks to our objectives. This will then feed into our policymaking and our supervision of firms. We want to really understand what is happening to your customers, the deal they are getting and the issues they face. This will include getting a better understanding of why consumers act in the way they do, so we can adapt our regulation to their common behavioural traits. Fewer firms will have regular direct contact with supervisors, as we shift resources to allow us to deal more quickly and effectively with emerging issues, and run more cross-industry projects to get to the root cause of problems. We will have new partners to work with and our relationship with the new Prudential Regulation Authority will be crucial, and driven by a culture of cooperation. We will aim to bring our expertise to international debates, so that EU and international policymaking works for UK consumers and firms. All of this will be delivered by a new culture in the FCA. We will encourage our staff to be more confident in making bold, firm and predictable decisions.
_____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com

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To help us do our job, the Government intends to give the FCA new tools to ensure that consumers get products that meet their needs. This builds on one of the key lessons from past problems, which is that regulation is often more effective if it steps in early to pre-empt and prevent widespread harm. We will reflect this in our supervision work when we look at how firms design and sell their products. But a key new power will mean that we can step in and ban the sale of products that pose unacceptable risks to consumers for up to 12 months, without consulting first. We will also be able to ban misleading advertising. We will use these new tools in a measured way – and while we will act sooner, and more decisively, our approach will be based on a proper understanding of the issues and a full consideration of the potential solutions. So whilst there may be times when we have to act rapidly, this is not something that firms should be afraid of. Firms selling the right products, in the right way, to the right consumers have little to fear. Our new approach will mean that we will take competition into account in all our work. We will weigh up the impact on competition of new measures we propose. We will also consider whether competition could lead to better results than other action we could take. In our work here, and in other areas, I am very conscious that we have to work with firms. Making regulation work better for us is also about allowing firms room to try new ideas and develop their business. Promoting competition will play an important part in this.
_____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com

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We are not here to stand in the way of progress that will be of benefit to consumers. Our goals as the FCA are clear: we will work for an industry that is better at serving the needs of its customers. I see this as an opportunity – not just for us but for the industry. We can do our job better if we work with you, and I am pleased that so many of the chief executives that I speak to are talking the same language and have committed to rebuilding confidence and trust, and reconnecting with their customers. It is great hearing about these good intentions, but the difficult bit for us all is to make sure this change actually happens. There are challenges and opportunities for both us the regulator, and you the industry. It is a journey we have to walk together, as we put consumers back at the heart of what we do.

_____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com

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Cyber Experts Engage on DARPA’s Plan X
Proposers’ Day dialogue cements program approach When the team behind DARPA’s Plan X mapped out where it wanted to go with research in the development of cyber capabilities and platforms, it knew the DARPA approach to problem solving included soliciting input from the leading experts in the field. On October 15 and 16, DARPA outlined its plans for Plan X to a packed house of potential developers and performers and solicited their feedback. More than 350 software engineers, cyber researchers and human-machine interface experts attended the event. DARPA officials presented the goals of Plan X in preparation for release of the program’s Broad Agency Announcement (BAA)—anticipated within the next month. Plan X, announced in May 2012, is the first DARPA program of its kind. It will attempt to create revolutionary technologies for understanding, planning and managing DoD cyber missions in real-time, large-scale and dynamic network environments. Plan X will conduct novel research on the cyber domain. The Plan X program is explicitly not funding research and development efforts in vulnerability analysis or generation of cyberweapons. “Insights obtained from discussions with government partners and potential performers during the Proposers’ Day workshop will help us finalize our approach to the Plan X program,” said Dan Roelker, DARPA program manager.
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“The program covers largely unchartered territory as we attempt to formalize cyber mission command and control for the DoD.”

It is anticipated that the BAA for this effort will be posted to www.fbo.gov within the next month.

_____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com

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Technical Specifications for the Solvency II valuation and Solvency Capital Requirements calculations (Part I) Note
This technical specification is a working document proposed by EIOPA to be used by insurance and reinsurance undertakings participating in any quantitative assessment to be undertaken until new update is available. As there are essential parts of the valuation framework still under political discussions, i.e. the discount rates for the technical provisions calculations, this document is not intended to be a complete set of technical specifications for the Solvency 2 balance sheet valuation nor for the Solvency Capital Requirements calculations. Howsoever these essential parts are not included at this stage but will follow in due course. Not even when the specification of discount rates for TP calculations are finally added, the resulting technical specifications should be seen as a complete implementation of the Solvency II framework, since for the purpose of feasibility of testing exercises, shortcuts and ad hoc simplifications have been included. In particular, relevant parts of the SCR calculation such as internal models section, undertaking specific parameters section and within the group section: the combination method, the treatment of Participations, Ring Fenced funds and internal model for group calculation have been deliberately not included in the current technical specifications, as these were not considered by EIOPA as providing key information for the purposes of the quantitative tests that may be launched in the coming months.
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However, this should not be interpreted as an EIOPA speculation on its inclusion in the final Solvency II framework. This technical specification is inspired by the knowledge that EIOPA has on the current status of the negotiations on Omnibus 2 Directive, the working documents on implementing measures and its own work in the development of Technical Standards and Guidelines. EIOPA plans to incorporate the relevant elements of the technical provisions valuation, once the outcome of the OMDII negotiations is stabilised.

Important parts IAS 39 Financial Instruments: Recognition and Measurement
IAS 39 establishes principles for recognising and measuring financial assets, financial liabilities and some contracts to buy or sell non-financial items. For the purpose of measuring a financial asset after initial recognition, this Standard classifies financial assets into the following four categories defined in paragraph 9: (a) Financial assets at fair value through profit or loss; (b) Held-to-maturity investments; (c) Loans and receivables; and (d) Available-for-sale financial assets. These categories apply to measurement and profit or loss recognition under this Standard. The entity may use other descriptors for these categories or other categorisations when presenting information in the financial statements.
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After initial recognition, an entity shall measure financial assets, including derivatives that are assets, at their fair values, without any deduction for transaction costs it may incur on sale or other disposal, except for the following financial assets: (a) Loans and receivables, which shall be measured at amortised cost using the effective interest method (b) Held-to-maturity investments, which shall be measured at amortised cost using the effective interest method (c) Investments in equity instruments that do not have a quoted market price in an active market and whose fair value cannot be reliably measured and derivatives that are linked to and must be settled by delivery of such unquoted equity instruments, which shall be measured at cost. Solvency II framework: Fair value measurement principles are considered to be consistent with article 75 of Directive 2009/138/EC, except for subsequent adjustments to take account of the change in own credit standing of the insurance or reinsurance undertaking after initial recognition in the measurement of financial liabilities.

Technical Provisions Introduction
TP.1.1. The reporting date to be used by all participants should be 30 June. TP.1.2. Solvency II requires undertakings to set up technical provisions which correspond to the current amount undertakings would have to pay if they were to transfer their (re)insurance obligations immediately to another undertaking. The value of technical provisions should be equal to the sum of a best estimate and a risk margin.
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However, under certain conditions that relate to the replicability of the cash flows underlying the (re)insurance obligations, best estimate and risk margin should not be valued separately but technical provisions should be calculated as a whole. TP.1.3. Undertakings should segment their (re)insurance obligations into homogeneous risk groups, and as a minimum by line of business, when calculating technical provisions TP.1.4. The best estimate should be calculated gross, without deduction of the amounts recoverable from reinsurance contracts and SPVs. Those amounts should be calculated separately. TP.1.5. The calculation of the technical provisions should take account of the time value of money by using the relevant risk-free interest rate term structure. TP.1.6. The actuarial and statistical methods to calculate technical provisions should be proportionate to the nature, scale and complexity of the risks supported by the undertaking.

V.2.1. Segmentation General principles
TP.1.7. Insurance and reinsurance obligations should be segmented as a minimum by line of business (LoB) in order to calculate technical provisions. TP.1.8. The purpose of segmentation of (re)insurance obligations is to achieve an accurate valuation of technical provisions. For example, in order to ensure that appropriate assumptions are used, it is important that the assumptions are based on homogenous data to avoid introducing distortions which might arise from combining dissimilar business.

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Therefore, business is usually managed in more granular homogeneous risk groups than the proposed minimum segmentation by lines of business where it allows for a more accurate valuation of technical provisions. TP.1.9. Undertakings in different Member States and even undertakings in the same Member State offer insurance products covering different sets of risks. Therefore it is appropriate for each undertaking to define the homogenous risk group and the level of granularity most appropriate for their business and in the manner needed to derive appropriate assumptions for the calculation of the best estimate. TP.1.10. (Re)insurance obligations should be allocated to the line of business that best reflects the nature of the risks relating to the obligation. In particular, the principle of substance over form should be followed for the allocation. In other words, the segmentation should reflect the nature of the risks underlying the contract (substance), rather than the legal form of the contract (form). TP.1.11. The segmentation into lines of business distinguishes between life and non-life insurance obligations. This distinction does not coincide with the legal distinction between life and non-life insurance activities or the legal distinction between life and non-life insurance contracts. Instead, the distinction between life and non-life insurance obligations should be based on the nature of the underlying risk: - Insurance obligations of business that is pursued on a similar technical basis to that of life insurance should be considered as life insurance obligations, even if they are non-life insurance from a legal perspective. - Insurance obligations of business that is not pursued on a similar technical basis to that of life insurance should be considered as non-life insurance obligations, even if they are life insurance from a legal perspective.
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TP.1.12. In particular, annuities stemming from non-life insurance contracts (for example for motor vehicle liability insurance) are life insurance obligations. TP.1.13. The segmentation should be applied to both components of the technical provisions (best estimate and risk margin). It should also be applied where technical provisions are calculated as a whole.

Segmentation of non-life insurance and reinsurance obligations
TP.1.14. Non-life insurance obligations should be segmented into the following 12 lines of business:

Medical expenses insurance
This line of business includes obligations which cover the provision of preventive or curative medical treatment or care including medical treatment or care due to illness, accident, disability and infirmity, or financial compensation for such treatment or care, where the underlying business is not pursued on a similar technical basis to that of life insurance, other than obligations considered as workers' compensation insurance;

Income protection insurance
This line of business includes obligations which cover financial compensation in consequence of illness, accident, disability or infirmity where the underlying business is not pursued on a similar technical basis to that of life insurance, other than obligations considered as medical expenses or workers' compensation insurance;

Workers’ compensation insurance
This line of business includes health insurance obligations which relate to accidents at work, industrial injury and occupational diseases and where the underlying business is not pursued on a similar technical basis to that of life insurance covering:
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- the provision of preventive or curative medical treatment or care relating to accident at work, industrial injury or occupational diseases; or - financial compensation for such treatment;
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or financial compensation for accident at work, industrial injury or occupational diseases;

Motor vehicle liability insurance
This line of business includes obligations which cover all liabilities arising out of the use of motor vehicles operating on land (including carrier’s liability);

Other motor insurance
This line of business includes obligations which cover all damage to or loss of land vehicles, (including railway rolling stock);

Marine, aviation and transport insurance
This line of business includes obligations which cover all damage or loss to river, canal, lake and sea vessels, aircraft, and damage to or loss of goods in transit or baggage irrespective of the form of transport. This line of business also includes all liabilities arising out of use of aircraft, ships, vessels or boats on the sea, lakes, rivers or canals (including carrier’s liability).

Fire and other damage to property insurance
This line of business includes obligations which cover all damage to or loss of property other than motor, marine aviation and transport due to fire, explosion, natural forces including storm, hail or frost, nuclear energy, land subsidence and any event such as theft;

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General liability insurance
This line of business includes obligations which cover all liabilities other than those included in motor vehicle liability and marine, aviation and transport;

Credit and suretyship insurance
This line of business includes obligations which cover insolvency, export credit, instalment credit, mortgages, agricultural credit and direct and indirect suretyship;

Legal expenses insurance
This line of business includes obligations which cover legal expenses and cost of litigation;

Assistance insurance
This line of business includes obligations which cover assistance for persons who get into difficulties while travelling, while away from home or while away from their habitual residence;

Miscellaneous financial loss insurance
This line of business includes obligations which cover employment risk, insufficiency of income, bad weather, loss of benefits, continuing general expenses, unforeseen trading expenses, loss of market value, loss of rent or revenue, indirect trading losses other than those mentioned before, other financial loss (not-trading) as well as any other risk of non-life insurance business not covered by the lines of business already mentioned. TP.1.15. Obligations relating to accepted proportional reinsurance should be segmented into 12 lines of business in the same way as non-life insurance obligations are segmented.
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TP.1.16. Obligations relating to accepted non-proportional reinsurance in non-life should be segmented into 4 lines of business as follows: - Health: non-proportional reinsurance obligations relating to insurance obligations included in the following lines: medical expenses, income protection and workers’ compensation. - Property: non-proportional reinsurance obligations relating to insurance obligations included in the following lines: other motor insurance, fire and other damage to property, credit and suretyship, legal expenses, assistance, miscellaneous financial loss. Casualty: non-proportional reinsurance obligations relating to insurance obligations included in the following lines: motor vehicle liability and general liability. - Marine, aviation and transport: non-proportional reinsurance obligations relating to insurance obligations included in the line marine, aviation and transport insurance

Segmentation of life insurance and reinsurance obligations
TP.1.17. Life insurance obligations should be segmented into 6 lines of business.

Health insurance
Health insurance obligations where the underlying business is pursued on a similar technical basis to that of life insurance, other than those included in the following line of business “Annuities stemming from non-life insurance contracts and relating to health insurance obligations”.

Life insurance with profit participation
Insurance obligations with profit participation other than those obligations included in the annuities stemming from non-life insurance contracts.
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Index-linked and unit-linked insurance
Insurance obligations with index-linked and unit-linked benefits other than those included in the annuities stemming from non-life insurance.

Other life insurance
obligations other than obligations included in any of the other life lines of business. Annuities stemming from non-life insurance contracts and relating to health insurance obligations (annuities stemming from non-life contracts and NSLT health insurance). Annuities stemming from non-life insurance contracts and relating to insurance obligations other than health insurance obligations TP.1.18. Obligations relating to accepted reinsurance in life should be segmented into 4 lines of business as follows:

Health reinsurance
Reinsurance obligations which relate to the obligations included in lines of business health insurance and “Annuities stemming from non-life insurance contracts and relating to health insurance obligations”.

Life reinsurance
Reinsurance obligations which relate to the obligations included in lines of business “Life Insurance with profit participation”, “Index-linked and unit-linked insurance”, “Other life insurance” and “Annuities stemming from non-life insurance contracts and relating to insurance obligations other than health insurance obligations”. TP.1.19. There could be circumstances where, for a particular line of business in the segment "life insurance with profit participation"
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(participating business), the insurance liabilities can, from the outset, not be calculated in isolation from those of the rest of the business. For example, an undertaking may have management rules such that bonus rates on one line of business can be reduced to recoup guaranteed costs on another line of business and/or where bonus rates depend on the overall solvency position of the undertaking. However, even in this case undertakings should assign a technical provision to each line of business in a practicable manner.

Health insurance obligations
TP.1.20. Health insurance covers one or both of the following: - The provision of preventive or curative medical treatment or care including medical treatment or care due to illness, accident, disability and infirmity, or financial compensation for such treatment or care; - Financial compensation in consequence of illness, accident, disability or infirmity. TP.1.21. In relation to their technical nature two types of health insurance can be distinguished: - Health insurance which is pursued on a similar technical basis to that of life insurance (SLT Health) - Health insurance which is not pursued on a similar technical basis to that of life insurance (Non-SLT Health) TP.1.22. Health insurance obligations pursued on a similar technical basis to that of life insurance (SLT Health) are the health insurance obligations for which it is appropriate to use life insurance techniques for the calculation of the best estimate. Health insurance obligations should be assigned to life insurance lines of business where such obligations are exposed to biometrical risks (i.e.
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mortality, longevity or disability/morbidity) and where the common techniques used to assess such obligations explicitly take into consideration the behaviour of the variables underlying these risks. Where insurance or reinsurance health obligations are calculated according to the conditions set out in Article 206 of Directive 2009/138/EPC they should be assigned to SLT health insurance lines of business. TP.1.23. SLT health insurance obligations should be allocated to one of the four following lines of business for life insurance obligations defined in subsection V .2.1: - Insurance contracts with profit participation where the main risk driver is disability/morbidity risk - Index-linked and unit-linked life insurance contracts where the main risk driver is disability/morbidity risk - Other insurance contracts where the main risk driver is disability/morbidity risk - Annuities stemming from non-life contracts. TP.1.24. With regard to the line of business for annuities stemming from non-life contracts or health insurance includes only annuities stemming from Non-SLT health contracts (for example workers' compensation and income protection insurance). Insurance or reinsurance obligations that, although stemming from Non-Life or NSLT health insurance, and originally segmented into Non-Life or NSLT health lines of business, as a result of the trigger of an event are pursued on a similar technical basis to that of life insurance, should be assigned to the relevant life lines of business as soon as there is sufficient information to assess those obligations using life techniques. TP.1.25. Non-SLT health obligations should be allocated to one of the three following lines of business for non-life insurance obligations:
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- Medical expense - Income protection - Workers' compensation TP.1.26. The definition of health insurance applied in the Quantitative Assessment may not coincide with national definitions of health insurance used for authorisation or accounting purposes. TP.1.27. The granularity of the segmentation of insurance or reinsurance obligations should allow for an adequate reflection of the nature of the risks. For the purpose of calculation of the technical provisions, the segmentation should consider the policyholder’s right to profit participation, options and guarantees embedded in the contracts and the relevant risk drivers of the obligations.

Unbundling of insurance and reinsurance contracts
TP.1.28. Where a contract includes life and non-life (re)insurance obligations, it should be unbundled into its life and non-life parts. TP.1.29. Where a contract covers risks across the different lines of business for non-life (re)insurance obligations, these contracts should be unbundled into the appropriate lines of business. TP.1.30. A contract covering life insurance risks should always be unbundled according to the following lines of business - SLT - Life insurance with profit participation - Index-linked and unit-linked life insurance - Other life insurance

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TP.1.31. Where a contract gives rise to SLT health insurance obligations, it should be unbundled into a health part and a non-health part where it is technically feasible and where both parts are material. Notwithstanding the above, unbundling may not be required where only one of the risks covered by a contract is material. In this case, the contract may be allocated according to the main risk.

Best estimate V.2.2.1. Methodology for the calculation of the best estimate Appropriate methodologies for the calculation of the best estimate
TP.2.1. The best estimate should correspond to the probability weighted average of future cash-flows taking account of the time value of money. TP.2.2. Therefore, the best estimate calculation should allow for the uncertainty in the future cash-flows. The calculation should consider the variability of the cash flows in order to ensure that the best estimate represents the mean of the distribution of cash flow values. Allowance for uncertainty does not suggest that additional margins should be included within the best estimate. TP.2.3. The best estimate is the average of the outcomes of all possible scenarios, weighted according to their respective probabilities. Although, in principle, all possible scenarios should be considered, it may not be necessary, or even possible, to explicitly incorporate all possible scenarios in the valuation of the liability, nor to develop explicit probability distributions in all cases, depending on the type of risks involved and the materiality of the expected financial effect of the scenarios under consideration.

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Moreover, it is sometimes possible to implicitly allow for all possible scenarios, for example in closed form solutions in life insurance or the chain-ladder technique in non-life insurance. TP.2.4. Cash-flow characteristics that should, in principle and where relevant, be taken into consideration in the application of the valuation technique include the following: a) Uncertainty in the timing, frequency and severity of claim events. b) Uncertainty in claims amounts, including uncertainty in claims inflation, and in the period needed to settle and pay claims. c) Uncertainty in the amount of expenses. d) Uncertainty in the expected future developments that will have a material impact on the cash in- and out-flows required to settle the insurance and reinsurance obligations thereof (e.g. the value of an index/market values used to determine claim amounts). For this purpose future developments shall include demographic, legal, medical, technological, social, environmental and economic developments including inflation. e) Uncertainty in policyholder behaviour. f) Path dependency, where the cash-flows depend not only on circumstances such as economic conditions on the cash-flow date, but also on those circumstances at previous dates. A cash-flow having no path dependency can be valued by, for example, using an assumed value of the equity market at a future point in time. However, a cash-flow with path-dependency would need additional assumptions as to how the level of the equity market evolved (the equity market's path) over time in order to be valued. g) Interdependency between two or more causes of uncertainty. Some risk-drivers may be heavily influenced by or even determined by several other risk-drivers (interdependence).
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For example, a fall in market values may influence the (re)insurance undertaking’s exercise of discretion in future participation, which in turn affects policyholder behaviour. Another example would be a change in the legal environment or the onset of a recession which could increase the frequency or severity of non-life claims. TP.2.5. Undertakings should use actuarial and statistical techniques for the calculation of the best estimate which appropriately reflect the risks that affect the cash-flows. This may include simulation methods, deterministic techniques and analytical techniques. TP.2.6. For certain life insurance liabilities, in particular the future discretionary benefits relating to participating contracts or other contracts with embedded options and guarantees, simulation may lead to a more appropriate and robust valuation of the best estimate liability. TP.2.7. For the estimation of non-life best estimate liabilities as well as life insurance liabilities that do not need simulation techniques, deterministic and analytical techniques can be more appropriate.

Cash-flow projections
TP.2.8. The best estimate should be calculated gross, without deduction of the amounts recoverable from reinsurance contracts and special purpose vehicles. Recoverables from reinsurance and Special Purpose Vehicles should be calculated separately. In the case of co-insurance the cash-flows of each co-insurer should be calculated as their proportion of the expected cash-flows without deduction of the amounts recoverable from reinsurance and special purpose vehicles. TP.2.9. Cash-flow projections should reflect expected realistic future demographic, legal, medical, technological, social or economic developments.
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TP.2.10. Appropriate assumptions for future inflation should be built into the cash-flow projection. Care should be taken to identify the type of inflation to which particular cash-flows are exposed (i.e. consumer price index, salary inflation). TP.2.11. The cash-flow projections, in particular for health insurance business, should take account of claims inflation and any premium adjustment clauses. It may be assumed that the effects of claims inflation and premium adjustment clauses cancel each other out in the cash flow projection, provided this approach undervalues neither the best estimate, nor the risk involved with the higher cash flows after claims inflation and premium adjustment.

Recognition and derecognition of (re)insurance contracts for solvency purposes
TP.2.12. The calculation of the best estimate should only include future cash-flows associated with obligations within the boundary of the contract. TP.2.13. A reinsurance or insurance obligation should be initially recognised by insurance or reinsurance undertakings at whichever is the earlier of the date the undertaking becomes a party to the contract that gives rise to the obligation or the date the insurance or reinsurance cover begins. TP.2.14. A contract should be derecognised as an existing contract only when the obligation specified in the contract is extinguished, discharged or cancelled or expires.

The boundary of an existing (re)insurance contract
TP.2.15. The definition of the contract boundary should be applied in particular to decide whether options to renew the contract, to extend the insurance coverage to another person, to extend the insurance period, to increase the insurance cover or to establish additional insurance cover gives rise to a new contract or belongs to the existing contract.
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Where the option belongs to the existing contract the provisions for policyholder options should be taken into account. TP.2.16. For the purpose of determining which insurance or reinsurance obligations arise in relation to an insurance or reinsurance contract, the boundaries of the contract shall be defined in the following manner: (a) Where the insurance or reinsurance undertaking has at a future date: (i) A unilateral right to terminate the contract, (ii) A unilateral right to reject premiums payable under the contract, or (iii) A unilateral right to amend the premiums or the benefits payable under the contract in such a way that the premiums fully reflect the risks, any obligations which relate to insurance or reinsurance cover which might be provided by the undertaking after that date do not belong to the contract, unless the undertaking can compel the policy holder to pay the premium for those obligations; (b) Where the insurance or reinsurance undertaking has a unilateral right as referred to in point (a) that relates only to a part of the contract, the same principle as defined in point (a) shall be applied to this part; (c) Notwithstanding points (a) and (b), where an insurance or reinsurance contract: (i) Does not provide compensation for a specified uncertain event that adversely affects the insured person, (ii) Does not include a financial guarantee of benefits, any obligations that do not relate to premiums which have already been paid do not belong to the contract, unless the undertaking can compel the policy holder to pay the future premium; (d) Notwithstanding points (a) and (b), where an insurance or reinsurance contract can be unbundled into two parts and where one of these parts meets the requirements set out in points (c)(i) and (ii), any obligations that do not relate to the premiums of that part and which have already been paid do not belong to the contract, unless the undertaking can compel the policy holder to pay future premium of that part; (e) All other obligations relating to the contract, including obligations relating to unilateral rights of the insurance or reinsurance undertaking to
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renew or extend the scope of the contract and obligations that relate to paid premiums, belong to the contract. TP.2.17. Where an insurance or reinsurance undertaking has the unilateral right to amend the premiums or benefits of a portfolio of insurance or reinsurance obligations in such a way that the premiums of the portfolio fully reflect the risks covered by the portfolio, the undertaking's unilateral right to amend the premiums or benefits of those obligations shall be regarded as complying with the condition set out in paragraph TP.2.16(a). TP.2.18. Premiums shall be regarded as fully reflecting the risks covered by a portfolio of insurance or reinsurance obligations, only where there is no scenario under which the amount of the benefits and expenses payable under the portfolio exceeds the amount of the premiums payable under the portfolio; TP.2.19. Notwithstanding paragraph TP.2.17, in the case of life insurance obligations where an individual risk assessment of the obligations relating to the insured person of the contract is carried out at the inception of the contract and that assessment cannot be repeated before amending the premiums or benefits, the assessment of whether the premiums fully reflect the risk in accordance with the condition set out in paragraph 1(a) shall be made at the level of the contract. TP.2.20. For the purpose of points (a) and (b) of paragraph TP.2.16, restrictions of the unilateral right and limitations of the extent by which premiums and benefits can be amended that have no discernible effect on the economics of the contract, shall be ignored. TP.2.21. For the purpose of points (c) and (d) of paragraph TP.2.16, coverage of events and guarantees that have no discernible effect on the economics of the contract, shall be ignored. TP.2.22. Annex D includes several examples that illustrate the application of the definition of the contract boundary.

Time horizon
TP.2.23. The projection horizon used in the calculation of best estimate should cover the full lifetime of all the cash in- and out-flows required to
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settle the obligations related to existing insurance and reinsurance contracts on the date of the valuation, unless an accurate valuation can be achieved otherwise. TP.2.24. The determination of the lifetime of insurance and reinsurance obligations should be based on up-to-date and credible information and realistic assumptions about when the existing insurance and reinsurance obligations will be discharged or cancelled or expired.

Gross cash in-flows
TP.2.25. To determine the best estimate the following non-exhaustive list of cash in-flows should be included: - Future premiums; and - Receivables for salvage and subrogation. TP.2.26. The cash in-flows should not take into account investment returns (i.e. interests earned, dividends…).

Gross cash out-flows
TP.2.27. The cash out-flows could be divided between benefits to the policyholders or beneficiaries, expenses that will be incurred in servicing insurance and reinsurance obligations, and other cash-flow items such as taxation payments which are charged to policyholders.

Benefits
TP.2.28. The benefit cash out-flows (non-exhaustive list) should include: Claims payments Maturity benefits Death benefits Disability benefits Surrender benefits Annuity payments Profit sharing bonuses
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Expenses
TP.2.29. In determining the best estimate, the undertaking should take into account all cash-flows arising from expenses that will be incurred in servicing all recognised insurance and reinsurance obligations over the lifetime thereof. This should include (non-exhaustive list): - Administrative expenses - Investment management expenses - Claims management expenses / handling expenses TP.2.30. Expenses that are pertinent to the valuation of technical provisions would usually include both allocated and overhead expenses. Allocated expenses are those expenses which could be directly assignable to the source of expense that will be incurred in servicing insurance and reinsurance obligations. Overhead expenses comprise all other expenses which the undertaking incurs in servicing insurance and reinsurance obligations. TP.2.31. Overhead expenses include, for example, expenses which are related to general management and service departments which are not directly involved in new business or policy maintenance activities and which are insensitive to either the volume of new business or the level of in-force business. The allocation of overhead expenses to homogeneous risk groups or the premium provisions and the provisions for claims outstanding shall be done in a realistic and objective manner and on a consistent basis over time. The same requirements shall apply to the allocation of overhead expenses to existing and future business. TP.2.32. Administrative expenses are expenses which are connected with policy administration including expenses in respect of reinsurance contracts and special purpose vehicles.
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Some administrative expenses relate directly to insurance contract or contract activity (e.g. maintenance cost) such as cost of premium billing, cost of sending regular information to policyholders and cost of handling policy changes (e.g. conversions and reinstatements). Other administrative expenses relate directly to insurance contracts or contract activity but are a result of activities that cover more than one policy such as salaries of staff responsible for policy administration. TP.2.33. Investment management expenses are usually not allocated on a policy by policy basis but at the level of a portfolio of insurance contracts. Investment management expenses could include expenses of recordkeeping of the investments’ portfolio, salaries of staff responsible for investment, remunerations of external advisers, expenses connected with investment trading activity (i.e. buying and selling of the portfolio securities) and in some cases also remuneration for custodial services. Investment management expenses have to be based on a portfolio of assets appropriate to cover their portfolio of obligations. In case the future discretionary benefits depend on the assets held by the undertaking and for unit-linked contracts the undertaking should ensure that the future investment management expenses allow for the expected changes to the future aforementioned portfolio of assets. In particular, a dynamic expense allowance should be used to reflect a dynamic asset strategy. TP.2.34. Usually investment management expenses differ regarding different assets classes. To ensure that investment management expenses will properly reflect the characteristics of the portfolio, investment management expenses in relation to different assets will be based on existing and predicted future split of assets.

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TP.2.35. Investment management expenses are considered as cash out-flow in the calculation of the best estimate since discounting is made with a yield curve gross of investment expenses. TP.2.36. Claims management expenses are expenses that will be incurred in processing and resolving claims, including legal and adjuster’s fees and internal costs of processing claims payments. Some of these expenses could be assignable to individual claim (e.g. legal and adjuster’s fees), others are a result of activities that cover more than one claim (e.g. salaries of staff of claims handling department). TP.2.37. Acquisition expenses include expenses which can be identified at the level of individual insurance contract and have been incurred because the undertaking has issued that particular contract. These are commission costs, costs of selling, underwriting and initiating an insurance contract that has been issued. TP.2.38. Overhead expenses include salaries to general managers, auditing costs and regular day-to-day costs i.e. electricity bill, rent for accommodations, IT costs. These overhead expenses also include expenses related to the development of new insurance and reinsurance business, advertising insurance products, improvement of the internal processes such as investment in system required to support insurance and reinsurance business (e.g. buying new IT system and developing new software). TP.2.39. Expenses connected with activities which are not linked with servicing insurance and reinsurance obligations are not taken into account when calculating technical provisions. Such expenses could be for example company pension scheme deficits, holding companies’ operational expenses connected with expenses linked to entities which are not insurance or reinsurance undertakings.

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TP.2.40. Undertakings should value and take into account charges for embedded options in the valuation of the technical provisions where possible. For life insurance contracts with embedded options it is rather common that for the cost of the embedded option only a minor charge is made up front and that the remainder is due in an extended period of time. This does not necessarily have to be the total time until maturity and is in general not necessary fixed or known exactly in advance. Charges from embedded options are taken into account in the best estimate valuation of technical provisions and they are kept separately from expense loadings. For example a surrender charge could possibly be seen as a charge to offset the uncollected charges in average, but could also be seen as a way to force the policyholder to continue the contract and hence it would not directly be related to the cost of embedded options. TP.2.41. To the extent that future premiums from existing insurance and reinsurance contracts are taken into account in the valuation of the best estimate, expenses relating to these future premiums should be taken into consideration. TP.2.42. Undertaking should consider their own analysis of expenses and any relevant data from external sources such as average industry or market data. Undertakings should assess the availability of market data on expenses by considering the representativeness of the market data relative to the portfolio and the credibility and reliability of the data. TP.2.43. Where average market information is used, consideration needs to be given as to the representativeness of the data used to form that average.

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For example, market information is not deemed to be sufficiently representative where the market information has material dispersion in representativeness of the portfolios whose data have been used to calculate such market information. The assessment of credibility considers the volume of data underlying the market information. TP.2.44. Assumptions with respect to future expenses arising from commitments made on or prior to the date of valuation have to be appropriate and take into account the type of expenses involved. Undertakings should ensure that expense assumptions allow for future changes in expenses and such an allowance for inflation is consistent with the economic assumptions made. Future expense cash flows are usually assumed to vary with assumed rates of general level of expense inflation in a reasonable manner. TP.2.45. Relevant market data needs to be used to determine expense assumptions which include an allowance for future cost increase. The correlation between inflation rates and interest rates are taken into account. An undertaking needs to ensure that the allowance for inflation is consistent with the economic assumptions made, which could be achieved if the probabilities for each inflation scenario are consistent with probabilities implied by market interest rates. Furthermore, expense inflation must be consistent with the types of expenses being considered (e.g. different levels of inflation would be expected regarding office space rents, salaries of different types of staff, IT systems, medical expenses, etc.). TP.2.46. Any assumptions about the expected cost reduction should be realistic, objective and based on verifiable data and information.
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TP.2.47. For the assessment of the future expenses, undertakings should take into account all the expenses that are directly related to the on-going administration of obligations related to existing insurance and reinsurance contracts, together with a share of the relevant overhead expenses. The share of overheads should be assessed on the basis that the undertaking continues to write further new business. Overhead expenses have to be apportioned between existing and future business based on recent analyses of the operations of the business and the identification of appropriate expense drivers and relevant expense apportionment ratios. Cash flow projections should include, as cash out-flows, the recurrent overheads attributable to the existing business at the calculation date of the best estimate. TP.2.48. In order to determine which expenses best reflect the characteristics of the underlying portfolio and to ensure that the technical provisions are calculated in a prudent, reliable and objective manner, insurance and reinsurance undertakings should consider the appropriateness of both market consistent expenses and undertaking specific expenses. If sufficiently reliable, market consistent expenses are not available participants should use undertaking-specific information to determine expenses that will be incurred in servicing insurance and reinsurance obligations provided that the undertaking-specific information is assessed to be appropriate. TP.2.49. Expenses, that are determined by contracts between the undertaking and third parties have to be taken into account based on the terms of the contract. In particular, commissions arising from insurance contracts have to be considered based on the terms of the contracts between the undertakings and the sales persons, and expenses in respect of reinsurance are taken
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into account based on the contracts between the undertaking and its reinsurers.

Tax payments
TP.2.50. In determining the best estimate, undertakings should take into account taxation payments which are charged to policyholders. Only those taxation payments which are settled by the undertaking need to be taken into account. A gross calculation of the amounts due to policyholders suffices where tax payments are settled by the policyholders; TP.2.51. Different taxation regimes exist across Member States giving rise to a broad variety of tax rules in relation to insurance contracts. The assessment of the expected cash-flows underlying the technical provisions should take into account any taxation payments which are charged to policyholders, or which would be required to be made by the undertaking to settle the insurance obligations. All other tax payments should be taken into account under other balance sheet items. TP.2.52. The following tax payments should be included in the best estimate: transaction-based taxes (such as premium taxes, value added taxes and goods and services taxes) and levies (such as fire service levies and guarantee fund assessments) that arise directly from existing insurance contracts, or that can be attributed to the contracts on a reasonable and consistent basis. Contributions which were already included in companies’ expense assumptions (i.e. levies paid by insurance companies to industry protection schemes) should not be included. TP.2.53. The allowance for tax payments in the best estimate should be consistent with the amount and timing of the taxable profits and losses that are expected to be incurred in the future.
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In cases where changes to taxation requirements are substantially enacted, the pending adjustments should be reflected.

TP.2.54. Homogeneous risk groups of life insurance obligations
The cash-flow projections used in the calculation of best estimates for life insurance obligations shall be made separately for each policy. Where the separate calculation for each policy would be an undue burden on the insurance or reinsurance undertaking, it may carry out the projection by grouping policies, provided that the grouping complies with the following requirements: (1) There are no significant differences in the nature and complexity of the risks underlying the policies that belong to the same group; (2) The grouping of policies does not misrepresent the risk underlying the policies and does not misstate their expenses; (3) The grouping of policies is likely to give approximately the same results for the best estimate calculation as a calculation on a per policy basis, in particular in relation to financial guarantees and contractual options included in the policies. TP.2.55. In certain specific circumstances, the best estimate element of technical provisions may be negative (e.g. for some individual contracts). This is acceptable and undertakings should not set to zero the value of the best estimate with respect to those individual contracts. TP.2.56. No implicit or explicit surrender value floor should be assumed for the amount of the market consistent value of liabilities for a contract. This means that if the sum of a best estimate and a risk margin of a contract is lower than the surrender value of that contract there is no need to increase the value of insurance liabilities to the surrender value of the contract.

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Non-life insurance obligations
TP.2.57. The valuation of the best estimate for provisions for claims outstanding and for premium provisions should be carried out separately. With respect to the best estimate for premium provisions, the cash-flow projections relate to claim events occurring after the valuation date and during the remaining in-force period (coverage period) of the policies held by the undertaking (existing policies). The cash-flow projections should comprise all future claim payments and claims administration expenses arising from these events, cash-flows arising from the ongoing administration of the in-force policies and expected future premiums stemming from existing policies. TP.2.58. The best estimate of premium provisions from existing insurance and reinsurance contracts should be given as the expected present value of future in- and out-going cash-flows, being a combination of, inter alia: - cash-flows from future premiums; - cash-flows resulting from future claims events; - cash-flows arising from allocated and unallocated claims administration expenses; - cash-flows arising from ongoing administration of the in-force policies. There is no need for the listed items to be calculated separately. TP.2.59. With regard to premium provisions, the cash in-flows could exceed the cash out-flows leading to a negative best estimate. This is acceptable and undertakings are not required to set to zero the value of the best estimate.
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The valuation should take account of the time value of money where risks in the remaining period would give rise to claims settlements into the future. TP.2.60. Additionally, the valuation of premium provisions should take account of future policyholder behaviour such as likelihood of policy lapse during the remaining period. TP.2.61. With respect to the best estimate for provisions for claims outstanding, the cash-flow projections relate to claim events having occurred before or at the valuation date – whether the claims arising from these events have been reported or not (i.e. all incurred but not settled claims). The cash-flow projections should comprise all future claim payments as well as claims administration expenses arising from these events. TP.2.62. Where non-life insurance policies give rise to the payment of annuities, the approach laid down in the following subsection on substance over form should be followed. Consistent with this, for premium provisions, its assessment should include an appropriate calculation of annuity obligations if a material amount of incurred claims is expected to give rise to the payment of annuities.

Principle of substance over form
TP.2.63. When discussing valuation techniques for calculating technical provisions, it is common to refer to a distinction between a valuation based on life techniques and a valuation based on non-life techniques. The distinctions between life and non-life techniques are aimed towards the nature of the liabilities (substance), which may not necessarily match the legal form (form) of the contract that originated the liability.

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The choice between life or non-life actuarial methodologies should be based on the nature of the liabilities being valued and from the identification of risks which materially affect the underlying cash-flows. This is the essence of the principle of substance over form. TP.2.64. Traditional life actuarial techniques to calculate the best estimate can be described as techniques that are based on discounted cash-flow models, generally applied on a policy-by-policy basis, which take into account in an explicit manner risk factors such as mortality, survival and changes in the health status of the insured person(s). TP.2.65. On the other hand, traditional non-life actuarial techniques include a number of different approaches. For example some of the most common being: - Methodologies based on the projection of run-off triangles, usually constructed on an aggregate basis; - Frequency/severity models, where the number of claims and the severity of each claim is assessed separately; - Methodologies based on the estimation of the expected loss ratio or other relevant ratios; - Combinations of the previous methodologies; TP.2.66. There is one key difference between life and non-life actuarial methodologies: life actuarial methodologies consider explicitly the probabilities of death, survival, disability and/or morbidity of the insured persons as key parameters in the model, while non-life actuarial methodologies do not. TP.2.67. The choice between life or non-life actuarial methodologies should be based on the nature of the liabilities valued and on the identification of risks which materially affect the underlying cash-flows.
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TP.2.68. In practice, in the majority of cases the form will correspond to the substance. However, for example for certain supplementary covers included in life contracts (e.g. accident) may be better suited for an estimation based on non-life actuarial methodologies. TP.2.69. The following provides additional guidance for the treatment of annuities arising in non-life insurance. The application of the principle of substance over form implies that such liabilities should be valued using methodologies usually applicable to the valuation of life technical provisions, Specifically, guidance is provided in relation to: - the recognition and segmentation of insurance obligations for the purpose of calculating technical provisions (i.e. the allocation of obligations to the individual lines of business); - the valuation of technical provisions for such annuities; and - possible methods for the valuation of technical provisions for the remaining non-life obligations TP.2.70. The treatment proposed in these specifications for annuities should be extended to other types of liabilities stemming from non-life and health insurance whose nature is deemed similar to life liabilities (such as life assistance benefits), taking into consideration the principle mentioned in the previous paragraph.

Allocation to the individual lines of business
TP.2.71. Where non-life and Non-SLT health insurance policies give rise to the payment of annuities such liabilities should be valued using techniques commonly used to value life insurance obligations. Such liabilities should be assigned to the lines of business for annuities stemming from non-life contracts.
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Valuation of annuities arising from non-life and Non-SLT health insurance contracts
TP.2.72. Undertakings should value the technical provisions related to such annuities separately from the technical provisions related to the remaining non-life and health obligations. They should apply appropriate life insurance valuation techniques. The valuation should be consistent with the valuation of life insurance annuities with comparable technical features.

Valuation of the remaining non-life and health insurance obligations
TP.2.73. The remaining obligations in the undertaking’s non-life and Non-SLT health business (which are similar in nature to non-life insurance obligations) have to be valued separately from the relevant block of annuities. TP.2.74. Where provisions for claims outstanding according to national accounting rules are compared to provisions for claims outstanding as calculated above, it should be taken into account that the latter do not include the annuity obligations. TP.2.75. Undertakings may use, where appropriate, one of the following approaches to determine the best estimate of claims provisions for the remaining non-life or health obligations in a given non-life or Non-SLT health insurance line of business where annuities are valued separately.

Separate calculation of non-life liabilities
TP.2.76. Under this approach, the run-off triangle which is used as a basis for the determination of the technical provisions should not include any cash-flows relating to the annuities.

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An additional estimate of the amount of annuities not yet reported and for reported but not yet agreed annuities needs to be added.

Allowance of agreed annuities as single lump-sum payments in the run-off triangle
TP.2.77. This approach also foresees a separate calculation of the best estimate, where the split is between annuities in payment and the remaining obligations. TP.2.78. Under this approach, the run-off triangle which is used as a basis for the determination of the technical provisions of the remaining non-life or health obligations in a line of business does not include any cash-flows relating to the annuities in payment. This means that claims payments for annuities in payment are excluded from the run-off triangle. TP.2.79. However, payments on claims before annuitisation1 and payments at the time of annuitisation remain included in the run-off triangle. At the time of annuitisation, the best estimate of the annuity (valued separately according to life principles) is shown as a single lump-sum payment in the run-off triangle, calculated as at the date of the annuitisation. Where proportionate, approximations of the lump sums could be used. TP.2.80. Where the analysis is based on run-off triangles of incurred claims, the lump sum payment should reduce the case reserves at the date of annuitisation. TP.2.81. On basis of run-off triangles adjusted as described above, the participant may apply an appropriate actuarial reserving method to derive a best estimate of the claims provision of the portfolio.

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Due to the construction of the run-off triangle, this best estimate would not include the best estimate related to the annuities in payment which would be valued separately using life principles (i.e. there would be no “double counting” in relation to the separate life insurance valuation), but it includes a best estimate for not yet reported and for reported but not yet agreed annuities.

Expert judgement
TP.2.82. Insurance and reinsurance undertakings shall choose assumptions based on the expertise of persons with relevant knowledge, experience and understanding of the risks inherent in the insurance or reinsurance business thereof (expert judgment). In certain circumstances expert judgement may be necessary when calculating the best estimate, among other: - in selecting the data to use, correcting its errors and deciding the treatment of outliers or extreme events, - in adjusting the data to reflect current or future conditions, and adjusting external data to reflect the undertaking’s features or the characteristics of the relevant portfolio, - in selecting the time period of the data - in selecting realistic assumptions - in selecting the valuation technique or choosing the most appropriate alternatives existing in each methodology - in incorporating appropriately to the calculations the environment under which the undertakings have to run its business. TP.2.83. In the case of non-life insurance and non-life reinsurance obligations, participants should allocate the expenses into homogenous risk groups, as a minimum by line of business according to the
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segmentation of their obligations used in the calculation of technical provisions. Undertakings should allocate the expenses of non-life insurance and reinsurance obligations to premium provisions and to provisions for claims outstanding.

Obligations in different currencies
TP.2.84. The probability-weighted average cash-flows should take into account the time value of money. The time value of money of future cash-flows in different currencies is calculated using risk-free term structure for relevant currency. Therefore the best estimate should be calculated separately for obligations of different currencies.

Valuation of options and guarantees embedded in insurance contracts
TP.2.85. When calculating the best estimate, insurance and reinsurance undertakings shall identify and take into account: 1. All financial guarantees and contractual options included in their insurance and reinsurance policies; 2. All factors which may materially affect the likelihood that policy holders will exercise contractual options or the value of the option or guarantee.

Definition of contractual options and financial guarantees
TP.2.86. A contractual option is defined as a right to change the benefits2, to be taken at the choice of its holder (generally the policyholder), on terms that are established in advance. Thus, in order to trigger an option, a deliberate decision of its holder is necessary.
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TP.2.87. Some (non-exhaustive) examples of contractual options which are pre-determined in contract and do not require again the consent of the parties to renew or modify the contract include the following: - Surrender value option, where the policyholder has the right to fully or partially surrender the policy and receive a pre-defined lump sum amount; - Paid-up policy option, where the policyholder has the right to stop paying premiums and change the policy to a paid-up status; - Annuity conversion option, where the policyholder has the right to convert a lump survival benefit into an annuity at a pre-defined minimum rate of conversion; - Policy conversion option, where the policyholder has the right to convert from one policy to another at pre-specific terms and conditions; - Extended coverage option, where the policyholder has the right to extend the coverage period at the expiry of the original contract without producing further evidence of health. TP.2.88. A financial guarantee is present when there is the possibility to pass losses to the undertaking or to receive additional benefits as a result of the evolution of financial variables (solely or in conjunction with non-financial variables) (e.g. investment return of the underlying asset portfolio, performance of indices, etc.). In the case of guarantees, the trigger is generally automatic (the mechanism would be set in the policy’s terms and conditions) and thus not dependent on a deliberate decision of the policyholder / beneficiary. In financial terms, a guarantee is linked to option valuation. TP.2.89. The following is a non-exhaustive list of examples of common financial guarantees embedded in life insurance contracts:
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- Guaranteed invested capital - Guaranteed minimum investment return - Profit sharing TP.2.90. There are also non-financial guarantees, where the benefits provided would be driven by the evolution of non-financial variables, such as reinstatement premiums in reinsurance, experience adjustments to future premiums following a favourable underwriting history (e.g. guaranteed no-claims discount). Where these guarantees are material, the calculation of technical provisions should also take into account their value.

Valuation requirements
TP.2.91. For each type of contractual option insurers are required to identify the risk drivers which have the potential to materially affect (directly or indirectly) the frequency of option take-up rates considering a sufficiently large range of scenarios, including adverse ones. TP.2.92. The best estimate of contractual options and financial guarantees must capture the uncertainty of cash-flows, taking into account the likelihood and severity of outcomes from multiple scenarios combining the relevant risk drivers. TP.2.93. The best estimate of contractual options and financial guarantees should reflect both the intrinsic value and the time value. TP.2.94. The best estimate of contractual options and financial guarantees may be valued by using one or more of the following methodologies: - A stochastic approach using for instance a market-consistent asset model (includes both closed form and stochastic simulation approaches);
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- A series of deterministic projections with attributed probabilities; and - A deterministic valuation based on expected cash-flows in cases where this delivers a market-consistent valuation of the technical provision, including the cost of options and guarantees. TP.2.95. For the purposes of valuing the best estimate of contractual options and financial guarantees, a stochastic simulation approach would consist of an appropriate market-consistent asset model for projections of asset prices and returns (such as equity prices, fixed interest rate and property returns), together with a dynamic model incorporating the corresponding value of liabilities (incorporating the stochastic nature of any relevant non-financial risk drivers) and the impact of any foreseeable actions to be taken by management. TP.2.96. For the purposes of the deterministic approach, a range of scenarios or outcomes appropriate to both valuing the options or guarantees and the underlying asset mix, together with the associated probability of occurrence should be set. These probabilities of occurrence should be weighted towards adverse scenarios to reflect market pricing for risk. The series of deterministic projections should be numerous enough to capture a wide range of possible out-comes (and, in particular, it should include very adverse yet possible scenarios) and take into account the probability of each outcome's likelihood (which may, in practice, need to incorporate judgement). The costs will be understated if only relatively benign or limited economic scenarios are considered. TP.2.97. When the valuation of the best estimate of contractual options and financial guarantees is not being done on a policy-by-policy basis, the segmentation considered should not distort the valuation of technical provisions by, for example, forming groups containing policies which are "in the money" and policies which are "out of the money".
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TP.2.98. Regarding contractual options, the assumptions on policyholder behaviour should be appropriately founded in statistical and empirical evidence, to the extent that it is deemed representative of the future expected behaviour. However, when assessing the experience of policyholders’ behaviour appropriate attention based on expert judgements should be given to the fact that when an option is out of or barely in the money, the behaviour of policyholders should not be considered to be a reliable indication of likely policyholders’ behaviour when the options are heavily in-the-money. TP.2.99. Appropriate consideration should also be given to an increasing future awareness of policy options as well as policyholders’ possible reactions to a changed financial position of an undertaking. In general, policyholders’ behaviour should not be assumed to be independent of financial markets, a firm’s treatment of customers or publicly available information unless proper evidence to support the assumption can be observed. TP.2.100. Where material, non-financial guarantees should be treated like financial guarantees.

Valuation of future discretionary benefits
TP.2.101. In calculating the best estimate, undertakings should take into account future discretionary benefits which are expected to be made, whether or not those payments are contractually guaranteed. Undertakings should not take into account payments that relate to surplus funds which possess the characteristics of Tier 1 basic own funds. Surplus funds are accumulated profits which have not been made available for distribution to policyholders and beneficiaries. (Cf. Article 91 of the Solvency II Framework Directive.) TP.2.102. When undertakings calculate the best estimate of technical provisions, the value of future discretionary benefits should be calculated separately.
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TP.2.103. Future discretionary benefits means benefits of insurance or reinsurance contracts which have one of the following characteristics: - The benefits are legally or contractually based on one or several of the following results: - The performance of a specified pool of contracts or a specified type of contract or a single contract; - Realised or unrealised investment return on a specified pool of assets held by the insurance or reinsurance undertaking; - The profit or loss of the insurance or reinsurance undertaking or fund that issues the contract that gives rise to the benefits; - The benefits are based on a declaration of the insurance or reinsurance undertaking and the timing or the amount of the benefits is at its discretion. TP.2.104. Index-linked and unit-linked benefits should not be considered as discretionary benefits. TP.2.105. The distribution of future discretionary benefits is a management action and assumptions about it should be objective, realistic and verifiable. In particular assumptions about the distribution of future discretionary benefits should take the relevant and material characteristics of the mechanism for their distribution into account. TP.2.106. Some examples of characteristics of mechanisms for distributing discretionary benefits are the following. Undertakings should consider whether they are relevant and material for the valuation of future discretionary benefits and take them into account accordingly, applying the principle of proportionality.

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- What constitutes a homogenous group of policyholders and what are the key drivers for the grouping? - How is a profit divided between owners of the undertaking and the policyholders and furthermore between different policyholders? - How is a deficit divided between owners of the undertaking and the policyholders and furthermore between different policyholders? - How will the mechanism for discretionary benefits be affected by a large profit or loss? - How will policyholders be affected by profits and losses from other activities? - What is the target return level set by the firm’s owners on their invested capital? - What are the key drivers affecting the level of discretionary benefits? - What is an expected level (inclusive of any distribution of excess capital, unrealised gains etc.) of discretionary benefits? - How are the discretionary benefits made available for policyholders and what are the key drivers affecting for example the split between reversionary and terminal discretionary benefits, conditionality, changes in smoothing practice, level of discretionary by the undertaking, etc. - How will the experience from current and previous years affect the level of discretionary benefits? - When is an undertaking's solvency position so weak that declaring discretionary benefits is considered by the undertaking to jeopardize a shareholder’s or/and policyholders’ interest? - What other restrictions are in place for determining the level of discretionary benefits?
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- What is an undertaking's investment strategy? - What is the asset mix driving the investment return? - What is the smoothing mechanism if used and what is the interplay with a large profit or loss? - What kind of restrictions are in place in smoothing extra benefits? - Under what circumstances would one expect significant changes in the crediting mechanism for discretionary benefits? - To what extent is the crediting mechanism for discretionary benefits sensitive to policyholders’ actions? TP.2.107. Where the future discretionary benefits depend on the assets held by the undertaking, the calculation of the best estimate should be based on the current assets held by the undertaking. Future changes of the asset allocation should be taken into account according to the requirements on future management actions. TP.2.108. The assumptions on the future returns of these assets, valued according to the subsection V.1, should be consistent with the relevant risk-free interest term structure for the Quantitative Assessment. Where a risk neutral approach for the valuation is used, the set of assumptions on returns of future investments underlying the valuation of discretionary benefits should be consistent with the principle that they should not exceed the level given by the forward rates derived from the risk-free interest rates.

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Assumptions underlying the calculation of the best estimate Assumptions consistent with information provided by financial markets
TP.2.109. Assumptions consistent with information about or provided by financial markets include (non-exhaustive list): - relevant risk-free interest rate term structure, - currency exchange rates, - market inflation rates (consumer price index or sector inflation) and - economic scenario files (ESF). TP.2.110. When undertakings derive assumptions on future financial market parameters or scenarios, they should be able to demonstrate that the choice of the assumptions is appropriate and consistent with the valuation principles set out in subsection V.1; TP.2.111. Where the undertaking uses a model to produce future projections of market parameters (market consistent asset model, e.g. an economic scenario file), such model should comply with the following requirements: i. It generates asset prices that are consistent with deep, liquid and transparent financial markets 4; ii. It assumes no arbitrage opportunity; TP.2.112. The following principles should be taken into account in determining the appropriate calibration of a market consistent asset model:

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a) The asset model should be calibrated to reflect the nature and term of the liabilities, in particular of those liabilities giving rise to significant guarantee and option costs. b) The asset model should be calibrated to the current risk-free term structure used to discount the cash flows. c) The asset model should be calibrated to a properly calibrated volatility measure. TP.2.113. In principle, the calibration process should use market prices only from financial markets that are deep, liquid and transparent. If the derivation of a parameter is not possible by means of prices from deep, liquid and transparent markets, other market prices may be used. In this case, particular attention should be paid to any distortions of the market prices. Corrections for the distortions should be made in a deliberate, objective and reliable manner. TP.2.114. A financial market is deep, liquid and transparent, if it meets the requirements specified in the subsection of these specifications regarding circumstances in which technical provisions should be calculated as a whole. TP.2.115. The calibration of the above mentioned assets models may also be based on adequate actuarial and statistical analysis of economic variables provided they produce market consistent results. For example: a) To inform the appropriate correlations between different asset returns. b) To determine probabilities of transitions between rating classes and default of corporate bonds.
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c) To determine property volatilities. As there is virtually no market in property derivatives, it is difficult to derive property implied volatility. Thus the volatility of a property index may often be used instead of property implied volatility.

Assumptions consistent with generally available data on insurance and reinsurance technical risks
TP.2.116. Generally available data refers to a combination of: - Internal data - External data sources such as industry or market data. TP.2.117. Internal data refers to all data which is available from internal sources. Internal data may be either: - Undertaking-specific data: - Portfolio-specific data: TP.2.118. All relevant available data whether external or internal data, should be taken into account in order to arrive at the assumption which best reflects the characteristics of the underlying insurance portfolio. In the case of using external data, only that which the undertaking can reasonably be expected to have access too should be considered. The extent to which internal data is taken into account should be based on: - The availability, quality and relevance of external data. - The amount and quality of internal data.
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TP.2.119. Where insurance and reinsurance undertakings use data from an external source, they should derive assumptions on underwriting risks that are based on that data according to the following requirements: (a) Undertakings are able to demonstrate that the sole use of data which are available from an internal source are not more suitable than external data; and (b) The origin of the data and assumptions or methodologies used to process them is known to the undertaking and the undertaking is able to demonstrate that these assumptions and methodologies appropriately reflect the characteristics of the portfolio.

Policyholders’ behaviour
TP.2.120. Undertakings are required to identify policyholders’ behaviour. TP.2.121. Any assumptions made by insurance and reinsurance undertakings with respect to the likelihood that policyholders will exercise contractual options, including lapses and surrenders, should be realistic and based on current and credible information. The assumptions should take account, either explicitly or implicitly, of the impact that future changes in financial and non-financial conditions may have on the exercise of those options. TP.2.122. Assumptions about the likelihood that policy holders will exercise contractual options should be based on analysis of past policyholder behaviour. The analysis should take into account the following: (a) How beneficial the exercise of the options was or would have been to the policyholders under past circumstances (whether the option is out of or barely in the money or is in the money), (b) The influence of past economic conditions,
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(c) The impact of past management actions, (d) Where relevant, how past projections compared to the actual outcome, (e) Any other circumstances that are likely to influence a decision whether to exercise the option. TP.2.123. The likelihood that policyholders will exercise contractual options, including lapses and surrenders, should not be assumed to be independent of the elements mentioned in points (a) to (e) in the previous paragraph, unless proper evidence to support such an assumption can be observed or where the impact would not be material. TP.2.124. In general policyholders’ behaviour should not be assumed to be independent of financial markets, of undertaking’s treatment of customers or publicly available information unless proper evidence to support the assumption can be observed. TP.2.125. Policyholder options to surrender are often dependent on financial markets and undertaking-specific information, in particular the financial position of the undertaking. TP.2.126. Policyholders’ option to lapse and also in certain cases to surrender are mainly dependent on the change of policyholders’ status such as the ability to further pay the premium, employment, divorce, etc.

Management actions
TP.2.127. The methods and techniques for the estimation of future cash-flows, and hence the assessment of the provisions for insurance liabilities, should take account of potential future actions by the management of the undertaking. TP.2.128. As examples, the following should be considered: - changes in asset allocation, as management of gains/losses for different asset classes in order to gain the target segregated fund return; management of cash balance and equity backing ratio with the aim of
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maintaining a defined target asset mix in the projection period; management of liquidity according to the asset mix and duration strategy; actions to maintain a stable allocation of the portfolio assets in term of duration and product type, actions for the dynamic rebalancing of the assets portfolio according to movements in liabilities and changes in market conditions; - changes in bonus rates or product changes, for example on policies with profit participation to mitigate market risks; - changes in expense charge, for example related to guarantee charge, or related to an increased charging on unit-linked or index-linked business; TP.2.129. The assumptions on future management actions used in the calculation of the technical provisions should be determined in an objective manner. TP.2.130. Assumed future management actions should be realistic and consistent with the insurance or reinsurance undertaking’s current business practice and business strategy unless there is sufficient current evidence that the undertaking will change its practices. TP.2.131. Assumed future management actions should be consistent with each other. TP.2.132. Insurance and reinsurance undertakings should not assume that future management actions would be taken that would be contrary to their obligations towards policyholders and beneficiaries or to legal provisions applicable to the insurance and reinsurance undertakings. The assumed future management actions should take account of any public indications by the insurance or reinsurance undertaking as to the actions that it would expect to take, or not take in the circumstances being considered. TP.2.133. Assumptions about future management actions should take account of the time needed to implement the management actions and any expenses caused by them.
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TP.2.134. Insurance and reinsurance undertakings should be able to verify that assumptions about future management actions are realistic through a comparison of assumed future management actions with management actions actually taken previously by the insurance or reinsurance undertaking.

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International Association of Insurance Supervisors

IAIS Releases Proposed Policy Measures for Global Systemically Important Insurers

Public consultation to continue through 16 December 2012 Basel – The International Association of Insurance Supervisors (IAIS) today released its proposed policy measures for global systemically important insurers, or G-SIIs. The paper was endorsed for consultation by the Financial Stability Board (FSB), which is coordinating the overall project to reduce the moral hazard posed by global systemically important financial institutions. Supervisors, insurers and other interested parties are encouraged to submit comments on the proposed policy measures through 16 December. “These proposed policy measures are intended to reduce moral hazard and the negative externalities stemming from the potential disorderly failure posed by a G-SII,” said Peter Braumüller, Chair of the IAIS Executive Committee. “Each of the proposed policy measures has also been designed to take account of the specific nature of the insurance business model and is the result of intensive and thorough discussion at the IAIS.” The IAIS has proposed a framework of policy measures for G-SIIs based upon the general framework published by the FSB with adjustments that, as with the proposed assessment methodology, reflect the factors that make insurers different from other financial institutions. The proposal consists of three main types of measures:

1. Enhanced Supervision.
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These measures build on the IAIS Insurance Core Principles and the FSB’s Supervisory Intensity and Effectiveness recommendations and include the development of a Systemic Risk Reduction Plan and enhanced liquidity planning and management.

2. Effective Resolution.
Based on the FSB’s Key Attributes of Effective Resolution Regimes for Financial Institutions, which include the establishment of Crisis Management Groups, the elaboration of recovery and resolution plans, the conduct of resolvability assessments, and the adoption of institution-specific cross-border cooperation agreements. The IAIS proposals take account of the specificities of insurance through the inclusion of plans for separating non-traditional, non-insurance (NTNI) activities from traditional insurance activities, the potential use of portfolio transfers and run-off arrangements, and the recognition of existing policyholder protection and guarantee schemes.

3. Higher Loss Absorption (HLA) Capacity.
This proposal utilises a cascading approach. In the first step if, and to the extent to which, the G-SII has demonstrated effective separation of NTNI activities from traditional insurance activities, targeted HLA will be applied to the separate entities. Under the second step, whether or not NTNI activities have been separated, an overall assessment of group-wide HLA needed will be undertaken and the group wide supervisor will determine whether the HLA capacity held at the NTNI entities is sufficient or needs to be further increased.

About the IAIS:
The IAIS is a global standard setting body whose objectives are to promote effective and globally consistent regulation and supervision of the insurance industry in order to develop and maintain fair, safe and
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stable insurance markets for the benefit and protection of policyholders; and to contribute to global financial stability. Its membership includes insurance regulators and supervisors from over 190 jurisdictions in some 140 countries. More than 120 organisations and individuals representing professional associations, insurance and reinsurance companies, international financial institutions, consultants and other professionals are Observers.

Global Systemically Important Insurers: Proposed Policy Measures Public Consultation Document Comments due by 16 December 2012 Cover note
The global financial crisis underscored the interconnected nature of financial firms and the severe financial and economic costs associated with public sector interventions for those that were distressed or expected to fail. It also underscored the need to act promptly and proactively to identify firms that are systemically important and to take measures to lessen the impact and reduce the moral hazard associated with the failure of such firms. As such, the International Association of Insurance Supervisors (IAIS) is participating in a global initiative, along with other standard setters, central banks and financial sector supervisors, and under the purview of the Financial Stability Board (FSB) and G20, to identify global systemically important financial institutions (G-SIFIs). The focus of IAIS analysis is in relation to potential global systemically important insurers (G-SIIs).
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Earlier this year, the IAIS developed an assessment methodology to identify any insurers whose distress or disorderly failure, because of their size, complexity and interconnectedness, would cause significant disruption to the global financial system and economic activity. The IAIS has now developed a framework of policy measures that should be applied to insurers that are determined to be G-SIIs. Interested parties may wish to consult relevant background papers which are available on the IAIS, FSB and Basel Committee on Banking Supervision (Basel Committee) websites, including the IAIS’ report Insurance and Financial Stability. Other key papers include: • The IMF/FSB/Bank for International Settlements (BIS) staff report submitted to the G20 Finance Ministers and Central Bank Governors entitled Guidance to Assess the Systemic Importance of Financial Institutions, Markets and Instruments (October 2009); • The FSB’s recommendations on Reducing the moral hazard posed by systemically important financial institutions (SIFIs) (October 2010); • The Basel Committee framework for identifying global systemically important banks (G-SIBs) and requirements for additional loss absorbency for G-SIBs (November 2011); and • The determination of the first cohort of G-SIBs (November 2011). All comments will be published on the IAIS website, unless a specific request is made for comments to remain confidential.

Glossary of abbreviations
BCBS Basel Committee on Banking Supervision (also Basel Committee) BIS Bank for International Settlements
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CDS Credit Default Swap ComFrame IAIS Common Framework for the Supervision of Internationally Active Insurance Groups CMGs Crisis Management Groups FSB Financial Stability Board G-SIBs Global Systemically Important Banks G-SIFIs Global Systemically Important Financial Institutions G-SIIs Global Systemically Important Insurers G20 Group of Twenty Countries HLA Higher Loss Absorbency or Higher Loss Absorption capacity IAIGs Internationally Active Insurance Groups IAIS International Association of Insurance Supervisors ICPs IAIS Insurance Core Principles IGT Intra-group Transactions ISDA International Swaps and Derivatives Association Key Attributes FSB’s Key Attributes for Effective Resolution Regimes MCR Minimum Capital Requirement NTNI Non-traditional Insurance and Non-insurance activities PCR Prescribed Capital Requirement RRPs Recovery and Resolution Plans
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SIFIs Systemically Important Financial Institutions SRRP Systemic Risk Reduction Plan

Executive Summary FSB framework for G-SIFIs
The Financial Stability Board (FSB) framework for reducing the moral hazard and risk to the global financial system posed by systemically important financial institutions (SIFIs) recommends several policies which should combine to: • Apply more intensive and co-ordinated supervision of SIFIs, • Improve the authorities’ ability to resolve SIFIs in an orderly manner without destabilising the financial system and exposing the taxpayer to the risk of loss, • Require higher loss absorption (HLA) capacity for SIFIs to reflect the greater risks that these institutions pose to the global financial system, • Provide other supplementary prudential and other requirements as determined by the national authorities.

Policy measures proposed by IAIS
The IAIS proposes a framework of policy measures for G-SIIs in line with the FSB recommendations. Measures will often require strong cooperation among authorities, including authorities with responsibility for non-insurance entities.

i) Enhanced supervision
The foundation for G-SII policy measures is the existing IAIS Insurance Core Principles (ICPs).
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The FSB’s “Supervisory Intensity and Effectiveness” recommendations (SIE recommendations) would form the basis of the IAIS’ approach to enhanced supervision. In addition, the IAIS Common Framework for the Supervision of Internationally Active Insurance Groups (ComFrame) will aim to foster global convergence of regulatory and supervisory measures and approaches for Internationally Active Insurance Groups (IAIGs), whether or not they are identified as G-SIIs, although ComFrame is not expected to directly focus on addressing systemic risk. For G-SIIs, the supervisor should have direct powers over holding companies to ensure that a direct approach to consolidated group-wide supervision can be applied. Special attention should be paid to group-wide supervision since G-SIIs are most likely to take the form of a group and NTNI (non-traditional and non-insurance) activities are often carried out by separate entities within a group and/or the group may have significant interconnections to other parts of the financial system. The supervisor should require G-SIIs to have, in particular, adequate arrangements in place to deal with liquidity risk management for the whole group, primarily for the NTNI business, but secondarily also for the remainder of the G-SII. The authorities should analyse activities that cause systemic importance of G-SIIs and take necessary measures to reduce that systemic importance. The authorities should oversee the development of a Systemic Risk Reduction Plan (SRRP) by each G-SII (in addition to recovery and resolution plans (RRPs)) to reduce that systemic importance and monitor implementation of the plan. Where feasible and appropriate, the SRRP may include effective separation of systemically important NTNI activities from traditional
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insurance business and/or restrictions or prohibitions of specified systemically important activities or any other measures. Where separation of NTNI activities is contemplated, the SRRP should seek to ensure it achieves self-sufficiency in terms of structure and financial condition of the separated entities. Structural aspects of self-sufficiency will likely involve a combination of restructuring measures and the restriction or prohibition of parental guarantees and cross-default clauses to ensure that any separation into legal entities is not undermined by contractual obligations. Self-sufficiency in terms of financial condition means there should be no capital or funding subsidies or multiple-gearing. The authorities should avoid the creation by the G-SII of non-regulated entities through the separation of NTNI activities. Any entities used to separate NTNI activities should be effectively regulated under direct consolidated group-wide supervision including coordination with other involved supervisors, as discussed above.

ii) Effective resolution
In 2011, the FSB published an international standard for resolution – “Key Attributes of Effective Resolution Regimes for Financial Institutions” (Key Attributes). This standard sets out a range of specific requirements that should apply to any financial institution that could be systemically significant or critical if it fail. The requirements applied to at least G-SIFIs include (i) The establishment of Crisis Management Groups (CMGs); (ii) The elaboration of recovery and resolution plans (RRPs);
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(iii) The conduct of resolvability assessments (iv) The adoption of institution-specific cross-border cooperation agreements For G-SIIs, effective resolution will take account of the specificities of insurance including: • Plans and steps needed for separating NTNI activities from traditional insurance activities, • The possible use of portfolio transfers and run off arrangements as part of the resolution of entities conducting traditional insurance activities, and • The existence of policyholder protection and guarantee schemes (or similar arrangements) in many jurisdictions.

iii) Higher loss absorption (HLA) capacity
Mandating a higher loss absorption capacity for a G-SII will help to reduce its probability of failure. This is important given the greater risks that the failure of G-SIIs poses to the global financial system. The IAIS proposes that the following cascading approach to achieve HLA capacity should apply. This is in line with the principle for HLA is to be targeted, where possible, at activities that have the potential to generate or aggravate systemic risk. • Step 1 – if, and to the extent to which, the G-SII has demonstrated effective separation of NTNI activities from traditional insurance activities, targeted HLA will be applied to the separate entities conducting NTNI activities.

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• Step 2 – whether or not NTNI activities have been separated, an overall assessment of group-wide HLA needed is required. In the case where Step 1 has been applied, this should take into account the HLA in the separate entities and the fact that separation exists, but only where that HLA was not created by multiple-gearing through down streaming capital within the G-SII. The group-wide supervisor determines (in consultation with involved supervisors) whether the HLA capacity held at the NTNI entities is sufficient or needs to be further increased at the group level. As an alternative to Step 2, there is on-going discussion within the IAIS on whether there is a need for group-wide HLA if targeted HLA, and other measures (such as restrictions and prohibitions), are effective in reducing the level of systemic importance to an acceptable level. Instruments comprising the highest quality capital – that is permanent capital that is fully available to cover losses of the insurer at all times on a going-concern basis – are the appropriate instruments to meet HLA capacity requirements. The HLA assessment will take into account any capital charges imposed to mitigate the systemic risk of an insurer that are in place under national legislation. Regarding the proposed policy measures on HLA, the IAIS will elaborate and develop a concrete plan by the end of 2013.

Implementation time frame
It is planned that the first cohort of G-SIIs will be designated and subsequently published in the first half of 2013. G-SII measures on enhanced supervision (including development of the SRRP) and effective resolution should begin to be implemented immediately afterwards.
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The SRRP and measures on effective resolution should be completed within 18 months after designation. The implementation of the SRRP should be assessed by the authorities in 2016. Measures on HLA capacity should begin to be implemented in 2019 for the G-SIIs designated in 2017 allowing for the assessment of implementation of structural measures in the SRRP. The IAIS expects national authorities to prepare a framework in which insurers will be able to provide high quality data for the indicators. To ensure the transparency of the methodology (for the benefit of market participants and to promote market discipline) and the efficient identification of G-SIIs, the IAIS expects all participating insurers to disclose relevant data when the G-SII policy is implemented and the IAIS will provide reporting guidance. Implementation of G-SII policy measures should be monitored by an IAIS peer review process in order to ensure international consistency. The full implementation timeframe is:

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1 Introduction
1. The IAIS is participating in a global initiative, along with other standard setters, central banks and financial sector supervisors, and under the purview of the Financial Stability Board (FSB) and G20, to identify global systemically important financial institutions (G-SIFIs). The focus of IAIS analysis is in relation to potential Global Systemically Important Insurers (G-SIIs). To this end, the IAIS has developed a public consultation document “Global Systemically Important Insurers (G-SIIs): Proposed Assessment Methodology”, explaining the proposed assessment methodology to identify any insurers whose distress or disorderly failure, would cause significant disruption to the global financial system and economic activity. Any such insurers should be regarded as systemically important on a global basis. 2. The IAIS has now also developed a proposed framework of policy measures for G-SIIs. The proposed framework is based upon the general framework published by the FSB with adjustments. As with the assessment methodology, these adjustments reflect the factors that make insurers, and the reasons why they might be systemically important, different to other financial institutions. 3. At the Summit meeting in Seoul, November 2010, the G20 leaders endorsed the FSB’s framework for reducing the moral hazard posed by systemically important financial institutions. The framework recommends several policies which should combine to:

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• Improve the authorities’ ability to resolve SIFIs in an orderly manner without destabilising the financial system and exposing the taxpayer to the risk of loss, • Require higher loss absorbency for SIFIs to reflect the greater risks that these institutions pose to the global financial system, • Apply more intensive and co-ordinated supervision of SIFIs, • Strengthen core financial infrastructures, and • Provide other supplementary prudential and other requirements as determined by the national authorities. 4. As discussed in the IAIS’ report, Insurance and Financial Stability, the two most important factors for assessing the systemic importance of insurers are non-traditional insurance and non-insurance activities and interconnectedness. Non-traditional and non-insurance (NTNI) activities are important because, among other matters, the longer timeframe over which insurance liabilities can normally be managed may not be present, and interconnectedness is important because there can be strong connections between the insurance and banking sectors that can amplify the impact of stress events. Therefore, the policy measures need to address these causes of systemic importance. 5. The purpose of this consultation document is to seek views from supervisors, industry and the public on the proposed policy measures framework for G-SIIs.

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2 Overview 2.1 The supervisory challenges in relation to G-SIIs
6. G-SIIs are a risk to financial stability because their scope, the nature of their business and their position in the financial system is such that, if they fail, they may cause disruption to the rest of the financial system and the real economy. 7. G-SIIs are different to Global Systemically Important Banks (G-SIBs), in part because the traditional insurance business model is not inherently systemically important. Insurers vary widely from banks in their structures and activities and consequently in the nature and degree of risks they pose to the global financial system. The activities or variations on the traditional insurance business model that would make an insurer a G-SII can vary greatly from one insurer to another. This requires a policy response designed to address the specific nature and source of systemic importance and the different drivers of possible negative externalities.

2.2 Objectives of G-SII policy measures
8. The proposed G-SII policy measures should reduce moral hazard and the negative externalities stemming from the potential disorderly failure posed by a G-SII. These policy measures should: • Reduce the probability and impact of distress or failure of G-SIIs and thus reduce the expected systemic impacts which disorderly failure may cause.
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• Incentivise G-SIIs to become less systemically important, and give non-G-SIIs strong disincentives from becoming G-SIIs, and • Be linked to the drivers of the G-SII status of each individual insurer. 9. G-SIIs may be regarded as a safe haven by policyholders and institutional investors, either because of a perceived implicit state guarantee or maybe more so because the policy measures are understood to bring an additional level of security. Within the financial market place, this might have substantial distortional consequences. For example, the G-SII designation of insurers could result in giving G-SIIs access to lower funding costs. The financial strength rating assessment by credit rating agencies and the bespoke ratings assigned by investment banks and repo dealers today do not assume any implicit state guarantee for insurers. During implementation of the policy measures for G-SIIs, potential unintended consequences should be considered and avoided where possible.

3 The G-SII policy measures 3.1 Overview
10. The IAIS proposes a framework of policy measures for G-SIIs in line with the FSB recommendations.

• Enhanced supervision:
Enhanced supervision applies immediately to all G-SIIs to ensure that they rapidly achieve the higher standards of risk management their G-SII status demands. The Insurance Core Principles (ICPs), the common framework for supervision of internationally active insurance groups (ComFrame), and
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the FSB’s “Supervisory Intensity and Effectiveness” (SIE) recommendations would form the basis of the IAIS’s approach to enhanced supervision while special emphasis would be placed on group-wide supervision and liquidity planning, as described below. The authorities should also analyse activities that cause systemic importance of G-SIIs and take necessary measures to reduce that systemic importance. This includes development and implementation of a Systemic Risk Reduction Plan (SRRP) which could include measures such as separation of NTNI activities from traditional insurance business and/or restriction or prohibition of systemically important NTNI activities).

• Increased resolvability:
The FSB’s “Key Attributes for Effective Resolution Regimes” (Key Attributes) would be the basis for improved resolvability and would help reduce the impact of a G-SII failing. Under the Key Attributes, all G-SIIs will be required to produce recovery and resolution plans (RRPs) with their supervisor. The G-SII authorities will also be required to establish a crisis management group (CMG), conduct resolvability assessments and have cooperation agreements with other involved supervisors.

• Higher loss absorption (HLA) capacity:
This will entail the supervisor requiring the G-SII to hold more regulatory capital or to increase loss absorption capacity by other means. Higher capital will be targeted at those NTNI activities the G-SII undertakes which generate systemic risk if, and to the extent to which, the G-SII has demonstrated effective separation of NTNI activities from traditional insurance activities. It is noted that some national supervisory frameworks are expected to provide for capital surcharges that account for the systemic risk profile of
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an insurance group and these additional capital requirements would be taken into consideration in assessing whether the G-SII has an appropriate level of HLA capacity. 11. When applying policy measures authorities should keep the following points in mind: • Measures should be proportionate and should avoid unintended adverse consequences, where practicable • Measures should be directed at the source of systemic importance and linked to the assessment methodology • Measures will often require strong cooperation among authorities, including authorities with responsibility for non-insurance entities within the insurance group.

3.2 Enhanced supervision 3.2.1 General description
12. Enhanced supervision of G-SIIs will generally mean, in line with the SIE recommendations, specifically tailored regulation, greater supervisory resources and bolder use of existing supervisory tools compared to the supervision of non-systemically important insurers. The enhanced supervision of G-SIIs should include a direct approach to consolidated group-wide supervision and should especially focus on the unique risk profile and possible risk concentrations of G-SIIs in order to lessen the probability and impact of failure. In doing so, involved supervisors should take into account the reasons for the systemic importance of the G-SII suggested by the results of G-SII assessment methodology. 13. The desired outcomes of enhanced supervision are:
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• The supervisor determines a set of measures to reduce the risks posed by the G-SII and establishes timelines and indicators to adequately monitor the effectiveness of the measures. • There is a group-wide supervisory framework that applies to the group as a whole with a particular focus on its systemic risks and the need for cooperation among supervisors, including supervisors with responsibility for non-insurance entities within the insurance group. Obstacles that could hinder effective group-wide supervision are identified and removed. For G-SIIs, the supervisor has direct powers over holding companies to ensure that a direct approach to consolidated group-wide supervision can be applied. • The supervisor has clear visibility of internal control systems and risk management and solvency assessment procedures within the insurance group. This includes requiring the G-SII to have the ability to aggregate and identify risk exposures and concentrations quickly and accurately at the group-wide level, across business lines and legal entities, and to other firms. • The G-SII has internal controls and limits that are appropriate, investments and reinsurance arrangements that are appropriately diversified, increased disclosure and additional stress testing. • Enhanced supervisory co-ordination is achieved via supervisory colleges (cross-sector and cross-jurisdictions). 14. The IAIS approach to enhanced supervision builds on: • The IAIS ICPs, which are applicable to all insurers and will be the foundation for the G-SII policy measures.

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• The IAIS ComFrame, which will aim to foster global convergence of regulatory and supervisory measures and approaches for Internationally Active Insurance Groups (IAIGs), whether or not they are identified as G-SIIs, although ComFrame is not expected to directly focus on addressing systemic risk. • Special attention should be paid to group-wide supervision since G-SIIs are most likely to take the form of a group and NTNI activities are often carried out by separate entities within a group. • The FSB’s recommendations for “Intensity and Effectiveness of SIFI Supervision”, (SIE recommendations), especially in relation to: – Unambiguous mandates, independence and appropriate resources Mandates geared toward active early intervention can facilitate a culture where supervisors have the will to act early. The mandate should convey the point that the supervisory authority’s risk view of a firm will always reflect a higher degree of conservatism and will therefore often be a source of conflict when viewed against the respective risk appetites of senior management, board and shareholders. Reinforcing the operational independence and resources of supervisory agencies is critical to ensuring supervisory effectiveness and credibility in general. Supervisor independence is of particular importance as the mandates of agencies is broadened to include authority to take countercyclical actions such as imposing more conservative underwriting standards in boom times, or raising capital requirements, which may run contrary to public perceptions of risk and be politically unpopular. – Full suite of supervisory powers Since the crisis, the need for tools such as increased liquidity requirements, large exposure limits, imposing dividend cuts, requiring additional capital etc. have come to the forefront.
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Given that a full suite of powers is critical to a supervisor executing their role, the inventory of required tools should be updated. Supervisors need to ensure that the stress testing undertaken is comprehensive and commensurate with the risks and complexities of these institutions. – Improved standards and methods Increased focus on outcomes of governance and business processes and greater use of horizontal reviews are desirable. Supervisors need to evaluate whether their approach to and methods of supervision remain effective or have, for example, moved too far toward focusing on adequacy of capital and control systems, and away from detailed assessments of sources of profits and financial data. Supervisory interactions with Boards and senior management should be stepped up, in terms of frequency, level of seniority, and assessment of their effectiveness. Consideration should be given to developing expanded guidance to supervisors on how to assess a board with the goal of being better armed with tools and techniques which enable better determination of board effectiveness. Supervisors should adopt proactive approaches to deal with succession planning and performance expectations for key positions within G-SIIs (e.g. CEOs, CROs, Internal Auditors), elements that should no longer be regarded as only internal matters for institutions. – Stricter assessment regime Supervisors should consider how their supervisory frameworks set internal control expectations (including risk management frameworks) for G-SIIs, and they should be confident that the assessment criteria for the control environment at G-SIIs set a “higher bar” for these firms to achieve in the areas of internal controls given the potential systemic impact that they pose.
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Supervisors should further explore ways to formally assess risk culture, particularly at G-SIIs. Establishing a strong risk culture at financial institutions is an essential element of good governance. – Group-wide and consolidated supervision Group-wide supervisory work can be impaired when supervisors do not have the legal right or ability to review the group entities including non-regulated entities (including parents and/or affiliates), yet those entities have the potential to pose risks to the regulated entity. Consolidated supervisory blind spots can be created when there are entities within the regulated firm that the consolidated supervisor does not have access to or influence over. In some cases this is caused by business lines that have a primary supervisor that is different from the primary supervisor of the consolidated entity. Competing mandates and approaches of these supervisors can fragment the overall supervisory effort. – Risk aggregation Supervisors should study their data needs and data processing capabilities in the context of the higher requirements for G-SII supervision. Where there are deficiencies in any or all of i) The type of data collected, ii) The authority’s ability to process the data in a timely and fulsome way, or iii) Their ability to collect ad-hoc data in a timely manner, these should be addressed as soon as possible.
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Supervisors need to consider putting in place additional data management and analysis processes for the information available from a range of sources, such as that collected by trade repositories and other centralised sources of financial data, so that key players in markets and market anomalies are identified.

3.2.2 Enhanced liquidity planning and management
15. The supervisor should require the G-SII to have adequate arrangements in place to manage liquidity risk for the whole group, primarily in relation to NTNI activities and key channels of interconnectedness and secondarily also for the remainder of the group. These arrangements should include written strategies and policies for liquidity risk management during normal and stressed conditions subject to clearly documented governance requirements. Adjustments for expected behavior of market participants and customers during stressed conditions (especially in relation to acceleration of liabilities) should be considered. Liquidity risk management policies should include all relevant issues. Relevant issues may include: the basis for managing liquidity (for example, regional or central); the degree of concentrations, potentially affecting liquidity risk, that are acceptable to the firm; a policy for managing the liability side of liquidity risk and potential effects of downgrades on rating triggers; the role of marketable, or otherwise realisable, assets; ways of managing both the firm's aggregate foreign currency liquidity needs and its needs in each individual currency; ways of managing market access; the use of derivatives to minimise liquidity risk (including potential for collateral calls and margin calls); and, if NTNI activities exist, the management of intra-day liquidity.

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3.2.3 Structural measures and the Systemic Risk Reduction Plan (SRRP)
16. The authorities should analyse activities that cause systemic importance of G-SIIs and take necessary measures to reduce that systemic importance. The authorities should select the most effective policy measures to achieve this goal. The authorities should oversee the development of a SRRP by each G-SII (in addition to the recovery and resolution plans (RRPs)) to reduce that systemic importance and monitor implementation of the plan. Where feasible and appropriate, the SRRP may include effective separation (so as to achieve self-sufficiency) of systemically important NTNI activities from traditional insurance business (in combination with targeted HLA) and/or restrictions or prohibitions of specified systemically important activities or any other measures.

3.2.3.1 Separation of non-traditional and non-insurance (NTNI) activities
17. Separation of NTNI activities is an ex-ante policy measure aiming for greater transparency, self-sufficiency and resolvability of G-SIIs by targeting the structure of G-SIIs. The desired outcomes of implementing this measure are: • Traditional insurance business is more strongly shielded from NTNI business and vice versa. The qualities and resilience of traditional insurance business can be largely preserved20, even in G-SIIs with less traditional operations. • The resolvability of G-SIIs is structurally improved ex-ante, unlike RRPs which are conceived ex-ante but executed ex-post.
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The resolvability of traditional insurance business can be largely preserved, even in G-SIIs with less traditional operations, and the resolvability of NTNI business is addressed. (see 3.3 Effective Resolution) • (In combination with targeted HLA) the expected impact of the distress or failure of the NTNI entities is reduced to non-systemic level. 18. The aforementioned outcomes are supported by the following combination of specific measures: • NTNI business is conducted in separate legal entities that are structurally and financially self-sufficient – Structural self-sufficiency means that it should be possible to ring-fence (and liquidate) self-sufficient legal entities without impacting the remaining legal entities of a group. As well as legal entity separation, it requires that problematic NTNI intra-group transactions such as guarantees (especially any unlimited guarantees, upward and peer guarantees and intra-group transactions aimed at capital gearing) as well as cross-default clauses are prohibited or at a minimum adequately monitored and restricted. – Financial self-sufficiency requires economically adequate capitalisation of legal entities that account for their systemic importance and hence of the G-SII; avoiding certain structures designed to allow for undercapitalisation and subsidies of selected legal entities. • Subsidies in the form of capital and/or funding to the benefit of NTNI entities should not be allowed • Self-sufficiency in terms of structure and financial condition is to be monitored and verified by the authorities during the process of implementation of the SRRP.

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19. Company structures exist in such a variety of forms that it is impossible to capture the structural measures in a set of all-encompassing rules. The structure of G-SIIs becomes more transparent and hence tractable with their businesses separated according to the business segments proposed in Insurance and Financial Stability. This allows supervisors to target their supervisory actions and measures more effectively and efficiently to the nature and risks of the respective business segments. In terms of tractability and transparency, the organisational structure of G-SIIs would be simpler to understand if different types of activities and businesses were compartmentalised. The financial statements would also be simpler to understand if segment reporting is aligned accordingly. 20. The authorities should avoid the creation by the G-SII of non-regulated entities through the separation of NTNI activities. Any entities used to separate NTNI activities should be effectively regulated under direct consolidated group-wide supervision including coordination with other involved supervisors, as discussed above.

3.2.3.2 Restrictions and prohibitions
21. The supervisor could choose to apply restrictions and prohibitions with the following goals in mind: - to reduce the probability and impact of failure resulting from systemically important activities within G-SIIs - to eliminate or limit systemically important activities based on the nature of the activity

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- to discourage such activities and thereby encourage G-SIIs to reduce or eliminate their systemically important activities and discourage other insurers from undertaking potentially systemically important activities. 22. Restrictions and prohibitions are most effectively applied to NTNI and interconnectedness activities and could be applied on a stand-alone basis or in combination with other policy measures. Restrictions and prohibitions could be targeted to specific legal entities within the G-SII or they could be tailored to specific systemic NTNI activities or those activities that make a company more interconnected. 23. Restrictions and prohibitions cover a broad range of options that include both direct prohibitions, limitations and restrictions on activities as well as measures that provide strong disincentives and/or internalise the costs for engaging in systemically important activities. These include: • Direct prohibition or limitation of the systemically important activity • Requirements for prior approval of transactions that fund or support systemically important activities • Requirements for spreading or dispersing risks relating to systemically important activities. • Limiting or restricting diversification benefits between traditional insurance business and other businesses. This measure improves the overall capital position and hence provides HLA capacity. In practical terms, it could either be applied at ultimate parent level or at the NTNI sub-holding or entity level

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24. Given the premise that insurers are not likely to inherently generate systemic risk other than through NTNI and interconnectedness, prohibitions or strict limitations of an activity can be applied to G-SIIs where the goal is to eliminate the activity or severely curtail the risky activity. When a systemically important activity is conducted by a non-insurance entity within a group and joint banking and insurance make it more desirable to contain the risk rather than remove the activity, restriction may play a lesser role when compared with structural measures (e.g. segregation or separation) and HLA capacity.

3.3 Effective Resolution
25. The desired outcomes of effective resolution are: - to ensure the resolution of G-SIIs can take place without severe systemic disruption and without exposing taxpayers to loss, - to protect vital economic functions through mechanisms which make it possible for shareholders and unsecured creditors to absorb losses in a manner that respects the hierarchy of claims in liquidation, - to ensure that policyholder protection arrangements remain as effective as possible, - to avoid unnecessary destruction of value and ensure that non-viable G-SIIs can exit the market in an orderly way, and - to identify and remove impediments to smooth resolution.

3.3.1 Resolution regimes and tools for G-SIIs
26. In 2011, the FSB published an international standard for resolution – “Key Attributes of Effective Resolution Regimes for Financial Institutions” (Key Attributes).
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This standard sets out a range of specific requirements for institutions that should apply at a minimum to all G-SIFIs including G-SIIs. They include (i) The establishment of Crisis Management Groups (CMGs); (ii) The elaboration of recovery and resolution plans (RRPs); (iii) The conduct of resolvability assessments; and (iv) The adoption of institution-specific cross-border cooperation agreements. 27. To carry out an effective resolution, authorities need to have at their disposal a broad range of tools that enable them to intervene safely and quickly to protect policyholders and avoid destabilisation of financial markets. At present, many IAIS jurisdictions have a fourfold power in connection with the trigger points of a recovery system to require a solvency plan if the “prescribed capital requirement” (PCR) is breached, a financing plan if the “minimum capital requirement” (MCR) is breached, a recovery plan if the asset/liability ratio is breached and a liquidation plan if both the asset/liability ratio and the MCR are breached. These powers should be considered for RRPs of G-SIIs when they are in good health. The FSB Key Attributes should serve as a point of reference for the reform of national resolution regimes, setting out the responsibilities, instruments and powers that all national resolution regimes should have to enable authorities to resolve failing G-SIIs in an orderly manner and without exposing the taxpayer to the risk of loss. 28. It needs to be further examined whether a mainly traditional insurance group with a large derivatives portfolio may experience a disorderly
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run-off and, if so, whether there needs to be adjustments to the methodology or policy measures as a result. 29. Authorities will consider and take all necessary actions to ensure effective resolution including removing obstacles to the separability of non-traditional and non-insurance (NTNI) activities from traditional insurance activities during a stressed event. The resolvability assessment will include assessing whether, and the extent to which, effective ex ante separation of activities is in place. (See 3.2.3 Structural measures and the SRRP). 30. The FSB Key Attributes provide guidance to assist authorities in implementing the requirements for G-SIFIs. The IAIS concurs that these requirements are also relevant for G-SIIs, although insurance specificities need to be taken into account in implementing them. The FSB is currently developing an assessment methodology which should be used for assessments by the IMF and World Bank of national resolution regimes for financial institutions. The IAIS considers that the methodology should contain insurance-specific elements and hence is working closely with the FSB to ensure that the methodology addresses insurance specificities. Where necessary, the IAIS will explore with its members the need to develop further guidance for inclusion in the assessment methodology. Insurance specificities which need to be taken into account, include: • Plans and steps for separating NTNI activities from traditional insurance activities, • The possible use of portfolio transfers and run off arrangements as part of the resolution of entities conducting traditional insurance activities, and
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• The existence of policyholder protection and guarantee schemes (or similar arrangements) in many jurisdictions. 31. The IAIS will also consider whether to develop a template for assessing resolvability of G-SIIs. This template could assist authorities in identifying structural measures that would better prepare G-SIIs for resolution if the G-SII needs to be resolved. The issues discussed under the previous section 3.2.3.1 on separation should also be considered in this context.

3.4 Higher Loss Absorption (HLA) capacity 3.4.1 General description and purpose
32. All G-SIIs should have higher loss absorption (HLA) capacity to reflect the greater risks that G-SIFIs pose to the global financial system. The desired outcomes of HLA capacity, all of which work to reduce the probability or failure of distress and thus expected impact, include: • The G-SII is more resilient to low probability but high impact events. • Supervisors intervene earlier than they would for non-G-SIIs giving them more time to address emerging risks to the soundness of the G-SII. • Any implicit or explicit funding subsidy linked to G-SII status is offset. 33. HLA can be applied as an instrument at the group level or as a targeted instrument at the legal entity level if, and to the extent to which, the G-SII has demonstrated effective separation of NTNI activities from traditional insurance activities. 34. The application of HLA to G-SIIs is complicated by the fact that there is no global solvency standard for insurers.
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By requiring group-wide HLA, it might further aggravate differences between jurisdictions which might result in further regulatory arbitrage possibilities. Furthermore, the international differences in accounting and regulatory requirements would need to be considered when deciding the basis for any calculations, with IFRS, US GAAP or Japan GAAP with bridges to IFRS as the basis. 35. Mandating a higher loss absorption capacity for a G-SII will help to reduce its probability of failure. This is important given the greater risks that the failure of G-SIIs poses to the global financial system. The IAIS proposes that the following cascading approach to achieve HLA capacity should apply. This is in line with the principle for HLA is to be targeted, where possible, at activities that have the potential to generate or aggravate systemic risk. • Step 1 – if, and to the extent to which, the G-SII has demonstrated effective separation (so as to achieve self-sufficiency) of NTNI activities from traditional insurance activities, targeted HLA will be applied to the separate entities conducting NTNI activities. • Step 2 – whether or not NTNI activities have been separated, an overall assessment of the HLA needed at the group level is required. In the case where Step 1 has been applied, this should take into account the HLA in the separate entities and the fact that separation exists, but only where that HLA was not created by multiple-gearing through down streaming capital within the G-SII. The group-wide supervisor determines (in consultation with involved supervisors) whether the HLA capacity held at the NTNI entities is sufficient or needs to be further increased at the group level. • As an alternative to Step 2, there is on-going discussion within the IAIS on whether there is a need for group-wide HLA if targeted HLA, and
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other measures (such as restrictions and prohibitions), are effective in reducing the level of systemic importance to an acceptable level. 36. The HLA assessment will take into account any capital charges imposed to mitigate the systemic risk of an insurer that are in place under national legislation. 37. The structural measures required to achieve self-sufficiency are discussed in the previous section 3.2.3.1 on separation.

3.4.2 Methodology for applying group HLA capacity
38. There is currently no global solvency standard for insurance groups upon which to build HLA capacity requirements to apply consistently across jurisdictions. Nevertheless, the IAIS has decided in November 2011 that the capital component of the solvency assessment in ComFrame should have, among other items, a partly harmonised set of standards and parameters that sets out a narrow range of target criteria and time horizons for measurement purposes. 39. Currently, ICPs 17.3, 17.4 and 17.5 describe the concept of solvency control levels which could be used as the basis for applying HLA capacity. These ICPs specify a “prescribed capital requirement” (PCR), above which level the supervisor does not intervene on capital adequacy grounds. The PCR should be set such that, in adversity, an insurer’s obligations to policyholders will continue to be met as they fall due, that is, at a level such that the insurer is able to absorb the losses from adverse events that may occur over a defined period while technical provisions remain covered. HLA capacity would essentially be setting a higher PCR that accounts for the fact that the failure or distress of a G-SII is associated with negative
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externalities towards the global financial system and the economy, not just the policyholders and other direct stakeholders of the G-SII. 40. HLA capacity could be applied to the current national/regional solvency regime, as an HLA uplift to the closest conceptual equivalent to the PCR that is required under each country’s regulation. This approach should fit with most solvency regimes provided there is an equivalent of a PCR. Because it would be an add-on to the existing baseline solvency requirements in each jurisdiction, the large part of the overall solvency requirement should still be risk sensitive (to the extent that the existing regime is risk sensitive). This approach would also not impede the convergence of solvency standards over time.

Step 1 – Targeted HLA capacity
41. If, and to the extent to which, the G-SII has demonstrated effective separation (so as to achieve self-sufficiency in terms of structure and financial condition) of NTNI activities from traditional insurance activities, targeted HLA will be applied to the separate entities conducting NTNI activities. Thus it sits where it is most needed in situations of stress. Targeted HLA capacity establishes an additional capital buffer and also makes it more expensive to carry out systemic activities. It is specifically aimed at the systemic NTNI business of insurers and is a disincentive as G-SIIs would require more capital. 42. Targeted HLA could directly affect the activities that pose systemic risk within the insurance business and also provides incentives to undertake any activities that pose systemic risk to a lesser extent.

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43. For any banking or bank-like activities, whether carried out in a bank subsidiary or a non-insurance financial entity, the targeted HLA capacity could be set according to Basel III rules (eg HLA of at least 1% of risk-weighted assets). Where Basel III can be used, it should be carefully designed to avoid regulatory arbitrage by applying the same rule to the same activity. Moreover, the same standards should apply to the same business in different jurisdictions to ensure a level playing field. 44. For other NTNI activities, the supervisor would need to determine suitable rules based on the nature of the activities and the principles in the ICPs and other relevant regulatory frameworks. The IAIS will provide guidance for supervisors as part of the proposed concrete policy measures on HLA, by the end of 2013.

Step 2 – Group-wide HLA capacity
45. Under Step 2, an overall assessment of the HLA needed at the group level is required. In the case where Step 1 has been applied, this should take into account the HLA in the separate entities and the fact that separation exists, but only where that HLA was not created by multiple-gearing through down streaming capital within the G-SII. Possible add-ons should also be considered. Ideally, the level of group-wide HLA capacity should reduce the expected impact of a G-SII failing to an agreed benchmark. One way to set the appropriate level of group-wide HLA capacity would be so that the probability of failure is reduced to the point that the expected impact of a G-SII failing equals the expected impact of other similar insurance groups that

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are not G-SIIs failing. This approach is not considered feasible in the short term, as there is not sufficient data available to make a proper assessment.

Application of the HLA uplift
46. Deciding a basis to calculate the HLA uplift is complicated by different solvency regimes and accounting requirements across jurisdictions. Two options on which the HLA uplift could be based are to use a capital measure or a balance sheet measure:

i) Capital measure based on existing local solvency regimes
The capital measure could be the nearest equivalent solvency standard to the PCR and the HLA uplift would be a percentage of the PCR (possibly in the range of 10% to 30%). Advantages: • Simple to handle. • Consistent with the concept of PCR which is the baseline of HLA uplift. Disadvantages: • As the baseline of group-wide HLA capacity is different, distortions could occur, depending on what business is being taken into account under local regimes and whether the major part of the business lies in jurisdictions with higher or lower regulatory capital requirements. • Aggregation of local regimes may not create a sufficient capital measure or, conversely, may provide an excessive capital measure. • Most local regimes will have little or no regard for specific treatment of NTNI activities.
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ii) Total balance sheet (including off-balance sheet positions)
The balance sheet measure could be based on the total balance sheet (excluding capital but including off balance sheet items) and the HLA uplift would be a percentage of that amount (possibly in the range of 0.5% to 1.5%). It should be considered whether and how to deduct insurance assets and insurance liabilities in an appropriate manner in order to dis-incentivise reductions in insurance technical reserves and related assets. Advantages: • More global approach • Improves comparability between G-SIIs provided IFRS, US GAAP or Japan GAAP with bridges to IFRS are used as a basis • Independent from the levels of regulatory capital, and hence may provide more consistency between jurisdictions than the previous approach. Disadvantages: • Not as precise as a fully-fledged economic capital regime. • Not risk-sensitive, and could be inconsistent with an insurer's risk management framework. • Accounting differences across jurisdictions in the calculation of insurance liabilities mean this approach could also yield considerable inconsistency of HLA uplift. • This approach penalises insurers with healthier balance sheets within jurisdictions, including those insurers that maintain more conservative technical provisions. • It is technically difficult to define off-balance sheet items.
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3.4.3 Acceptable instruments
47. Currently, there is no common global definition of capital in the insurance sector. The ICP 17.11.34 provides an example of broad categorisation of capital as follows. a. Highest quality capital: permanent capital that is fully available to cover losses of the insurer at all times on a going-concern and a wind-up basis; b. Medium quality capital: capital that lacks some of the characteristics of highest quality capital, but which provides a degree of loss absorption during on-going operations and is subordinated to the rights (and reasonable expectations) of policyholders; c. Lowest quality capital: capital that provides loss absorption in insolvency/ winding-up only. 48. The FSB report, endorsed at the G20 Seoul Summit in November 2010, states that G-SIFIs should have greater loss absorption capacity whereby a higher share of their balance sheets is funded by capital and/or by other instruments which increase the resilience of the institution as a going concern. 49. In line with the FSB recommendation, given the going-concern objective of the HLA capacity requirement, the HLA capacity should be met by the highest quality capital as defined in the above-mentioned ICP 17.11.34. Instruments comprising the highest quality capital – that is permanent capital that is fully available to cover losses of the insurer at all times on a going-concern basis – are the appropriate instruments to meet a HLA capacity requirement for the time being. 50. The supervisor should judge whether an instrument which exists in its jurisdiction constitutes the highest quality of capital or not.
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It should also be noted that the IAIS has decided that a common definition of capital resources is to be established by 2013. 51. Attention should be paid to the fact that the additional capital should sit in the place where it is most needed (e.g. in separate NTNI businesses). Otherwise, particularly if sitting in non-regulated entities (e.g. holding companies), issues relating to supervisory powers as well as transfer impediments might arise.

3.4.4 Refining the HLA capacity requirement
52. The IAIS will elaborate the above-mentioned HLA capacity measure and develop a concrete proposal by the end of 2013 taking into account that a sufficient transitional period of the introduction of this measure has been proposed as implementation is scheduled to begin from 2019 (see section 4).

4 Implementation 4.1 Implementation timeframe
53. The starting point for the implementation of G-SII policy measures is the public determination by the FSB and national supervisory authorities that a particular insurer is found to be a G-SII. For each G-SII, the group-wide supervisor would contact the G-SII to commence the process of implementing required policy measures. The key dates and timeframes are expected to be:

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54. Discussions with the G-SII would focus first on the particular drivers of G-SII status. The authority would immediately begin to implement measures with regards to enhanced supervision (including development of the SRRP) and effective resolution. The SRRP and resolution measures should be completed within 18 months after G-SII designation.
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The implementation of the SRRP should be assessed by the authorities 3 years after G-SII designation. Implementation of the SRRP is a prerequisite for application of the targeted HLA capacity requirements. 55. Regarding the proposed policy measures on HLA, the IAIS will elaborate and develop a concrete plan by the end of 2013. 56. The HLA capacity requirements will apply from 2019 for those G-SIIs designated in 2017 and will be based on the status of implementation of the SRRP in 2017. The list of designated G-SIIs will be updated every year. After the first designation in 2017, a newly designated G-SII will be allowed to have the same period to meet the HLA capacity requirement. 57. The IAIS expects national authorities to prepare a framework in which insurers will be able to provide high quality data for the indicators. To ensure the transparency of the methodology (for the benefit of market participants and to promote market discipline) and the efficient identification of G-SIIs, the IAIS expects all participating insurers to disclose relevant data when the G-SII policy is implemented and the IAIS will provide reporting guidance. 58. Implementation of G-SII policy measures should be monitored by an IAIS peer review process in order to ensure international consistency.

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President's Summary of Outcomes from the Experts’ meeting on Corruption
1. The Financial Action Task Force (FATF) convened, in collaboration with the G20 Anti-Corruption Working Group, an Experts Meeting on Corruption. In this meeting, 88 delegates from 28 jurisdictions and 14 organisations participated including: the FATF, G20 Anti-Corruption Working Group, Asia Pacific Group (APG), Intergovernmental Action Group against Money Laundering in Africa (GIABA), Middle East &North Africa Financial Action Task Force (MENAFATF), Commonwealth Secretariat, Group of States Against Corruption (GRECO), International Anti-Corruption Academy (IACA), International Association of Insurance Supervisors (IAIS), International Monetary Fund (IMF), Organisation for Economic Co-operation and Development (OECD), United Nations Office on Drugs and Crime (UNODC), World Customs Organisation, and World Bank. The meeting was chaired by the President of the FATF, Mr Bjørn S. Aamo (Norway), at facilities in Paris offered by the World Bank. The FATF continues to emphasise the anti-corruption agenda, while avoiding duplication of the role of mandated anti-corruption bodies. Part of that work is focused on bringing together anti-money laundering and counter-terrorist financing (AML/CFT) experts and anti-corruption (AC) experts for the purpose of discussing issues of mutual interest. 2. This is the second time that the FATF has held such an event. The first FATF Experts Meeting was held in February 2011 under the Mexican FATF Presidency, and was the first international platform for exchanging views between operational-level AML/CFT and anticorruption experts, policy makers from both developing and
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developed countries, and international standard setters and assessment/monitoring bodies. 3. This meeting has been focused on the experience of countries, particularly in relation to asset recovery issues, and taking into account the domestic dimension. The timing of this meeting is significant, as it occurs at a critical stage during the FATF’s work to develop a new assessment methodology, new mutual evaluation procedures, and new guidance which will assist countries in their implementation of the new FATF standards. It is particularly important for the FATF to have input from anti-corruption practitioners at this point in time when it is in the process of making the revised FATF Recommendations operational. 4. This meeting has also been an important opportunity for the experts who are present to provide input to the FATF’s work. The information gathered during this meeting will be reported back to the FATF membership at the FATF Plenary which is being held in Paris next week, and will provide useful input into the development of the new assessment methodology and procedures, and guidance papers. 5. The key objectives for this meeting were: - To identify key challenges and possible solutions for facilitating international cooperation by exploiting the synergies between AML/CFT measures and AC measures - To have an in-depth discussion of key issues concerning international co-operation in the context of investigating and prosecuting corruption, bribery and related money laundering offences - To identify and discuss key AML/CFT tools that asset recovery practitioners should be aware of and use

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- To use the results of the discussions as input into FATF’s and anti-corruption standard setters’ ongoing and future work on corruption - To identify those FATF Recommendations that are particularly useful for AC experts and that should be included in FATF best practices on corruption 6. Experts heard presentations on the following issues: i) Asset tracing and financial investigations ii) Provisional measures (freezing and seizing) iii) Confiscation iv) Asset recovery and international cooperation. Participants discussed the issues outlined below. Additionally, there was a recognition of the important synergies between the work of the FATF and the work of the G20 Anti-Corruption Working Group.

Asset tracing and financial investigations
7. The FATF Recommendations require countries to implement domestic AML/CFT measures that provide valuable tools for tracing assets, conducting financial investigations, and facilitating the confiscation of the proceeds of corruption and bribery offences. These tools can add value to a corruption case, even where it may not be possible to pursue related money laundering charges. In practice, suspicious transaction reports (STR) have uncovered corruption activity, triggered corruption investigations, and been used to support ongoing financial investigations of corrupt activity.
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STRs can provide a valuable source of financial intelligence for investigators in both the identification and tracing of the proceeds of corruption. Unfortunately, adequate feedback on the value of STR reporting is not always transmitted back to reporting entities. The rigorous and effective prosecution of corruption and bribery cases also provides an important source of information for money laundering cases. It is useful to preserve the closed files of such cases, as these may be reopened and used as a source of information for future investigations. 8. Customer due diligence (CDD), enhanced CDD for politically exposed persons (PEPs), and record keeping measures are also important tools. Where financial institutions and designated non-financial businesses and professions (DNFBP) hold accurate information about the identity of their customers, including beneficial ownership information, the ability to trace assets is greatly enhanced. Administrative authorities, such as tax authorities, can hold useful information about the ownership and control of assets, and on declared income and assets. As well, FATF Recommendation 3 requires tax crimes to be predicate offences for money laundering (see the definition of “designated categories of offences”, as that term is defined in the Glossary to the FATF Recommendations). 9. Financial institutions and DNFBP play a key role in this process. For example, it is important for financial institutions and DNFBP to implement robust programmes to combat money laundering.

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This includes policies and procedures for sharing information within financial groups for AML/CFT purposes, in line with FATF Recommendation 18. Financial institutions should also be required, at a minimum, to ensure that their foreign branches and majority owned subsidiaries apply AML/CFT measures consistent with the home country requirements. Supervisors and regulators also have an important role which includes ensuring that the financial sector meets the applicable AML requirements, and understands where the corruption and bribery risks are. 10. It is important for countries to have mechanisms in place to facilitate domestic co-ordination and co-operation among relevant law enforcement agencies, administrative authorities, and financial intelligence units (FIUs) in the investigation and prosecution of corruption offences and related money laundering, in line with FATF Recommendation 2. International cooperation is also needed to ensure that the authorities can successfully trace assets which have been moved abroad. Networks of practitioners can be a useful tool, enabling practitioners who are working on the same case in their respective countries to come together and better coordinate their efforts.

Provisional measures (freezing and seizing)
11. AML/CFT measures such as the FATF Recommendations provide for valuable tools that enable the freezing and seizing of assets related to corruption. There are also many useful tools available in international Conventions, including the United Nations Convention against Corruption (UNCAC). The participants recognised the need for strong domestic and international cooperation to ensure that the financial intelligence
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gathered through AML/CFT measures can be effectively used by the authorities in corruption and related money laundering cases, and to facilitate the enforcement of foreign freezing/seizing orders. 12. Transforming the information which is gathered by FIUs into evidence that can be used in court to support a freezing/seizing action is sometimes challenging. Where the enforcement of a domestic freezing/seizing order is being sought, further obstacles may arise if the processes and standard of proof required by the requested country are not well understood by the requesting country. The challenges associated with international corruption cases were also discussed including: the length, complexity and cost of investigations; the difficulties associated with obtaining evidence to the required standard; and the complexity of restraining assets internationally. 13. It is important to ensure that stolen assets do not remain frozen abroad indefinitely. Countries need to implement effective measures which facilitate international cooperation, and also respect the important principles of due process, rule of law and fundamental human rights. Experience in recent years has shown the difficultly of transforming a national freezing action into a successful confiscation and asset recovery action which results in the frozen assets being returned to the countries and people from whom they were stolen. The participants recognised that this is an area which would benefit from further capacity building and resources.

Confiscation
14. AML/CFT measures are useful in facilitating the confiscation of assets in corruption and related money laundering cases.
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The participants discussed a number of successful cases of international cooperation involving confiscation. Many countries already have in place sufficient legal frameworks to enable confiscation, including non-conviction based confiscation. However, in practice, action is sometimes not taken swiftly enough, and before the assets are hidden or moved abroad. The ease of moving money electronically or through the use of cash couriers or bulk cash smuggling, combined with the use of legal persons and arrangements (including shell companies and trusts), and the lack of accurate information on beneficial ownership create serious obstacles to confiscation. The effective implementation of AML/CFT measures as required by the FATF Recommendations and other international instruments, such as the OECD Anti-Bribery Convention, are valuable tools for addressing these issues. 15. Taking confiscation action in international corruption cases can be particularly challenging because much of the evidence in a foreign bribery cases is often not locally available. Political upheaval and social unrest can sometimes create practical impediments to secure Information exchange with foreign counterparts. It is also important to focus on both the demand side and the supply side of bribery transactions. It was also noted that multiple legal proceedings create complexity in confiscation cases. For example, assets might be dissipated in the course of a criminal case, leaving little for victims who are seeking compensation or restitution through a civil action. Overall, the participants recognised that there is a great need for further
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capacity building in this area.

Asset recovery and international cooperation
16. Effective and timely international cooperation is essential for the recovery of assets related to corruption. The necessary legal frameworks for international cooperation should be in place, based on international instruments such as the UNCAC, and the FATF Recommendations. The FATF Recommendations require countries to implement a strong framework for information sharing. Under FATF Recommendation 37, countries should provide the widest possible range of mutual legal assistance (MLA) in relation to money laundering and associated predicate offences such as corruption and bribery. Under FATF Recommendation 38, countries should have the authority to take expeditious action in response to requests by foreign countries to identify, freeze, seize and confiscate the proceeds of crime. Where dual criminality is required for MLA, it is important for countries to have criminalised an adequate range of corruption and bribery offences, and related money laundering, in line with FATF Recommendation 3. Participants agreed that these requirements are particularly important in asset recovery cases, given their international dimension. 17. There are many potential obstacles to effective mutual legal assistance which can seriously delay and thwart the investigation and prosecution of corruption, bribery and related money laundering. For example, not all countries have established an FIU with sufficient capacity to trace assets and cooperate with foreign counterparts.
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The cross-jurisdictional aspect of cases involving stolen assets creates legal and practical complexities, including those of language. Corruption can negatively impact how the rule of law is applied in some countries, which can impede their ability to provide international cooperation effectively. Conflicts can arise where mirror proceedings are not underway in the country where the predicate offence was committed as well as in the country where the assets are held, and the UNCAC provides for mechanisms to help address this issue, such as spontaneous information exchange. 18. Proactive approaches are particularly useful including: spontaneous information exchanges among competent authorities and making effective use of FIU information transmission channels and exchange mechanisms, in line with FATF Recommendation 40; utilising open source information; taking a multi-agency approach and strategic planning, in line with FATF Recommendation 2; and developing a case management strategy with the country from where the assets were stolen and other countries which may be holding stolen assets (e.g., to consider issues such as which country should start the criminal, civil or administrative proceedings). The participants also noted that a number of supporting initiatives are available to help countries manage these issues, including the Stolen Asset Recovery Initiative (StAR) which is a partnership between the World Bank and the UN Office on Drugs and Crime (UNODC).

Conclusions
19. Both anti-corrruption and AML experts confirmed that there is a growing recognition that, even though anti-corruption and AML efforts are mutually reinforcing, they have not always been brought together effectively.

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It would be extremely useful to have a greater understanding, at the policy, legislative, operational and enforcement levels of how AML/CFT measures may be effectively leveraged in the fight against corruption. Developing tools which take into account the needs of anti-corruption experts, such as best practices, to further this understanding could usefully advance cooperation and the effectiveness of both anti-corruption and AML/CFT efforts. The participants noted that anti-corruption and AML/CFT experts should continue working together on these important issues.

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Lim Hng Kiang: What’s next for hedge funds?
Keynote address by Mr Lim Hng Kiang, Minister for Trade and Industry and Deputy Chairman of the Monetary Authority of Singapore, at the SkyBridge Alternative (SALT) Conference, Marina Bay Sands *** Mr Anthony Scaramucci, Managing Partner, SkyBridge Capital Distinguished guests, ladies and gentlemen. A very good morning to all of you. I am very pleased to join you at the inaugural Asian leg of the SALT conference.

Global outlook
As we move into the last quarter of 2012, the world economic outlook remains uncertain. Advanced economies continue to encounter headwinds as deleveraging, fiscal consolidation and a still-weak financial system act as a drag on growth. With US and Europe facing economic difficulties, Asia will not be immune to a global slowdown given its heavy reliance on trade. This can be seen by Asia’s slowing growth in the last two quarters as weak demand in the G3, especially the Eurozone, exerted a sharp drag on exports from the region. The IMF has recently revised its growth estimates downwards.
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Global growth is now expected to be 3.3% in 2012 and 3.6% in 2013. However, this is dependent on the assumption that there will be sufficient policy action to ease financial conditions globally and that recent policy easing moves in emerging market economies will gain traction. Overall, global growth is expected to remain muted for an extended period.

Impact of macro conditions on the global hedge fund industry
The macro economic environment has left global institutions, including hedge funds, grappling with historically low interest rates, volatile financial markets, and an environment that has grown averse to risk taking. As hedge funds cope with a more demanding operating and economic environment, the industry will have to deal with two key challenges. Firstly, soft returns amidst the volatile environment. The average hedge fund returns across strategies was negative 4.6% in 2011, with most of the losses occurring in 3Q 2011 when global equities declined by around 17%. Whilst hedge fund performance this year-to-date as at end-August 2012 was up 3.8%, the outlook remains uncertain and I think hedge funds may struggle to provide consistent returns over time. Secondly, a more challenging fund-raising environment. Business and compliance costs have increased due to more stringent manager selection criteria by investors and enhanced global regulatory standards. As a result, funding gestation periods have lengthened and failure rates have increased.
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Hedge funds now require larger assets under management to breakeven and remain economically viable. Managers without a strong track record will be in for a hard time. Against this backdrop, some consolidation of the global hedge fund industry is to be expected.

Long term prospects for the hedge fund industry remains positive
Nonetheless, if we look beyond the immediate economic challenges, the long term prospects for the alternative investment industry remain positive. A number of studies have identified a growing interest from institutional investors for yields in the alternative space. In the 2012 Towers Watson Global Pension Asset Study, asset allocation to alternatives in the seven largest pension fund markets has increased from 5% in 1995 to 20% in 2011. In another recent study, McKinsey estimates that global alternative investments across the retail and institutional segments doubled in assets under management between 2005 and 2011, to reach US$6.5 trillion. This represents a compound annual growth rate of 14% over this period, exceeding the growth of the traditional asset classes. Specifically in the hedge fund space, institutional investors have increased allocations to hedge funds significantly over the last decade, from only US$125 billion in 2002 to approximately US$1.5 trillion as of end 2011. Looking forward, institutional investors in the major markets have indicated their intent to increase allocations to almost all alternative classes, including hedge funds. Increased institutional participation will
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drive growth as hedge funds become an important part of the investment landscape. To meet the demands of institutional investors and global regulatory standards, hedge funds have taken steps to beef up their risk management and compliance functions. In a recent study by the Managed Funds Association, BNY Mellon and Hedgemark, it was found that 79% of global hedge funds now separate the roles of the risk manager and fund manager, with 60% of the larger hedge funds having a dedicated risk management function. This augurs well for the hedge fund industry, as it allows the industry to grow in a more sustainable manner with strong internal control systems and risk management oversight.

Asia is well placed to provide capital and investment opportunities
As global institutions and investors seek to address challenges resulting from structural shifts in the global economy, many are turning to Asia to harness opportunities and to generate higher returns. This is due to a few reasons. Firstly, Asia has been leading the global recovery with growth expectations in developing Asia projected to exceed global growth at 6.7% in 2012 and 7.2% in 2013. Secondly, both demand and supply side factors in Asia are relatively positive. Corporate and government balance sheets are generally healthy. Households are not overly levered, savings rates are high and unemployment is comparatively low.
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The rising middle class, highly educated workforce and favourable demographics are also plus points for Asia. These factors, coupled with Asia’s strong commitment to economic openness and free trade, are important in creating a business friendly and conducive environment for its financial sector to continue to thrive and grow. Thirdly, with Asia’s relatively strong economic growth and favourable demographics, investible assets from the institutional and private wealth segments are set to grow. In a 2011 report published by Cerulli Associates, institutional investable assets from Asia ex-Japan are expected to triple from US$4.3 trillion in 2006 to US$13.6 trillion by 2015. Total wealth from the private wealth segment is also expected to increase. In its recent Wealth Report, Julius Baer expects the number of high net worth individuals in Asia to more than double over the next three years to almost 3 million. As Asia grows in wealth, there will be more capital requiring active and customised fund management expertise to take advantage of the investment opportunities in Asia. Asia’s strong fundamentals will support the valuations of Asian assets, which will draw a growing interest from institutional investors around the world looking to diversify and generate returns. According to Preqin, 46% of Asia-Pacific hedge fund investors intend to invest opportunistically in Asia-Pacific hedge funds, whilst 31% of Asia-Pacific hedge fund investors are looking to increase their longer-term allocations to Asia-Pacific. Deutsche Bank also noted in its 2012 Alternative Investment Survey that North America and Asia are currently the most sought after investment
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regions, with investors planning to allocate approximately 26% of assets to Asia.

Conclusion
As a source as well as a destination for investments, Asia presents compelling prospects for the hedge fund industry. Singapore’s strategic location makes us well-placed to serve as a hub with strong physical connectivity, trade and financial linkages to the rest of Asia. Together with our strong commitment to growing a well-regulated fund management industry, this makes Singapore an ideal vantage point for asset managers to understand Asia and to manage pan-Asian investments. So it leaves me now to congratulate SALT on its inaugural Asian leg of the SALT Conference. I wish all of you a fruitful conference ahead. Thank you.

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Gill Marcus: Why education is important to the South African Reserve Bank
Address by Ms Gill Marcus, Governor of the South African Reserve Bank, at the Partners in Performance 2012 Celebration Lunch at the Maths Centre, Braamfontein *** Good morning to the Board of Trustees, the partners, donors, members and friends of the Maths Centre for Professional Teachers. It gives me great pleasure to be here today. This is an institution whose work I have long admired, ever since I came to know its Executive Director, Ms. Sharanjeet Shan during my tenure at the Gordon Institute of Business Science. In my opinion, both Sharanjeet and her team are wonderful examples of what can be achieved when a small group of committed people sets out to make a difference in the world. From its humble beginnings in 1985, when it was only a very small outreach project run from Auckland Park school under the directorship of Mrs. Patchitt, the Centre has done extraordinary work to grow to the impressive organisation that it is today; one that is making a clear and important difference to the teaching, learning and understanding of Maths, Science, Technology and even entrepreneurship in the country. Without question, all of us are stakeholders in the outcomes of the South African education system.
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While the Maths Centre and other NGOs may work more directly in it and on it on a daily basis, as South Africans we see the reports and headlines. We know the statistics and we know the reality. We all know how critical it is to make every effort to steadily fix the education system, and to ensure that NGOs such as the Maths Centre, whose work is outstanding, act in a manner that renders such support. Why is education important to the South African Reserve Bank? This is not only for all the reasons we are familiar with, but because, as Michael Spence, the recipient of the 2001 Nobel Memorial Prize in Economic Sciences, has noted, “in a world in which knowledge and connectivity are increasingly the basis for value creation, failures in the education system are the surest form of exclusion there is.” It is also because the Bank, in fulfilling its mandate of price stability, touches the lives of every South African, directly or indirectly, and the greater the financial literacy in a society is, the better the understanding of the economy and the more effective is the inclusion in how society functions. So bear with me as I revisit some of South Africa’s educational facts and figures with statistics drawn from the National Planning Commission’s work. As the NPC points out, education is one of the Millennium Development Goals. It is also a prominent feature of South Africa’s Constitution. As such, our education system, one which encompasses just over 14 million learners, has received significant attention from government: • Grade R has been made mandatory for children turning five, resulting in a significant increase in the participation rate of these children. 80.9% were enrolled in 2007 compared to 22.5% in 1996. • Compulsory education for children aged 7 – 15 has been introduced.
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• Almost 6 million learners are fed nationally through the National School Nutrition programme. • The poorest 40% of our schools are exempt from school fees and have a no fee policy. • An equalisation of per capita government expenditure between races has been achieved. But despite this attention, as we all know, and as the NPC Commissioners put it clearly, “the system is grossly underperforming.” They go on to say that “several comparative studies show that South Africa’s educational outcomes are poorer than many poorer countries. Apart from a small minority of black children who attend former white schools and a small minority of schools performing well in largely black areas, the quality of education received by African learners remains poor. Literacy and numeracy tests are low by African and global standards, despite the fact that government spends about 6% of GDP on education and South Africa’s teachers are among the highest paid in the world (in purchasing-power parity terms)”. At the risk of stating the obvious, the causes and symptoms of this systemic underperformance are complex. Sometimes they seem intractable. But it is almost impossible to overstate the consequences since there is a clear relationship between the education that an individual receives and their prospects in life. Of course, there will always be exceptional individuals who transcend this generally true cause-and-effect relationship; those who, despite their lack of education, make notable successes of their life.

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Equally, the converse is true; there are many people who, despite all the educational opportunities in the world, never realise their potential. But for most of us, the relationship between education and success is a reinforcing one, one which starts with our socio-economic prospects at birth. It is these prospects which set the first potential parameters of our lives. They have a significant impact on our cognitive ability in early childhood and on the degree to which the foundations of learning, including our capacity to be numerate and literate, will be successfully laid. In turn, these early childhood foundations have a direct bearing on our educational performance in our early school years. These early school years then go on to influence our Matric educational achievement. And despite all the limitations of a Matric qualification, it was for most of us the key determinant of our ultimate educational achievement. It still is. Finally, more than any other factor, it is the quality of our educational achievement that ultimately affects our labour market performance, not least because it is a large determinant of whether we will be able to enter the job market at all. And from there, the cycle continues because our ability to enter the labour market – or not – then goes on determine the socio-economic situation of our own children. This inter-dependency between many causal factors is something that we ignore at our peril.

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This critical early phase is also one that we too often overlook in our relentless focus on pass rates and one pass rate at that, namely Matric exam results. This focus, while important, occurs far too late in the learning cycle of a child. Without question, Matric results are the obvious and critical ones to measure and assess ourselves against. It is simply unacceptable that we have such poor matric results in such an unacceptably high number of South African public schools. It is wholly without justification that our statistics show that of our university graduates, only 22% of 60 000 students graduated within the specified number of years. With the result that, to use Heather Dugmore’s words, our universities “become playgrounds for those who completed a substandard matric (instead of) places of higher education established to nurture top academic skills” But, as Professor Ruksana Osman, Head of the Wits School of Education pointed out so correctly: “To look at the end result, Matric, and declare the public education system is failing without attending to the issues in early learning gives us a distorted picture of the schooling system as a whole.” She makes it clear that she is arguing “for looking at the teaching and learning input from the earliest stage of schooling and not just the final output of schooling – the matric examination results.” This same point has been made by many others and I could not agree more. We need to be looking at the whole cycle and many indicators of success or signs of failure.
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We need to be broadening our definition of success to extend beyond just university degrees as an indicator and enabler of skills. Of the experts who have made this point are Mary Metcalfe, Mark Orkin and Jennie Glennie. In a newspaper article earlier this year, succinctly titled “Our pass rate focus is too narrow”, they outlined three critical additional indicators of success for education. The first is retention. In other words, are learners staying in school for a reasonable amount of time? This is not to say that all learners must, or will, finish 12 years of schooling. While this is unquestionably the ideal, the reality will always fall short. But how far does the reality fall short and for how many learners? Any situation where significant numbers of learners are leaving the schools system at a point before which they have a fundamental and critical mass of skill, cannot consider itself successful. The second is quality. Again, this is a self-evident and common sense indicator; one that speaks of meaningful teaching and learning and reasonable proportions of good and excellent marks within a framework of high standards. Access to education is of minimal benefit if the quality of that education is at best only marginally better than no education at all. The third additional indicator of success, over and above Matric pass rates, is equity.
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When education provides social mobility across issues such as gender, race, income and / or geography, it can be judged to be successful. When a lack of equity entrenches, rather than transcends, social patterns, the opposite is clearly true. Within this cycle of interdependence, and the debates around what successful education really looks like, quality Maths skills are critical – both as ends in and of themselves as well as means to various ends. In the same article I referred to earlier, Mary Metcalfe and her coauthors called Maths results “the litmus test of system quality for the needs of a modern economy.” And once again, the results of our litmus test are deeply troubling. While it is true that South Africa’s Maths pass rates have remained unchanged over the past few years, given that the number of candidates writing Matric Maths has declined, i.e. the denominator has decreased, basic Maths tells us that the numerator must have decreased too for this ratio to have remained constant. And this is precisely the case. The number of maths passes at the 40%-plus level were down from 85 000 to 67 000 for the period 2009 to 2011. Consequently, we have 18 000 fewer matriculants able to enter university programmes requiring this level. This decrease is compounded by marked differences between the provinces. While the pass rates of 27% in Limpopo and 20% in the Eastern Cape are deeply concerning, there is scant consolation to be had from looking at the best performing areas; only 54% of learners in the Western Cape achieved Maths passes at the 40% plus level compared to 45% in Gauteng.
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In defence of Limpopo and the Eastern Cape, however, it should be noted that 47% and 58% of matric candidates, respectively, at least attempted maths. In the Western Cape and Gauteng, however, it was only 35% and 38%. So, as with many things in life, the first and seemingly obvious problem we are presented with is not always the right problem and / or the only problem. Maths results are a litmus test not only because of the usefulness of maths skills in and of themselves but because such skills help develop a number of integrated thinking skills that are needed, today more than ever, to navigate a complex and changing world. Of course, maths is not the only thing that develops such integrated and integrative skills but it certainly helps lay a foundation. The first of these is creative thinking skills. While it may not seem so to many learners attempting to tackle an impenetrable calculus or algebra exam question, Maths really does help develop creative thinking skills, i.e. the ability to make connections between concepts and ideas that seem unconnected and unrelated. It was Steve Jobs, the founder of Apple, who said it best: “Creativity is just connecting things. When you ask creative people how they did something, they feel a little guilty because they didn’t really do it, they just saw something. It seemed obvious to them after a while. That’s because they were able to connect experiences they’ve had and synthesize new things.” Secondly, maths develops those problem-solving skills that allow people to recognise not only that a problem exists but also to be clear on what the
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right problem is, and, from there, to devise appropriate means of resolving it. This is a skill that is much more difficult than it sounds. Not least because there is a marked difference between the complex problems of real life and the exercises we get presented with in text books. Thirdly, maths helps develop decision-making skills, i.e. the capacity and competence to weigh up options and trade-offs between alternatives and, in the face of them, to make the best decision you can, at the time that you have to, with the information that you have. Finally, it helps develop the visualisation skills that allow us to imagine how things work – or could work – by looking at drawings, sketches or schematics. These integrative and holistic thinking skills are the ones that, at precisely the time we need them the most, are in chronically short supply. Not least because, in a world irrevocably changed by technology, we all too often fall into the trap of confusing instant access to almost infinite information with knowledge itself.

Clearly, information and knowledge are very different.
Just as real education is very different from much of the education that gets offered up. Real education is not the rote learning of facts that many of us were subjected to. Instead, it is the development of all our latent abilities. Similarly, real education concerns itself less with teaching us what to think and more with teaching us how to think.
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With these kinds of pressures facing all of us, the Reserve Bank is as subject as any other institution to the pressure to find positive ways to contribute and meaningfully enhance the capacity of our country. As part of our assessing our impact on stakeholders, the Bank recently concluded an extensive corporate reputation study. It was the first of its kind that we had undertaken and helped us to understand how we are perceived by our stakeholders, what the key drivers of our overall reputation are and what critical improvement areas and areas of strength we should address or leverage to further build our reputation. With the baseline now in place, we will be able to measure our progress as we proceed. The results of the survey were overwhelmingly positive, with the Bank considered highly respected and credible. It was clear that our stakeholders trust and respect us. However, their feedback also made the important point that the excellence that they see in us also imposes additional obligations on us. Specifically, stakeholders want and need us to engage even further with those parts of our society that are facing the most challenges, specifically education and the development of our youth. This feedback was very much in line with what the leadership of the Bank wanted to achieve. We had recognised the need to be more engaging with society and our stakeholders, and as part of a number of initiatives had taken a long, hard look at our Corporate Social Investment (CSI) policy. Of course CSI is only a small component of a company’s overall Corporate Social Responsibility.
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In the description offered by the World Economic Forum, Corporate Social Responsibility is “the entire contribution that a company makes to society through its core business activities, its social investment and philanthropy programmes and its engagement in public policy.” In the context of the current financial crisis, fundamental questions are being asked of central banks around the world. These questions go to the heart of our Corporate Social Responsibility. What is the role that central banks should have played in averting the crisis? What is the role we should play going forward? What is our contribution to society and to public policy? What should it be? As with education, these are complex, and in some quarters, contested issues. But as these debates continue, one of our responses at the SARB has been to institute a new Corporate Social Investment strategy based on four principles. First of these principles was that the Bank’s CSI policy and activities should be informed. In other words, our funding and partnership decisions should be grounded in research, benchmarking and an understanding of the legislative and other imperatives that underpin the South African CSI environment, one in which billions are spent every year. Education and skills development are universally accepted to be one of the key challenges facing South Africa.

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It is therefore a critical area for support and investment, not only when it comes to filling the Bank’s needs for skilled and trained employees but also for meeting the many challenges South Africa faces. Secondly, they should be meaningful. We want to ensure that whatever activities the Bank engages in are undertaken in such way that there is a real investment of effort and commitment from our side. This will not only maximise benefit for the Bank but also for partner organisations and, by extension, for society as a whole. Given the Bank’s unique role in the country, as well as its strong base as an institution of knowledge and research, it has a unique opportunity to add considerable value to many organisations, especially those working in education. Critically too, our activities should be partner orientated. We were adamant that the Bank should not seek to “reinvent the wheel”. Instead, it should focus on finding examples of best practice organisations and initiatives and partner with them. As and where the Bank does initiate something on its own, this would be the exception rather than the rule and only where a unique opportunity, one which by definition only we can fill, presents itself. Finally, we agreed that our CSI efforts should be aligned. In other words, we needed to be clear that the Bank’s CSI policy should be congruent with the Bank’s role as the central bank of the country, its strategy and its values. Our consequent focus on education is not only aligned with the Bank’s culture but also with its strategy, one which sees the Bank increasingly
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positioning itself as a knowledge institution with domestic and international stakeholders. Within our educational focus, there are a number of initiatives that we are very proud of as the Bank. These include our partnerships with three of the country’s universities – Rhodes, WITS and Pretoria. The partnerships with the Centre for Economic Journalism at Rhodes and WITS Journalism were motivated by the recognition that the Bank should seek to actively play a role in improving the level of economics journalism in the country. Monetary policy is a complex subject and it became of increasing concern a few years ago that the reasoning behind our decisions was not always sufficiently understood by the journalists who communicated them to the broader public. Our work with the Chair of Monetary Policy Economics at the University of Pretoria also aims to deepen the understanding of, and research into, the subject and to develop capacity in the field in South Africa and the continent. Our relationship with the South African Institute of Chartered Accountants is also one that we think is an important one given that we are working together to find, and nurture, talented upand-coming learners. At the same time, the generous bursaries that we give to talented students literally provide the potential to change the course of such student’s lives. But the project that we are particularly excited by this year is the pilot MPC Challenge which was initiated at the end of 2010. The Challenge was run in conjunction with the Gauteng Department of Education and modelled on initiatives run by other central banks around
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the world, including the Bank of England and the Reserve Bank of New Zealand. The aim of the challenge was threefold. Firstly, to increase understanding in South African schools of the role played by monetary policy and of economics. Secondly, to build relationships between the Reserve Bank, schools and learners and, thirdly, to get learners and schools excited about the subject of economics. Eighty three schools from across the province were chosen to participate in the inaugural challenge. The initial selection of schools was done having reviewed all Gauteng schools’ 2011 Matric Economics results. Only schools that received at least a 90% pass rate were invited into the inaugural challenge and invited schools represented all income quintiles and districts. The 56 schools that finally entered needed to select a team of between four and five Matric Economics learners. These teams were given data from the Bank’s Research Department to interrogate over the course of a few weeks in May and June. At the conclusion of the analysis period, each team then submitted a 1000 word essay to the Bank. Team essays followed the same format as the Bank’s Monetary Policy Statement, i.e. analysed local and global conditions and concluded with a decision as to what the country’s repo rate should be. Reserve Bank economists went through the initial essays and choose 5 finalist teams, who were then invited back to present to members of the Bank’s Monetary Policy Committee (MPC).
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The months of hard work by both Bank staff and learners and schools culminated on the 7th of August at a function at the Bank where Krugersdorp High School’s team were announced as the winners of the inaugural challenge. Both the team and the schools received cash prizes, the winning teacher a laptop and the team also became eligible for Reserve Bank bursaries. If you don’t remember the 7th of August, let me jog your memory by saying that it was the day that it snowed in Gauteng. Members of the Bank’s MPC Challenge team are still convinced that this is less to do with meteorological conditions and more to do with the fact that the walls of the Bank’s Conference Centre auditorium were resounding to the sound of The Black-Eyed Peas’ “I gotta feeling” as part of the winners announcement and celebrations. For those of you who know central banks, this is about as common as snow on the Highveld. The team’s final prize was to come to the Bank on the 20th of September with their teacher and school principal, as my guests, to be present at the live MPC decision announcement to the media. They then joined members of the MPC at a small function hosted in their honour afterwards. The challenge really offered a wonderful opportunity to Matric Economics learners and their teachers to make a very abstract subject come alive; to step into the shoes of the Bank’s Monetary Policy Committee and become central bankers for a few weeks and to be exposed to opportunities that might never have occurred to them otherwise. In this regard, Matthew Lester, a member of the winning team from Krugersdorp High School, made an indelible impression on me and all the judges of the MPC Challenge at the function after the MPC statement.

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In response to the question “What are you going to do after school?” he quite calmly and confidently informed us that he was going to study economics. While we were all nodding our approval, Matthew followed this up by pointing at Brian Kahn, my special advisor, and announcing that, once he finished his studies he was “going to join the Bank and then take his job.” The feedback from the Gauteng Department of Education, learners, teachers and the Bank’s members of staff who were involved was overwhelmingly positive; so much so that it was clear that we needed to continue with the Challenge and to take it further. How to do this most successfully is being considered at the moment and we look forward to announcing further details as soon as all necessary requirements are finalised. In conclusion, the words of one of the Gauteng Department of Education subject advisers we worked with on the MPC Challenge bear repeating and remembering by all of us. As she said it, “it’s not about how much we pour into learners but how much we plant”. A more feminine version perhaps of the Greek historian Plutarch’s wise admonition that “the mind is not a vessel to be filled but a fire to be lit.” Whichever way you say it though, the need to inspire and act was as true 2000 years ago in ancient Rome as it is in the world of the 21st century. It is as true for the Maths Centre as it is for the Reserve Bank. And it is as true when we work outside our respective organisations with our stakeholders as it is when we work within the boundaries of our organisation with each other. So, as we all navigate extremely challenging times – ones that show no sign of ending soon – may we all work together to contribute to fixing the
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education system, to plant seeds of hope and opportunity and to light fires of commitment and ability. Only then will we truly be able to deliver on the potential that South Africa holds. Thank you.

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Andrew G Haldane: The Bank and the banks

Speech by Mr Andrew G Haldane, Executive Director, Financial Stability, Bank of England, at Queen’s University, Belfast
***

The views expressed within are not necessarily those of the Bank of England or the Financial Policy Committee. I would like to thank Bethany Blowers, Forrest Capie, John Keyworth, Victoria Kinahan, Emma Murphy, Varun Paul, Richard Roberts, and the staff of the Bank’s archives for their comments and contributions. In the light of the financial crisis, there is much to explain. Doing so is not just important for reasons of accountability to the public. Explaining and understanding errors of the past is absolutely essential if policymakers are to learn lessons for the future. To misquote someone none of you have ever heard of, those who forget the errors of the past are doomed to repeat them. During the course of its 318-year history, the Bank of England has had plenty of crisis experience. And encouragingly, on my reading of history, there is evidence of it having learnt from this experience. In response, radical reform of the Bank’s policymaking framework has been commonplace. There are few better examples than the radical reform of the Bank’s transparency and accountability practices over the past twenty-five years.
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Those reforms are continuing to the present day. A wholly new framework for financial stability policy is being put in place in the UK, perhaps the most radical in the Bank’s history. I will discuss that framework later on. This framework can be seen as an evolutionary response to crisis experience, not just this crisis but a great many previous ones. It is impossible to know if this framework will proof us against future crises. But in remembering those errors of the past, it gives us a fighting chance of not repeating them. So I want to take you on an historical journey charting the Bank of England’s role in financial crises and its response to them. Now, I know what you are thinking. The evolution of financial stability in the UK viewed through the lens of the Bank of England sounds deadly dull. So I am going at least to try to add a touch of colour to the events and personalities of the time.

The very beginning
Let’s start at the very beginning. The Bank of England was put on earth, way back in 1694, to do none of the things it does today – namely, preserving monetary and financial stability. Instead, it was a confection of the then monarchs, William III and Mary II, to pay for their war debts.
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At the time the Bank was little more than a branch, with a mere twenty staff. Pretty early in its life, however, the Bank began to involve itself in the business of banking. It began to grow its balance sheet by taking deposits from and extending loans to other banks, typically by the practice of “discounting” bills of exchange. The Bank also issued its own notes which, due to the implicit backing of the government, circulated as currency with the public. At this stage, the Bank was far from being the nationalised, policymaking body we know today. Rather, the Bank was a quasi-private bank conducting its business for quasi commercial ends. Other banks at the time were engaged in similar commercial pursuits, including often issuing their own notes. Except, of course, they lacked the government as guarantor. This made for a competitive, and at times rather antagonistic, relationship between the Bank and the commercial banks. This strained relationship lasted for the whole of the 18th and a good chunk of the 19th centuries. Was the Bank friend or foe, collaborator or competitor? The commercial banks did not know. And the Bank – private in name but public in finances – was itself in a state of mild schizophrenia. These psychological flaws were exposed in the middle of the 19th century. By then, the Bank had been granted monopoly rights to issue currency.
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Quite literally, this cut the commercial banks out of a lucrative money-making scheme. This did little to ease competitive tensions between the Bank and the banks. This tension bubbled over in the famous case of Overend and Gurney Bank. In the early part of the 19th century, Overend had grown rapidly to become the largest discount house in London. If not too big to fail, it was certainly large enough to look after itself – as the Bank found out in 1860. Two years earlier, the Bank had abolished the right of other banks to come to it for cash by discounting bills. The banks took umbrage. With Overend and Gurney playing the role of shop steward, they collectively withdrew £1.6 million from the Bank over three days in an attempt to bring the Bank, if not to its knees, then at least to its senses. Dark, anonymous messages were sent to the Bank, presumably not by Twitter, warning: “Overends can pull out every note you have”. In the event Overend eventually caved, returning to the Bank the notes they had withdrawn apologetically – or at least semi-apologetically, as the notes actually came back cut in half. Six years later in 1866, when Overend and Gurney asked the Bank for an emergency loan of £400,000, the answer was “No”. The Bank won this battle, but was to lose decisively the war. Overend and Gurney failed. The City shook. Panic took hold.

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The Bank was forced to lend £4 million – ten times the initial sum – to support other banks. There was a chorus of disapproval. The Bank’s role in crisis management would never be the same again.

Supporting the financial system
Criticism of the Bank’s role in the Overend crisis came prominently from Walter Bagehot, then-editor of The Economist and Bank-of-England basher of his day. He lambasted the Bank’s acting “hesitatingly, reluctantly and with misgiving”. Henry Gibbs, Governor of the Bank from 1875 to 1877, highlighted the Overend experience as “the Bank’s only real blunder”. Yet the Bank had also learned from this experience. It had discovered that its role could be neither commercial nor competitive. Instead its role was as guardian of the financial system as a whole, protecting banks from what is today called systemic risk. In Bagehot’s words, the Bank should act as last resort lender to solvent institutions against good collateral at a penalty rate. It has done so ever since. The Bank did not have to wait long to put its new-found role into practice. On Saturday 8 November 1890 the Bank Governor of the day, William Lidderdale, summoned his Directors. This itself aroused suspicion. Bank directors were never seen at work at the weekend.
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They typically departed for the country around Friday lunchtime. (Let me tell you, things have changed for Bank of England Directors since then.) What Lidderdale told his Directors was electric. There were serious liquidity problems at another big and famous bank, Baring Brothers and Company. But the Bank had not the faintest clue as to Barings’ true financial position. To rectify that, Lidderdale ordered an accountant’s report on Barings to be brought to him with immediate effect. And with that, he departed to London Zoo with his son. The accountant’s report showed a solvent but illiquid Barings. Back from the Zoo, Lidderdale began to construct a financial “lifeboat” for Barings, with a contribution from the Bank but also from the commercial banks. This was the system acting in support of the system. The lifeboat was launched and Barings was saved, in what has become known as the “crisis that never became a drama”. The Bank’s lifeboat has since been re-launched on more than one occasion. A second financial lifeboat – different in detail, but identical in principle – was launched by the Bank of England in the early 1970s. Then, it was intended to save the small banks rather than the large. It, too, steadied some sinking ships.
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Third time, however, was not so lucky. On 24 February 1995, it was Barings Bank who were again knocking on the Bank of England’s door for help. Bank Directors were again summoned on a Saturday. I myself was caught by a TV crew entering the Bank on that Saturday morning, arousing suspicion something was amiss. In fact, I had not been recalled to save the day. (I believe I was filmed wearing a tracksuit.) And I was as blissfully unaware of Barings’ problems as most of the rest of the world. (I was at the Bank completing a research paper on “A Structural Vector Autoregressive Model of the Monetary Transmission Mechanism”.) Life was easier then. Nick Leeson, at the time a despised and corrupt rogue-trader, today a much-admired reality- TV star and after-dinner speaker, had put a huge hole in the Barings boat. Over the weekend, then-Governor Eddie George tried hard to assemble a lifeboat. All visits to London Zoo were cancelled. But the lifeboat failed and with it Barings. That Barings was allowed to fail, and did so without rupturing the system, is a key lesson for today, to which I will return later. So what does this tell us about how the Bank of England’s role had evolved on entering the 20th century?
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The Bank now spoke and acted as steward of the financial system, marshalling its own and others’ financial resources to keep the financial system panic-free. The Bank was at the frontline of crisis management. But these episodes also contained lessons. When the first Barings crisis came, the Bank had been reactive and backfoot. It had been blindsided by the risk to its own and the financial system’s balance sheet. The Bank was finding its feet as a crisis-container. But in attitude and expertise, it was a world away from being an effective crisis-preventer.

Supporting the economy
Fast forward to the start of the First World War. William Lidderdale had been replaced as Bank Governor by Walter Cunliffe. Cunliffe was not what would these days be called an equal opportunities employer. The Bank’s staff rules were stifling and sexist – although were ahead of their time compared to other City firms. The Bank went 150 years without employing any women at all. When they did, it was to do the work of 15–18 year old boys, sorting and listing returned notes.

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On getting married, women at the Bank were required to resign their position. The Bank was “Old Lady” by name but “Young Lady” by nature. Cunliffe’s greatest achievement was his contribution to solving the financial panic of 1914. On Friday 24 July, the City woke to the threat of war as Austria made an ultimatum to Serbia. There was a worldwide scramble for the safety of cash. Mass-selling led to stock markets closing in Europe, then New York, then Australia. London was not exempt. By 31 July, the London Stock Exchange had closed for the first time in its near 150-year history. Panic soon spread to the money markets, sucking liquidity and life out of the financial system. Unable to finance themselves, lending by the banks began to drain away, starving the economy of credit and causing it too to crater. This was truly a credit crunch. Cunliffe’s plan, hatched with the Treasury, was to lift the liquidity burden on the banks by purchasing the IOUs they were holding from overseas borrowers which had become understandably illiquid on the outbreak of war. These bills were bought by the Bank and stored in its vaults, in what became known as the “cold storage” scheme. By freeing the banks’ balance sheets in this way, the cold storage scheme was intended to stimulate credit.
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It was only a limited success, with the banks still fearful about making new loans because of the rising risk of default by overseas borrowers. In response, the government announced an extension to the scheme, with the government effectively insuring the banks against the credit risk on these assets too. It worked. Within a couple of months, money market conditions had stabilised and credit was once more flowing. Cunliffe’s cold storage plan had averted a credit crisis. The cold storage scheme was a piece of clever financial engineering by the Bank, designed to support credit and the wider economy. In the past few years, with credit growth and the economy weak, the Bank has been in the vanguard of creating new pieces of machinery to serve a similar end. In 2008, the Bank introduced a Special Liquidity Scheme, or SLS, to help finance UK banks’ legacy asset portfolio. Over £180 billion of support was provided to the banks and has since been repaid. The SLS bears more than a passing resemblance to the first phase of the cold storage scheme. In June this year, the Bank announced a second scheme, the Funding for Lending Scheme, or FLS. It provides liquidity support to UK banks on terms which depend on their lending to the UK economy, thereby acting as a direct incentive to stimulate new lending. The FLS bears some resemblance to the second phase of cold storage.

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The SLS and FLS may be less famous than JLS, the London R&B boy-band. But they are an important recognition of the Bank’s role in supporting credit intermediation. That role began in the early part of the 20th century with schemes like cold storage. The Bank’s role had expanded beyond its own doorstep, on which the banks stood, to the doorsteps of households and companies up and down the country seeking credit.

Supporting financial infrastructure
Yet one thing at least had stayed the same: in 1914, the Bank had only acted when jolted into doing so by war. Its role was still as crisis-container rather than preventer. During the 1920s and 1930s, the Bank of England became Montagu Norman’s Bank. And Norman set about changing that. Norman was not Cunliffe’s greatest fan and the feeling was clearly mutual. “There goes that queer-looking fish with the ginger beard again”, Cunliffe is said to have observed about Norman. “Do you know who he is? I keep seeing him creep about this place like a lost soul with nothing better to do.” Nor would Norman necessarily have ingratiated himself to today’s army of Bank economists.
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“You are not here to tell us what to do, but to explain why we have done it” is the way Norman rebuked the Bank’s Chief Economist of the day. Norman saw the Bank’s role in expansive terms, as provider not just of emergency help but as builder of infrastructure and supporter of industry. The Bank became part of the post-war reconstruction effort. Having spent 200 years tending to its back garden, the Bank began to explore pastures new. To take one example, in 1928 the Lancashire cotton industry was on its knees. These problems risked ricocheting back to the financial system, with at least two of the big five UK banks up to their neck in cotton. A plan was conceived involving consolidating the industry into a Lancashire Textile Corporation. This was to be financed with debt and shares issued and supported by – you’ve guessed it – the Bank of England. It was a bold and cunning plan. Unfortunately, it flopped. The share issue by the Corporation in 1931 was a resounding failure, leaving the underwriter with a large chunk of the shares. The Bank ended up having to support the market. It, too, found itself up to its neck in cotton. Undaunted, the stage had nonetheless been set for the Bank’s on-going involvement in financial infrastructure. This came not a moment too soon. In the immediate post-war period,
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the UK faced pressing financial infrastructure problems – the so-called “Macmillan gaps”. These gaps referred the inability of small firms to finance themselves with long-term loans. If these gaps sound strangely familiar, then they should. The post-war Bank set about closing these Macmillan gaps with gusto. In 1945 it set up two new financing entities – the Finance Corporation for Industry (FCI) and the Industrial and Commercial Finance Corporation (ICFC). These were financially supported by banks and institutional investors, providing a platform for the supply of longer term funding and venture capital finance to small firms. In 1973, the two corporations combined to form Finance for Industry (FFI). During the early 1980s, the company was rebranded as Investors in Industry, commonly known as 3i. In 1987, the entity went public as 3i Group. This was not a flop. Arguably, 3i and its predecessors were one of the largest feathers in the Bank’s post-war cap, helping support generations of new businesses and start-ups. And those MacMillan gaps? Regrettably, the crisis has re-opened them. Today, small firms are once more starved of finance, including many here in Northern Ireland.
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Once again, the quest is on for a new financial infrastructure to help close these gaps. Through the 1980s and 1990s, there were further examples of the Bank stepping in to close structural financial gaps. When the UK’s high-value payment system started creaking in the early 1980s, the Bank designed and built a new, bullet-proof system. Given the Bank’s somewhat chequered record on gender diversity up to that point, it was rather unfortunately named CHAPS. And indeed still is. In 1993, the Bank stepped-in to rescue a flagging project to upgrade the securities settlement process in the UK. The Bank designed and built a new, safety-first, system which again exists to this day. Fortunately, we did not call this one BLOKES, but rather the gender-neutral CREST. Most recently, in the light of the crisis, the Bank has been at the forefront of the debate about re-organising the structure of banking, with a ring-fence or firewall between the basic retail and investment banking sides of the business. This structural approach is increasingly finding favour both in the UK (through the proposals of the Vickers Commission) and internationally (for example, through the Volcker proposals in the US and the recent Liikanen proposals in Europe). For the past half-century, the Bank’s structural agenda has become a central feature. But at the time it marked a radical departure from the Bank’s past.
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Designing what are in effect financial public goods is a front-foot activity. The Bank had grown a new limb, augmenting its crisis-management right arm with a crisis-prevention left arm.

Stitching it all together
So far, I have made no real mention of monetary policy. That is because, for much of its life up to the early 1970s, monetary control at the Bank of England was pretty simple. It came care of fixing the exchange rate – first to gold under the Gold Standard and latterly in the post war period to the dollar. With the demise of the dollar standard in the early 1970s, however, the exchange rate anchor had been tossed overboard. At the Bank of England, as elsewhere, the search was on for a new nominal anchor. Into this vacuum stepped Andrew Duncan Crockett. Crockett joined the Bank in 1966 as a graduate entrant, just before the break-up of the Bretton Woods dollar standard. He set to work on the biggest problem of the day, locating a new nominal anchor. In so doing, he began working alongside another young(ish) new Bank entrant, Charles Goodhart. The result was a joint paper published in the Bank’s Quarterly Bulletin in June 1970. It was titled “The Importance of Money”. Re-reading it now, it was a prophetic piece of work.
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In the UK, it laid some of the analytical foundations for what, during the late 1970s and 1980s, became monetarism. More than that, the paper placed commercial bank money and credit at the centre of the macro-economy. It could as well have been titled “The Importance of Credit” or indeed “The Importance of Banks”. After a successful spell at the IMF, Crockett returned to the Bank of England in 1989. In 1994, he then became General Manager of the Bank for International Settlements, the central banks’ central bank. In central bank circles, change was in the air. Monetary policy was embarking on a path which targeted inflation and which, unlike monetarism before it, downplayed money and credit. And the regulation of banks, long the preserve of central banks, was in many countries being hived off to separate regulatory agencies. What happened next was truly extra-ordinary. Whether by coincidence or causality, the world experienced the largest banking bubble in history. Between 1990 and 2007, global bank balance sheets rose by a factor four. On the eve of the crisis they had reached around $75 trillion, or almost 1.5 times the annual output of the entire planet. At the Bank for International Settlements, Andrew Crockett saw trouble brewing. In 2000, he gave a speech calling for a “macro-prudential” approach to regulation.
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Crockett argued that central banks needed to look at, and act on, developments across the whole financial system if systemic risk was to be headed-off. Credit booms, the like of which was occurring for real at the time, sowed the seeds of that systemic risk. The rest is of course history, as pre-crisis credit boom turned to shuddering bust. Or rather it would be history were it not for the fact that this crisis, whose seeds were sown in the credit boom, is still with us. Output in the UK is still well below its 2007 level. The so-called Great Recession in the UK is already as severe as the Great Depression of the 1930s. In response, the policy framework has, once more, been radically augmented. Macroprudential policy is the next big thing. It is now widely acknowledged as the missing policy link during the pre-crisis period, the essential bridge between monetary policy and regulation. As I discuss below, this bridge is now being constructed through new frameworks in the UK and internationally.

The Bank tomorrow
So where does all of this leave the Bank today and, indeed, tomorrow? In the light of the crisis, we are moving to a wholly new structure for financial policymaking in the UK.

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In many important respects, this can be seen as building on the lessons of history. To illustrate that, let me set out some of its main features. First, there is to be a radical shift in the organisation and approach to supervising individual financial institutions. The UK will move to a so-called “twin-peaks” regime. That means in practice separating the safety and soundness aspects of the regulation (so-called prudential) from the consumer protection aspects (so-called conduct). The prudential part will from next year sit in the Bank of England in a new Prudential Regulatory Authority, or PRA. This is much more than deck-chair rearrangement. Accompanying this change will be a rootand-branch change in our approach to supervision. There will be a focus on the big risks – the Barings of yesteryear, the RBS of yesterday. Supervision will be front-foot, testing for stress before it strikes and visits to the zoo need to be cancelled. It will be also tolerant of bank failure – Barings Mark 2 rather than Mark 1 – so that market discipline can work its magic. Second, during the course of the crisis, there has been a radical, if underplayed, rethink of the Bank’s approach to supplying liquidity to the banking system. While not quite a change on the scale of the Overend and Gurney crisis, this allows banks to access the Bank’s facilities against a much wider range of collateral.
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The Bank’s liquidity menu is now crystal clear, from which banks can now themselves choose. Third, an entirely-new piece of policy machinery has been introduced – new not just for the UK, but internationally too. In the UK, this is called the Financial Policy Committee or FPC. It was put on earth to do macro-prudential policy, to act as the bridge, to provide the missing link, to monitor the punchbowl before it is emptied and before aspirin needs administering. A year on, the FPC is doing just that. Most recently the FPC has been navigating a particularly hazardous course. The financial system and economy are suffering the hangover from hell. The FPC’s task is to keep the system safe in the face of heightened risks of a relapse, while at the same time keeping the banks’ credit arteries open to support the economy. Both objectives are steeped in the Bank’s history – and both objectives are embodied in the FPC’s remit. The FPC has a remit, too, to strengthen the structural fabric of the financial system, including through improved financial infrastructure. That objective has a place deep in the Bank of England’s heart – from Lancashire cotton mills of the 1930s, to 3i of the post-war years, to CHAPs of the 1980s, to Vickers of the past few years. Supporting and executing these new responsibilities will be a massive task. First and foremost, it will require the Bank to have a rich and diverse set of skills.
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Historically at least, the Bank has been skills-rich but diversity-poor. But I am pleased to say that, too, has been changing for the better. This year’s graduate intake has close to a 50/50 gender split. One in seven of the intake is drawn from ethnic minorities. Only a fifth come from Oxford or Cambridge. The PRA’s arrival next year will broaden further the diversity of the Bank’s skills and experience – legal, accountancy, banking, insurance. The Bank’s policy committees, meanwhile, bring diversity of experience and expertise to the decision-making table, from academe and the private sector. There has been a transformation, too, in the Bank’s approach to external communications and transparency. Think back twenty years. Then, there were no quarterly Inflation Reports, no six-monthly Financial Stability Reports and certainly no press conferences to accompany both. Twenty years ago, there were no minutes of the deliberations of the Bank’s policy committees (today, the MPC and FPC). Back then, press interviews were rare and scripted to within an inch of their life. In the past year, Bank officials gave around 65 speeches and over 200 press interviews. In Montagu Norman’s day, the combined total was one. The days of “keeping the Bank out of the press and the press out of the Bank” are well and truly gone.
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Earlier this year, the Governor gave the Bank’s first live peacetime radio address to the nation for 73 years. The Bank Tweets, fortunately with rather less vigour than your average Premiership footballer. Soon we will have, for the first time in history, published minutes of the Bank’s Court of Directors. The Governor has appeared before the Treasury Committee on no less than 47 occasions since he took office. In 2011, a word search of “Mervyn King” in the press revealed more hits than “Kylie Minogue”. To my knowledge, this is the first time a sitting Bank of England Governor has toppled the Aussie pop princess in the media opinion polls. Given its new responsibilities, the Bank cannot fail to remain in the public’s eye in the period ahead. Transparency and accountability will remain the watchwords – and rightly so.

Conclusion
When pressed by the Macmillan Committee in 1930 to explain the Bank’s actions, Montagu Norman replied: “Reasons, Mr Chairman? I don’t have reasons, I have instincts”. I suspect such an answer would work less well with today’s Treasury Committee, to say nothing of today’s media. All public policymakers have an obligation to explain. And all policymakers have an obligation to learn from past crises and past mistakes.
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That is the only way credibility can be built: not the avoidance of crises and mistakes, which is impossible, but the recognition by the public that, when they do happen, the crises are contained and the mistakes are honest ones. The Bank of England is embarking on the latest chapter in its 318-year history. We cannot avoid a crisis but, as with Barings in 1890, we can endeavour to prevent it becoming a drama. We will certainly be doing our best to prevent it becoming a tragedy like that of the past few years. If nothing else, this new chapter will have learnt from, and will build on, the lessons of history. Thank you.

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Proposal for a Directive of the European Parliament and of the Council on criminal sanctions for insider dealing and market manipulation (MAD)
State of play and orientation debate

INTRODUCTION
1. On 21 October 2011 the Commission presented a proposal for a Directive of the European Parliament and of the Council on criminal sanctions for insider dealing and market manipulation (hereinafter "MAD") as part of a broader "package" of measures, including proposals currently under discussion in other preparatory bodies of the Council (Directive on markets in financial instruments - "MiFID"; Regulation on markets in financial instruments and OTC - "MiFIR"; Regulation on insider dealing and market manipulation - "MAR"). 2. The proposal for MAD has been examined in the Working Party for substantive criminal law (DROIPEN). On 25-26 April 2012 the Justice and Home Affairs Council reached partial general approach on Articles 5 to 12. Delegations kept open the possibility to revert to those provisions in the light of further developments in the negotiations concerning the remaining parts of the Directive. 3. The Cyprus Presidency resumed discussions on MAD at the meeting of DROIPEN on 9 July 2012. Subsequently, the Council Legal Service issued an opinion on the appropriateness of the legal basis of the proposal and on the compatibility of the proposal with the ne bis in idem principle.
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[Note: Ne bis in idem, translates literally from Latin as "not twice in the same". It means that no legal action can be instituted twice for the same cause of action. It is a legal concept originating in Roman Civil Law, but it is essentially the double jeopardy clause found in common law jurisdictions] 4. Furthermore, on 27 July 2012 the Commission submitted an amended proposal, integrating in the scope of MAD questions concerning the manipulation of benchmarks for interbanking lending rates; a similar proposal was submitted concerning MAR. 5. On the basis of these documents, and building on the comments received from delegations, the Presidency has presented an amended draft text of the Directive. This draft was discussed at the meeting of the Friends of the Presidency on 12 October 2012. Further meetings are planned for 22 October and 9 November 2012. 6. Given the outcome of discussions of the meeting of 12 October 2012 the Presidency would like to ask the Council for orientation in view of future work on the proposal, in particular for what concerns the question relating to the application of the principle of ne bis in idem.

APPLICATION OF THE PRINCIPLE
7. The legal basis of MAD is Article 83 (2) TFEU, according to which provisions of substantial criminal law may be the object of approximation through Directives when this "proves essential to ensure the effective implementation of a Union policy in an area which has been subject to harmonization measures". In this respect, MAD compliments MAR by ensuring proper implementation of the rules set out therein. For this purpose, it imposes on Member States the obligation to provide in their national law that certain forms of insider dealing and market
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manipulation are punishable as criminal offences, through sanctions which are dissuasive, proportionate and effective. 8. This implies that the description of the offences (administrative offences in MAR, criminal offences in MAD) is partially overlapping, with the concrete possibility that certain conduct may fall both within the scope of application of the administrative penalties provided for by MAR and within that of the criminal sanctions which the laws of the Member States will provide once MAD has been implemented. It should be recalled that this situation, i.e. that the same conduct may be punished both by criminal and by administrative sanctions, is common practice in several Member States while it is not known in some Member States. 9. It must be further recalled that, under certain conditions, penalties which are labelled as administrative could be considered to be in substance of a criminal, or punitive, nature. Among others, the case law of the European Court of Human Rights has since many years elaborated on the principles applicable (the so-called "Engel criteria", after the leading case on the subject of 1976) in its case-law. The CJEU has integrated these criteria in its own jurisprudence. 10. Considering the above, it could be argued that the current structure of the MAR and MAD proposals may give rise to tensions with the principle of ne bis in idem, enshrined in Article 50 of the Charter of Fundamental Rights of the European Union. In accordance with this principle, if a person has already been subject to criminal proceedings for a particular offence, and if he has been acquitted or convicted by a final decision of a competent authority of a Member State, that person cannot be subject to new criminal proceedings for the same act within the Union.

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11. During discussions in the Working Party, it has been indicated that the risk of breaching the ne bis in idem principle could present itself if the competent authorities of one (or more) Member States applied to the same conduct of a person both the criminal sanctions provided for under their national law for that criminal offence and administrative sanctions provided by MAR, when these are of such severity to be substantially considered punitive under the "Engel criteria". It should be noted, in this context, that the ne bis in idem principle applies across the borders of the EU. 12. Some delegations have indicated that this risk should already be taken into consideration at the level of the EU legislation and, consequently, be addressed by specific provisions of MAD (and MAR) regulating the relationship between the different instruments and sanctioning regimes. In the opinion of these Member States, since EU law imposes both an obligation to provide for administrative sanctions (in MAR) and an obligation to provide in national law for criminal sanctions for certain types of conduct (in MAD), it should be the same acts of EU law to provide Member States with the rules to avoid conflicts between these sanctions. 13. A number of other delegations disagree with this point of view. In their opinion the question of respecting the principle of ne bis in idem does not arise at the level of the EU legislation, but rather must be addressed by the competent authorities of each Member State in the application of the legislative instruments to a concrete case. Accordingly, the mere fact that MAR and MAD provide for (potentially) interfering sanctions - as is the case in the national law of several Member States - does not have any significance in relation to the principle of ne bis in idem. Instead, it is for the authorities of each Member State, acting in accordance with the rules of their legal system, to avoid in a concrete case that the simultaneous application of different types of sanctions would
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violate the right of the person not to be tried twice for the same offence. Each Member State would therefore be called to regulate the relationship between criminal and administrative sanctions for insider dealing and market manipulation in accordance with the specific rules that their legal system already employs to protect the ne bis in idem principle.

CONCLUSIONS
14. In the light of this discussion, and in order to advance in the examination of the proposal, the Presidency asks the Council for guidance. The Ministers are invited to express their views on this matter and, in particular, on the following questions: · Do Ministers consider that the protection of the principle of ne bis in idem is relevant in relation to the MAR and MAD proposals? · In case of a positive answer to the previous question, do Ministers consider that the task of protecting the principle of ne bis in idem should be left to each Member State, when implementing this legislation and in its application?

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Certified Risk and Compliance Management Professional (CRCMP) distance learning and online certification program.
Companies like IBM, Accenture etc. consider the CRCMP a preferred certificate. You may find more if you search (CRCMP preferred certificate) using any search engine. The all-inclusive cost is $297. What is included in the price:

A. The official presentations we use in our instructor-led classes (3285 slides)
The 2309 slides are needed for the exam, as all the questions are based on these slides. The remaining 976 slides are for reference. You can find the course synopsis at: www.risk-compliance-association.com/Certified_Risk_Compliance_ Training.htm

B. Up to 3 Online Exams
You have to pass one exam. If you fail, you must study the official presentations and try again, but you do not need to spend money. Up to 3 exams are included in the price. To learn more you may visit: www.risk-compliance-association.com/Questions_About_The_Certif ication_And_The_Exams_1.pdf www.risk-compliance-association.com/CRCMP_Certification_Steps_ 1.pdf

C. Personalized Certificate printed in full color
Processing, printing, packing and posting to your office or home.

_____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com

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D. The Dodd Frank Act and the new Risk Management Standards (976 slides, included in the 3285 slides)
The US Dodd-Frank Wall Street Reform and Consumer Protection Act is the most significant piece of legislation concerning the financial services industry in about 80 years. What does it mean for risk and compliance management professionals? It means new challenges, new jobs, new careers, and new opportunities. The bill establishes new risk management and corporate governance principles, sets up an early warning system to protect the economy from future threats, and brings more transparency and accountability. It also amends important sections of the Sarbanes Oxley Act. For example, it significantly expands whistleblower protections under the Sarbanes Oxley Act and creates additional anti-retaliation requirements. You will find more information at: www.risk-compliance-association.com/Distance_Learning_and_Cert ification.htm

_____________________________________________________________ International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.com