Roundtable on the Review of the Financial Conglomerates Directive Christian LAJOIE Head of Group Supervision Issues 08 September 2008 FCD Provisions on Capital IWCFC

2 Background Although, banks and insurance companies are both main actors of the financial system, they manage differently their activities and associated risks Banks mainly incur credit and funding risks and to a less extent, market, asset and liabilities management and operational risks while insurance companies bear essentially risks linked to underwriting or asset and liability management and are practically not subject to funding risk Banks first look at risks on an individual basis and then monitor them with a global view while it is the reverse process followed in insurance companies These differences are also naturally present in the Basel 2 and Solvency 2 reforms as well as in the IFRS implementation -Apparent similar framework but fundamental differences in the risk measurement approach and in the definition of own funds -Different accounting standards exceptions for each sector Thus, even if banks and insurance companies are working with the same financial instruments, they do not manage them neither in the same perspective nor with the same risk conception and subsequently the same definition of capital requirements These divergences are probably justified. I cannot imagine that regulators did not try to elaborate convergent rule and I must admit that I did not find the bases to seriously challenge this position so far This difficult situation has been wisely handled and anticipated in the FCD Directive, granting the necessary flexibility of implementation while reaching at the same time its main objective: To make the double gearing practice ineffective To bolster governance management consistency In this context, is it necessary to reconsider the FCD and to which extent ?

3 FCD review It would be more appropriate that the review and possible amendments of the FCD intervene after the finalization and stabilization of the Basel II and Solvency II implementation frameworks The FCD is an additional layer of regulation that completes sectoral rules Resources are limited and already mobilized on the implementation or definition of banking and insurance Directives, not to mention the attention paid to tame the current crisis and contain the resulting trend of over regulation Comparative strengths and weaknesses of these two pieces of fundamental regulation are yet to be identified not to mention assessed However, some marginal improvements may already be accomplished regarding the convergence of the implementation of the FCD in the 27 Member States particularly regarding the own funds’ eligibility definitions The next slides will not present the issues linked to the implementation of the FCD. Assumption is made that IWCFC will ensure that the transpositions in national regulations are compliant with the spirit of the Directive The second part of the presentation will focus on own funds’ eligibility and more especially the following concepts Own funds eligibility Deduction of participations

4 Composition of regulatory own funds The Solvency II reform is still at the stage of the fourth quantitative impact study. Nevertheless, the preliminary studies show that the insurance sector is likely to adopt a capital structure with a tier concept close to the one presented in the CRD However, the three capital classes defined or envisaged are different in their conception and I am still looking for the justification of these divergences Even if the composition of the 3 Tiers is not likely to be identical for the banking and the insurance activities, some interesting elements present in each regulation could, at least, be applied for both sectors Insurance regulation could recognize the eligibility of hybrids as described in the banking regulation. They are useful instrument to bring flexibility in the management of own funds The banking regulation could introduce in the regulatory own funds, the commitments of own fund increase like it is likely to be the case for insurance regulation A more general convergence of capital requirements would certainly be welcomed and it is still important to clarify and maintain the principle that the sum of requirements per sector must be lower than the eligible own funds at the consolidated level (MCR + 8% RWA)

5 Illustration of the capital structure differences CategoryMain constituents TIER 1 Capital, reserves, non distributed profits Paid-up capital, called-up capital Reserves Income, retained earnings Preferred Not mentioned explicitly Hybrids Super subordinated instruments The characteristics that these instruments have to comply with remain to determine more specifically Other elements Difference between economic value of assets (market value) and accounting value, net from differed taxes (methods to be defined) Difference between economic value of actuarial liabilities (best estimate + risk margin) and accounting value TIER 2 T1+T2 > MCR TIER 2 Capital not called-up nor paid-up Letter of credit and security issued by credit institutions Reminder of member’s subscription initiated by firms with mutual characteristic Permanent and forward subordinated instruments, lower rank than senior debts and rights of insured persons (characteristics and methods still to define) TIER 3 T1 + T2 + T3 > SCR Ancillary own funds Subordinated instruments not eligible in T2 (characteristics and methods still to define) RT2* eligible Category Main constituents TIER 1 Min. 4% of (RWA + RO + RM) Paid-up capital, published reserves, retained earnings Ordinary shares and investment certificates Reserves including revaluation adjustment Income, retained earnings Other reserves Premium Goodwill, consolidated adjustments, positive currency adjustment, minority interests (consolidated basis) Preferred Preferred shares with non cumulative dividends (CB approval required) Priority shares and investment certificates with non cumulative dividends (except shares with priority dividends without DDV) Hybrids (Max 15% of T1) Super subordinated instruments Permanent, non cumulative carry forward, lower rank than UT2 (CB approval required) TIER 2 Max. 100% of T1 Upper Tier 2 (“UT2”) Unrealized gains (45% limit) General provisions and mutual guaranty fund Positive difference reserves – EL (IRB approach) Super subordinated instruments out of T1 due to the 15% limit Permanent, subordinated instruments with cumulative carry forward, lower rank to LT2 (CB approval required) Lower Tier 2 (“LT2”) (Max 50% of T1) Forward subordinated instruments > 5 years, lower rank than senior debts (cumulative annual discount in the 5 last years) TIER 3 (T2R + T3 < 250% of T1R) Ancillary own funds Trading book interim profits Subordinated loans ≥ 2 years, not refundable before maturity, lower rank than senior debts Basel 2 (French transposition)Solvency 2 European Project *RT1, RT2: Residual T1 and T2 after coverage of credit risk and operational risk requirements

6 Deduction of participations The thresholds for the deduction of holding/participation in entities of the same sector are the following 20% for insurance companies 10% for banks To my knowledge, the use of different thresholds has yet to be justified and I am afraid it cannot be It could be sustained that only non consolidated participations should be deducted of own funds as defined by both the accounting standards IAS28 and the FCD Directive The accounting criteria according to IAS28: equity holdings are participations where there exists significant influence, ie the power to participate in the financial and operating policy decisions of the investee but is not control or joint control over those policies. If an investor holds, directly or indirectly (eg through subsidiaries), 20 per cent or more of the voting power of the investee, it is presumed that the investor has significant influence, unless it can be clearly demonstrated that this is not the case. Conversely, if the investor holds, directly or indirectly (eg through subsidiaries), less than 20 per cent of the voting power of the investee, it is presumed that the investor does not have significant influence, unless such influence can be clearly demonstrated. A substantial or majority ownership by another investor does not necessarily preclude an investor from having significant influence. The current FCD Directive definition: “participation” shall mean a participation within the meaning of the first sentence of Article 17 of Fourth Council Directive 78/660/EEC of 25 July 1978 on the annual accounts of certain types of companies (2), or the direct or indirect ownership of 20 % or more of the voting rights or capital of an undertaking;

7 Conclusion The FCD review exercise should not necessarily mean its amendment Actually, it could lead to changes to the CRD and the Solvency 2 proposed directive to better align the definition of eligible own funds Focusing on accounting inconsistencies and complexities would certainly be more helpful to strengthen the financial system and its intelligibility