Solvency II Updates and Corporate Governance in Financials - PRA "Back for Good"?

A few releases of note out of the UK regulator over the last working week or so means I had some catching up to do - sometimes it feels like "All I do each night is PRA"...

They started off with a Director's Letter just before the bank holiday weekend. A general unwillingness to crack whips was present throughout this doc, even at this late stage, with a few references to "inform your supervisor" as opposed to "just do it".

The letter states that the PRA were due to publish some of their findings from their balance sheet review work by the end of the month - not done as yet, hopefully turns out to be money well spent

Regarding Standard Formula appropriateness:

• They stress that firms must identify deviations from Standard Formula from their risk profiles, and include an assessment of the significance of that deviation in their ORSAs (emphasised in their October industry presentation from p6)- is the implication here that firms are not doing this at all at the moment, or just not reporting it in ORSA?
• Highlight that "supplementary information" used to explain such deviations will also be assessed by the PRA. Does this add significance to one's qualitative commentary around Standard Formula/Risk Profile deviations? Can a good explanation be the difference between having to IM/PIM at the earliest opportunity against being given a couple of years of capital add-on breathing room?
• The PRA note that, "...where a firm's conclusion on this question is not appropriate", it will intervene. It is not clear how a firm's conclusions about its deviation between SF and its Risk Profile could be considered "not appropriate", but I imagine that anything which attempts to dodge USPs/PIM/IM ONCE the divergence hits the limits in the Delegated Acts (276-287) would be frowned upon. There is certainly no appetite at the PRA for renewing capital add-ons in perpetuity (slide 13), which given the UK's familiarity with ICA and ICG, might be a desperado's first chance saloon.
• The PRA are planning "specific interventions" on this front (detailed here), but not necessarily in time to correct before 2016.

Regarding Internal Models

• Not happy with "wide variation in quality of IM Change policies. Sounds like firms are doing their best to avoid change criteria that results in frequent submissions for reapproval, which one would expect!



IMAP Submissions
- Everything Changes

• PRA seemingly expecting firms to have not only taken on board their feedback, but also had their IMs revalidated, before submitting their IM application. Given that validation will be chalked down as a 'once-a-year' job at the moment (despite the IRM's efforts), that seems highly unlikely. They give themselves a get-out-of-jail-free card though by stating that firms must be confident that any changes in their IMs both address PRA feedback and meet the tests and standards for model approval.
• They appear to advise against submitting applications if you have a material change in the pipeline.
• Heavily critical of Board involvement in validation. Here they look for evidence of Boards "overseeing and influencing" the validation process, whereas previous PRA presentation slides  did not have such expectations of Boards (slide 8 here), or indeed expected more (slide 9 here)!
• The expression "internal management loadings" appeared in my life for the first time, which sounds to a non-technical person like myself that firms are effectively "dumbing-up" the capital requirement currently delivered by their IM in order to plaster over mathematical or data weaknesses. PRA certainly not impressed by industry suggestions to date.
• Given the number of firms who must have dropped out of looking for Day 1 approval, they still shake the pineapple tree here in order to remind applicants that contingency plans should be ready in the case of application failures. "Many firms still have a considerable amount of work to do" sounds to me like some applicants are being pre-warned of their imminent failure!

The PRA also released a consultation paper entitled Corporate Governance: Board Responsibilities, which has the rather light ambition of identifying "key aspects of good board governance to which the PRA attaches particular importance in the conduct of its supervision".

A few straggler items in it;

• That failures in governance and/or risk management have been a key factor in "many" financial sector failures - as opposed to "all"
• That they consider the FRC's Corporate Governance Code, amongst others, a "comprehensive guide to good corporate governance" - given the firms experiencing the financial sector failures were most probably complying with it, not a great advert!
• "Culture is the collective responsibility of the Board" - a bit of a nowhere comment, but instinctively, I don't see how this can be right. They can be accountable to both supervisors and shareholders/members for cultural failings, but where could such a responsibility materialise into demonstrable actions? 
• "...the Board is responsible for the oversight of, but not for managing the business" - in relation to my comment directly above, can both statement be correct?
• "The Risk Control Framework should flow from the Board's Risk Appetite" - I'll work on the premise that this is missing the word "statement" at the end of the line
• Section 11 on remuneration expects that incentives are aligned with "prudent risk taking" - what if prudence is too conservative for one's risk appetite?

Into some of the expected themes;

• Strategy to be "owned by the Board as a whole"
• They wed Culture and Remuneration "...to encourage and enforce the kind of behaviours the Board wished to see"
• They want a "well articulated and measurable" Risk Appetite Statement which can also be "...readily understood by employees throughout the business". Doesn't seem feasible, given the metrics commonly used in risk appetite statements are not exactly Finance 101 (Solvency/Liquidity/Earnings-related),
• "It is the responsibility of the Board to ensure that the effectiveness of the Risk Control framework is kept actively under review" - has at least an air of COSO about it, don't think it was deliberate
• Big section (6) on responsibilities and accountabilities of exec and non-exec directors.
• Followed in 7.1 with "...non-executives should not simply delegate responsibility for major decisions to individuals among them who are considered specialist in the area" - this has internal models written all over it (p5-6)!

Happy to see this second document, though I don't know what it adds to firms' understanding about what is "good and bad".




"Comply or Explain" responses to EIOPA's preparatory guidance - UK oddities?

Isle of Man - "Call that a flood"

Happy New Year (or Blein Vie Noa as we say on the relatively unflooded Isle of Man). I hope you all took the opportunity to fall ill and get fat like I did, so we can recommence battle in 2014 with overflowing sinuses and bursting belt buckles...

I managed to take a look at some of the responses that EIOPA have received regarding whether or not the 32 National Competent Authorities (NCA) currently invested in the Solvency II game are planning to follow EIOPA's Preparatory Guidance over the next 2 years. Please serve yourselves from this central location.

It became evident over December that there was likely to be some non-compliance (both the French and British put their heads above the parapet), though as this was a "comply or explain" exercise, this was not necessarily grave - we are after all in the business of 'preparing' at this juncture - but I was curious to see precisely how different countries "explained" themselves.

In response to each guideline within the 4 EIOPA documents, the options for each NCA were to respond;

1. Yes - we already comply
2. Yes - we intend to comply
3. No - we do not and will not comply
4. Not applicable (though I'm not certain why this is an option)

They were also given space to provide text/links to prove how they are compliant with each guideline, and som space to provide explanations (questionnaire template here).

I was therefore surprised to see the British approach (which was generally "yes") also involved;

• Not providing an explanation when they have said "No" to a guideline (which admittedly is only in one case!)
• Unnecessarily using a copy/paste piece of text as an explanation for a number of guidelines where they have said they "Intend to comply"
• Unexpectedly answering "Not Applicable" to no fewer than 10 articles within the System of Governance guidance, some of which definitely featured in the feedback on the PRA's recent Supervisory Statement as bones of contention (the actuarial function's responsibilities for example).

Obviously no surprises that the French will not be attempting to comply anything in the System of Governance world after their earlier warning, though their rationale is expanded upon in this Risk.net article. That the strict definition of "AMSB" is an issue for the French industry is surely old news at this juncture, and it is ludicrous that such a matter has yet to be dealt with by the Commission's draftsmen. It certainly hasn't posed an issue for Germany (who intend to comply with all of Sys Gov), who operate dual boards.

While more may emerge over the next few weeks on what has been submitted here across the countries, I am more immediately interested in why the UK have elected to respond "not applicable" to so many System of Governance guidelines. It seems to fly in the face of their Supervisory Statement, and I can't imagine EIOPA are satisfied with that response. 

Reporting/Submission of information to NCAs - EIOPA's FINAL preparatory guidance for national supervisors

And last, but not least, EIOPA have produced their final preparatory guidance to NCAs regarding the submission of information by firms to their supervisors, covering both quantitative reporting templates (QRTs) and narrative reporting. The consultation paper (summarised here by the PRA) caused quite a stir due to the volume of requirements during what is purported to be the 'preparatory phase', and even EIOPA's own Insuarnce and Reinsurance Stakeholders Group (IRSG) put the boot in on a number of elements.

It was of course natural that a combination of parallel running, legacy system horror-shows and potential ambivalence from third party information vendors was going to make this consultation the most controversial, but that said, the outcome appears to be pretty fair insofar as concessions have been made by EIOPA while still keeping the pressure on over-reluctant firms to construct the required processes in a timely manner.

One attempt at quarterly reporting is therefore retained (set for Q3 2015) as well as one run at completing annual templates, based on YE 2014.

The preamble borrows from the other preparatory guidance documents without anything new, so ignoring that, the following items jumped out at me thematically;

Concessions
3.54 Despite the gibberish in paragraph a), this effectively allows for some simplification in the quarterly reporting during the preparatory phase
3.55 Captives are excused for the quarterly run in Q3 2015

Parallel run costs/strains
3.58 As with other papers, EIOPA don't care!

Template changes
3.62 A change log covering amendments between the original template release and those now available has been included to help firms level any work already done in this space. A surprisingly large number of changes made, magnifying the difficulties faced by firms, NCAs and ultimately EIOPA.

Legal entities which are below the threshold
3.72 If a legal entity is below the reporting threshold in isolation, but forms part of a group which is above it, the LE will still have work to do

Annual reporting
3.76 An extra two weeks added to the submission deadline (now 22 weeks for solos, 28 for groups)

Quarterly reporting
3.81 As above, the requirement to report on Q4 2015 has been removed, a practical attempt to manage the myriad other reports expected from firms in early 2016.

XBRL
3.83 Up to each NCA as to whether they demand firms use XBRL in submissions - I think some of the supervisors may already favour it or have indirect experience of handling it (UK, Ireland, France)
3.84 EIOPA will provide a tool to aid firms in doing this, should they want/need to

Internal Model applicants obliged to complete Standard Formula templates
3.94 Confirms that IM applicants will need to complete both, though their SF template work will be governed by the pre-application for internal model guidance (due to the different timescales applicable to that work)

Narrative reporting
3.102 Not negotiable - get it done!

Balance Sheet
3.106 Statutory accounts figures must be included

Assets
3.111 Unit-linked assets will not be exempted - also a clumsy reference to "contagious risk", one of many which betray mother-tongue related drafting problems

Particularly telling is that while the IRSG were obliged on some of their issues, they were not able to drive home all of their agenda - they had asked for and additional 4 weeks for completion of all templates for example.

Unquestionably a great deal of work to do for both firms and NCAs on this matter, and with existing reporting teams no doubt working to tight schedules, the sooner 2014 programmes factor in this disruption the better.

Pre-application for Internal Models - EIOPA's FINAL preparatory guidance for national supervisors

So the March consultation document for internal model pre-application brought a few eye-openers for those countries partaking in a less onerous application process than that favoured by the UK, with the detail in it suggesting that the UK very much had the whip hand in its drafting.

On the basis that there were still areas which even the most hardened IMAP-veteran may have winced at, it was interesting to see if anything got dropped in the lobbying stampede. On that basis, the final guidance for internal model pre-application covers the following in the preamble;

• 3.10 - That it is not in the NCAs gift to conduct pre-application preparation along the lines of provisional approval or to provide "roadmaps" to compliance (which may explain the PRA's caginess with the industry). It is purely about a firm's preparedness and suitability to submit an application
• 3.33 - On request, EIOPA have introduced a compulsion for NCAs to provide "regular feedback" to firms
• 3.35 - Confirms that not all model changes need to be reported to NCAs during pre-application, just those considered "relevant" by firms themselves

It is fair to say that the lobbying in this space has been noticeably more successful than for ORSA or System of Governance, no doubt due to the smaller sub-set of affected stakeholders having a more concentrated relevance. That said, there were still a number of rebuffs from EIOPA, particularly where the lobbying looked more like whinging about paperwork volumes! Highlights below;

Model Change Policy

3.38 - No danger of EIOPA supporting the recommendation to "fast track" model change approvals if a "major change" is required at short notice. They instead recommend "proactivity" with NCAs. Not sure what this does for the world of opportunistic acquisitions though

3.40 - Fudged the question as to whether parameter changes are considered "major", offering an answer of 'it depends' which, for me at least, leans more towards 'yes they are'.

Use Test

3.42 - Confirms that evidencing "use" is not compelling use of model outputs over and above other techniques

Assumptions and Expert Judgement

3.46 - Documentation and validation of assumption setting and expert judgements considered "crucial" in order for undertakings to counter the lack of data and subjectivity in those processes

3.47 - A guideline has also been amended to confirm that the materiality principle applies for this topic

3.48 - Only the most material assumptions will need AMSB sign-off

Methodological Consistency/PDF/Calibration

A number of changes made to clarify guidance in these areas

Profit and Loss Attribution

3.64 - No escaping the requirements to produce P&L attribution granularity at Legal Entity level, as well as by risk driver

Validation

3.68 - EIOPA do not accept that those who build models may also validate them

Documentation

3.70 - That the guidance around the documentation of the internal model should provide "...[protection] from key-person risk", which I have never seen offered as justification from the supervisory end before

Ultimately, there have been no huge concessions from the position in March, which one would think will cause a number of the more liberal EU regulators to give serious consideration to "explaining" rather than "complying" - that said, with this having been written in Union Jack ink, my British cousins should simply get their transition planning updated accordingly.

EIOPA's FINAL preparatory guidance for national supervisors - it's on at last!

Sporting less change than a busker's flatcap, EIOPA have published their final version of the preparatory guidance for the EU's National Competent Authorities (NCAs) to get themselves ready for Solvency II ahead of the anticipated implementation date of 2016. You can catch my post on EIOPA's consultation papers here if you want to dig out their position prior to the consultation, which saw over 4,000 comments offered.

EIOPA - Thanks for the feedback,
here's your change...

Over the last week, while I have been recuperating from yet another rugby injury, there is plenty of chatter recently about the kick-off date, Omnibus II's progression through trilogues (and hopefully parliament before the May 2014 elections), etc elsewhere, so I've just had a run through the final guidance to see what got lobbied out, and whether that is a win for all stakeholders, or just the industry. As the PRA have already made it clear that should the go-live date move, their expectations on supervisory reporting will also move (p3), whether it is 2016, 2017, etc. is kind of a moot point.

The mainstream press has trumpeted the big wins as being in the reporting space which, judging by the IRSG's scathing take on that topic, should be no surprise to anyone. However, it would appear that EIOPA have refused to bend for much else, adopting a relatively sniffy tone in response to stakeholders concerns/complaints.


Below are links to separate blog posts covering the more contentious highlights for each of EIOPA's 4 hot topics, while Mike Claffey and the Milliman crew have quickly summarised the changes here;

System of Governance - Final Guidance (EIOPA Doc)

ORSA/Forward Looking Risk Assessment - Final Guidance (EIOPA Doc)

Reporting/Submission of information to NCAs - Final Guidance (EIOPA Doc)

Pre-application for Internal Models - Final Guidance (EIOPA Doc)

PRA's take on EIOPA Guidance - no truck with dual reporting?

One of the Barnett Waddingham crew was kind enough to make a few notes about the PRA's current position, presented in an industry briefing back in early June (slides seemingly unavailable). While it didn't touch on pre-application for internal models, it did publicly tease out a few more details on ORSA and System of Governance from those already available, for example;

• The concept of a "Glide Path" towards ultimate Solvency II compliance, which is being agreed between firms and the PRA, to make up for the lack of certainty around both EIOPA's requirements from 2014 and of course the ultimate 'Go Live' date itself - gives both parties plenty of wriggle room in their preparations
• PRA are currently doing an "EIOPA vs PRA" comparison, but are not looking to change the PRA Handbook (which would neccesitate a consultation period, and therefore wouldn't be ready for 2014)
• That the PRA are not especially enamoured with their reporting requirements up to EIOPA!
• That the PRA believe that the trilogue discussions will be concluded before EIOPA's guidelines come into force. That seems less likely with every passing day
• That the PRA do not have the resources to feedback on any of the firms' efforts in the Solvency II reporting space

I guess the slightly odd thing is that the PRA have just announced a radically reduced Special Purpose Fee for Solvency II preparation (only £3.1m for IMAP, and a rebate for non-IMAP due to underspend last year - compare that to previous years!). Could they perhaps have just hung on to a bit more cash to provide a more substantial service in the next 18 months, or have they also given up the ghost on anything of substance happening in the foreseeable future?

EIOPA's response on the ORSA consultation - get on with it!

In a week so full of heavy reading (EIOPA's response to the Reporting Package consultation and the FSA's second tome on creating their SOLPRU handbook), I was hoping to get to something a bit lighter towards the end of the week (heard great things about 50 Shades of Grey on the grapevine...).

Then appears EIOPA's response to the ORSA consultation paper feedback, which is affixed to the document in a whopping 200 page annex. While I have blogged on the consultation paper itself back in November, the real meat and spuds of the response is condensed into the front 15 pages, from which I would flag the (non-exhaustive) following lobbyists points, along with EIOPA's responses;

• Lobbyists were still asking for more prescription/examples in areas of the guidelines, regardless of this being Level 3
• Specific concerns around the "deviation from risk profile" guideline, which may force insurers to adopt internal models
• Continued concerns around proportionality and materiality definitions
• Still seeking "ORSA Report" examples
• Concerns around projecting overall solvency needs over the planning period, so looking for simplifications in that area
• Range of concerns around Group ORSAs (diversification, Colleges of Supervisors, Third Countries, ORSA scope)

EIOPA's highlights in response are;

• Re: proportionality and materiality - stop whining and get on with it (p8)!
• Re: "Record of the ORSA" - a specific document containing all records of ORSA-related activity is NOT required, where existing documentation/records contribute to the assessment as they stand (in such cases "a reference to the relevant data is sufficient") (p9)
• To supplement this, they note "A record of an individual ORSA will in most cases contain more information than is contained either in the internal ORSA Report or the ORSA Supervisory Report" (p10)
• No specific approach for captives (so another 'get on with it'!) (p10)
• All risks are expected to be quantified, regardless of the difficulty (p10)
• Lobbying on forward looking perspective has clearly paid off, as the requirement to quantify overall solvency needs for each year of the projection period has been dropped (p10)
• Onus on companies to justify conclusions around the severity of deviations of risk profile (which may lead a Standard Formula firm to start modelling) - a result of sorts for the industry I guess (p11)
• Confirms that ORSA and SCR calculations cannot be completely divorced, but would allow an ORSA to be performed using an older SCR calculation, providing the risk profile hasn't materially changed in the interim

No reason to think they would radically divert from their proposal (indeed, they didn't on the reporting package as well, so at least the industry is getting the certainty it craves, if not the actual legislation!)

Central Bank of Ireland - Annual Compliance Statement guidance for new Corporate Governance Code

The fun never stops in the world of Irish corporate governance and risk management - new guidance from the Central Bank has been released to aid with the completion of Annual Compliance Statement (and how to evidence the statement's content) - "compliance" of course being with the new corporate governance code. Some fascinating elements, which should have crossover uses regardless of your jurisdiction, such as;

• Boards must determine breach "materiality", in the context that "the Central Bank views all areas of the Code to be equally important"
• Code will be reviewed "in light of relevant EU developments", naming Solvency II specifically - I personally read that to mean that the new code will be subservient to any Solvency II requirements.
• Retention of supporting documentation section - excellent as a checklist of the kind of materials all Solvency II-affected undertakings should be reviewing as part of System of Governance and ORSA requirements, as well as likely sources of Use Test evidence
• Risk Appetite section (sub section of the above) - confirms that, by implementing these requirements effectively, one should be in great shape for Pillar II

 Look forward to seeing some of the "material deviations" being made public once the guys get up and running, should be some nice test cases over 2012.