Freshfields Bruckhaus Deringer LLP Recovery and resolution the next phase: Non-bank RRPs FIG client seminar Presentations by Robert Stirling, James Smethurst and Lauren Honeyben 17 October 2013

1 Introduction Insurer RRPs The story so far Identification of G-SIIs IAIS policy measures Systemic Risk Management Plan FSB’s consultation on the application of “Key Attributes” to non-banks RRP planning Key issues for G-SIIs Timeline FMI RRPs Where are we? CCP – Default Waterfall FMI – Recovery and Resolution

2 The story so far International FSB’s “Key Attributes of Effective Resolution Regimes” November 2011 – requires resolution regimes for all systemically important financial institutions (banks and non- banks) and for financial market infrastructures FSB and IAIS published list of G-SIIs and applicable policy measures -18 July 2013 FSB consults on “Application of Key Attributes to Non-Banks” -12 August 2013 UK resolution regime Banking Act 2009 – Special Resolution Regime (SRR) for UK banks only HM Treasury published a consultation document “Financial sector resolution: broadening the regime” - 1 August 2012 EU proposals EU Recovery and Resolution Directive (RRD) – banks and investment firms (not yet insurers) – finalisation by the end of the year? EC currently consulting on its approach to systemic risk in non-banking financial institutions

3 Identification of G-SIIs What is a G-SII? “any insurer whose distress or disorderly failure, because of their size, complexity and interconnectedness, would cause significant disruption to the global financial system and economic activity”. Identification of G-SIIs Assessment methodology originally published by IAIS in 2012 ­Factors: size; global activity; inter-connectedness; NTNI activities; and substitutability Initial list of 9 G-SIIs announced on 18 July 2013 List of reinsurer G-SIIs delayed until July 2014 ­Factors of substitutability and interconnectedness are more complex List of G-SIIs will be updated annually and published by the FSB in November of each year

4 G-SIIs: IAIS Policy Measures Four main categories of measures which will apply to G-SIIs: Enhanced supervision ­Consolidated group-wide supervision ­Requirement for SRMPs and enhanced liquidity planning Increased resolvability ­Establishment of CMGs ­Requirement for RRPs “Backstop” capital requirements ­Required to hold regulatory capital for all group activities (including non-insurance subsidiaries) Higher loss absorption (HLA) capacity ­To apply to NTNI activities based on the extent to which they are separated from traditional insurance activities ­Where NTNI activities are not effectively separated, HLA capacity may be calculated based on the NTNI activities in the consolidated insurance group ­HLA measures to be finalised in 2015 and will apply to G-SIIs designated in 2017 from January 2019

5 Systemic Risk Management Plan Part of the enhanced supervision measure – to be developed by July 2014 Not required for banks Purpose of SRMP To explain how it will manage, mitigate and reduce its systemic risk To address: ­risks identified in decision to designate as G-SII ­the effective separation of NTNI activities ­liquidity risk ­brief but specific actions G-SII will take in order to comply with designation Issues What constitutes effective separation? ­Self sufficient entity ­Operational independence of management ­Must not result in unregulated financial entity ­Intra-group transactions must be at arms’ length Cost/capital efficiency implications?

6 FSB consultation on Application of the Key Attributes Based on Key Attributes for banks Powers of resolution authority: ­carry on all or some of the insurance business - including a wide range of powers to ensure maximisation of value and continuity of coverage for policyholders; ­restructure liabilities ­reducing future or contingent benefits or the value of contracts upon surrender; ­converting insurance liabilities from one type of insurance liability to another (eg with-profits into unit-linked; or ­reducing the value of inwards reinsurance ­carry out portfolio transfers ­suspend policyholders’ surrender rights ­stay the rights of reinsurers All jurisdictions will also be required to have in place a privately financed policyholder protection scheme Guidance on content of RRPs

7 Recovery and Resolution Plans for Insurers Timing In place and agreed with CMG - by December 2014 Recovery plans Starting point - existing solvency, finance, recovery and liquidation plans Form - learning from the banks’ experience Identifying essential functions and triggers Recovery options – specific to issues identified in SRMP ­sale/transfer of subsidiaries/portfolios ­actions to strengthen capital/bail-in ­changes to business mix, reinsurance programmes ­modifying contract terms Resolution plans Starting assumptions SPE v MPE? Likely that resolution strategies will comprise a blend of the features of both

8 Key issues for G-SIIs Understanding what makes them a G-SII Scoping the SRMP and RRPs How to deal with NTNIs ­What is effective separation? ­Cost/benefit analysis - lose natural hedge? ­HLA framework not yet established Jurisdictional differences Broader implications of G-SII status ­Capital requirements ­Credit rating ­Acquisition/disposal strategies Timing

9 Timeline for implementation Globally Systemically Important Insurers (G-SIIs) designated from 2014 and list updated annually in November ……… Crisis Management Groups (CMGs) established…………………………… Systematic Risk Management Plan (SRMP) completed ………………………………………... IAIS to finalise LA “backstop” capital requirements …………………………… Recovery and Resolutions Plans for G-SIIs designated in 2013 developed and agreed….. HLA: Implementation details developed …………………………… SRMP implementation assessed ……………… G-SIIs HLA requirements apply …… July Sept Dec July Nov July Nov

10 FMIs - Introduction “FMIs play an essential role in the global financial system. The disorderly failure of an FMI can lead to severe systemic disruptions if it causes markets to cease to operate effectively. Ensuring that FMIs can continue to perform critical operations and services as expected in a financial crisis is therefore central to the recovery plans they formulate and the resolution regime that applies to them.” [CPSS-IOSCO Recovery and Resolution of Financial Market Infrastructures] “Banks became too big to fail by accident. CCPs have almost been mandated by the [Group of 20] leaders as too big to fail.” [Paul Tucker]

11 Where are we? International FSB Key Attributes of Effective Resolution Regimes for Financial Institutions – November 2011 CPSS-IOSCO Principles for financial market infrastructures – April 2012 CPSS-IOSCO Recovery and resolution for financial market infrastructures – July 2012 CPSS-IOSCO Recovery of financial market infrastructures – August 2013 EU Commission consultation on possible recovery and resolution framework for financial institutions other than banks – 2012 Proposal expected? UK CCPs brought within scope of Banking Act 2009 Payment and Settlement Systems Special Administration Regime proposed as part of banking reform

12 FMIs Variety of different types of FMI ­CCPs, settlement systems, payment systems ­key distinction between FMIs that take on credit risk (e.g. CCPs) and those that don’t (e.g. some settlement systems) FMIs very likely to be systemic FMIs often have limited substitutability – there may be only one First line of defence is to ensure FMI able to withstand default / market shock ­efforts made to strengthen CCP regulatory regime – EMIR / DF But because consequences of failure likely to be so significant FMIs should have recovery and resolution plans to address even remote risk

13 CCP – Default Waterfall Defaulting clearing member margin Defaulting clearing member default fund contribution CCP “skin-in-the-game” Non-defaulting clearing member default fund contribution Further loss allocation measures other recovery options?

14 FMI: Recovery Importance of keeping critical functions going means focus on recovery plan “Recovery plans should be formulated on the presumption that any stress can be met by the FMI’s, its owners’, and its participants’ own resources and allocation of exposures” Plan to cover ­identification of critical services ­identification of stress scenarios ­recovery plan triggers ­recovery tools – FMIs can impose some tools via their rules ­allocation of uncovered losses to direct and indirect participants, third parties or owners e.g. margin haircuts; additional resources from clearing members ­establishment of matched book e.g. tear up of open contracts But recovery measures should minimise impact on wider financial system

15 FMI: Resolution CPSS-IOSCO consultative paper on recovery and resolution of financial market infrastructures – July 2012 ­application to FMIs of FSB’s Key Attributes of Effective Resolution Regimes Resolution tools ­loss allocation by resolution authority – including enforcing contractual rights of CCP against members ­imposing losses on shareholders ­stay on early termination? ­moratorium on payments? ­appointment of administrator / conservator ­transfer of critical functions to third party or bridge institution ­bail-in within resolution Key focus will be on continuity of critical functions

16 This material is for general information only and is not intended to provide legal advice. © Freshfields Bruckhaus Deringer LLP 2013