International Association of Risk and Compliance Professionals (IARCP)

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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.comTop 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,

What is the USD LCR?Welcome to the Basel iii implementation in Singapore and the new national discretions.

While the Liquidity Coverage Ratio (LCR) requirements are calculated on a consolidated basis and reported in a common currency, the Basel liquidity standard also expects banks and their supervisors to closely monitor LCR by significant currency.

Singapore is a regional treasury centre for many banks and their liabilities here are diversified in terms of currencies.

U.S. Dollar (USD) is the dominant foreign currency for most financial institutions in Singapore and one-third of these financial institutions also have 3 or more other significant currencies.

As such, there is a need to impose LCR by significant currencies, on top of the consolidated currency LCR requirement, to ensure that financial institutions have sufficient liquid assets in the foreign currencies and are not overly-reliant on the FX swap markets to meet their foreign currency liquidity needs during a liquidity stress situation, as highlighted by the reduced FX swap market liquidity during the last financial crisis.

The Monetary Authority in Singapore proposes to impose a USD LCR requirement on all financial institutions in Singapore given that it is the next most significant currency in the banking industry besides SGD.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 2

The proposed LCR requirement for USD in Singapore will be set at 80%, allowing financial institutions to rely on external sources such as the FX swap market to some extent.

Read more at Number 10 below.

I love risk management. There are so unique risks to quantify.

One of my best is longevity risk the risk to live longer than anticipated (by actuaries).

Ok, we can make it more scientific. Longevity risk is the risk of paying out on pensions and annuities longer than anticipated.

I love the American definition for individuals, longevity risk is the risk of ou t liv in g on es asset s , resulting in a lower standard of living, reduced care, or a return to employment. (National Association of Insurance Commissioners)

It is an important risk. The ageing population phenomenon being observed in many countries poses serious social policy challenges.Read more at Number 3 below.Also

Those bent on perpetrating and perpetuating organized crime often use the legitimate institutions and facilities established and recognized under law to disguise their transactions and give them a semblance of legitimacy.

In many instances the results of such transactions, where they are successful, are employed to further other criminal activities.

The nature of organized crime is such that it permeates national borders and assumes an international character.

This makes it difficult for any country on its own to efficiently and effectively investigate and prosecute acts of criminality without the aid ofInternational Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 3

other countries in which or through which the act of criminal conduct extends.

Thus the efficient and effective combating of organized crime calls for a collaborative effort and cooperation between countries and at an international level.

Such co-operation must be robust and multi-faceted in order to significantly thwart criminals from designing and executing their criminal intents.

This co-operative approach recognizes the mutuality of interest in maintaining law and order in society as well as ensuring the legitimate use of financial and other institutions to protect the security and financial stability of our communities.

The worlds economies are in many ways intertwined and the disruption of one often has negative consequences for others, albeit to varying degrees.

It therefore becomes incumbent on every jurisdiction large and small to put in place domestic measures and mechanisms geared towards fighting organized crime and above all to create an effective regime of assistance and co-operation to aid law enforcement institutions or agencies of other countries in this fight.

Such measures and mechanisms, coupled with an effective implementation process, act as a buffer in denying criminals a safe haven within which to engage in criminal activities.

Organised crime is far-reaching and extends to the market regulation and tax administration sectors; there are also individuals and business entities which exploit for ill-gain the legitimate business mechanisms designed to facilitate commerce and trade.

The manipulation of the securities market, insider dealing, abuse of corporate vehicles, evading legitimate taxes usually by employing unlawful means, and disguising the true nature of investment business to the detriment of investors are all forms of illegal activity which, if notInternational Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 4

checked, can bring about financial instability and disrupt otherwise orderly economies.

These areas therefore warrant the application of the benefits associated with established regimes of international co-operation, both nationally and internationally.

Another significant area of international co-operation relates to extradition.

Extradition serves as an effective medium of denying criminals a safe sanctuary; they may flee from the jurisdiction where they perpetrate their crimes, but they are not beyond the reach of law enforcement and prosecution.

While generally the extradition of criminals is founded on bilateral agreements and arrangements, the increasing trend in multilateral treaties is that where national laws do not provide for a legislative mechanism for the extradition ofcriminals, the relevant treaty may be used as the basis for effecting extradition.Who said that? Can you guess? No, you cannot!Located in the north-easternCaribbean Sea, a group of some 32 islands, 188 rocks and 20 cays situated 60 miles east of Puerto Rico and at the top of the Leeward Islands chain.

The British Virgin Islands!International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 5Read more at Number 9 below.Welcome to the Top 10 list.

Best Regards,George Lekatis President of the IARCPGeneral Manager, Compliance LLC1200 G Street NW Suite 800, Washington DC 20005, USA Tel: (202) 449-9750Email: lekatis@risk-compliance-association.com Web: www.risk-compliance-association.comHQ: 1220 N. Market Street Suite 804,Wilmington DE 19801, USA Tel: (302) 342-8828International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 6Joint ForumMortgage insurance: market structure, underwriting cycle and policy implications

The events of the last few years, particularly those in the global financial crisis that began in 2007, indicate that mortgage insurance (MI) is subject to significant stress in the worst tail events.

This report examines the interaction of mortgage insurers with mortgage originators and underwriters, and makes a set of recommendations directed at policymakers and supervisors which aim at reducing the likelihood of MI stress and failure in such tail events.FMA Liechtenstein

Facts and figures on the financial intermediaries supervised by the FMA 2013 edition

Interesting parts

As an integrated supervisory authority, the FMA Liechtenstein supervises banks and insurances as well as other participants in the Liechtenstein financial market such as asset managers, funds, professional trustees, and auditors.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 7Longevity risk transfer markets: market structure, growth drivers and impediments, and potential risks - consultative report, August 2013

The ageing population phenomenon being observed in many countries poses serious social policy challenges.

Longevity risk - the risk of paying out on pensions and annuities longer than anticipated - is significant when measured from a financial perspective.

Longevity risk transfer markets: market structure, growth drivers and impediments, and potential risks is a forward-looking report released by the Joint Forum on longevity risk transfer (LRT) markets.European Commission Recognises DFSAs Audit Oversight System

The European Commission (Commission) announced its decision, recently, to grant th e Du b ai Finan cial Se rv ices Authority s (DFS As) aud it monitorin g syst em equivalen t st at us with European Union (EU) member states.

Following an assessment of the supervisory regime for auditors in the Dubai International Financial centre (DIFC), the Commission considered the DFSAs audit oversight system equivalent with that of EU member states.On the basis of this decision, individual EU audit regulators may enterco-operative agreements with the DFSA with the view to relying on each others work on the supervision of auditors and audit firms.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 8Hedge Fund Corporate Governance Interesting partsInformation sharing for resolution purposes Consultative Document

The ability to exchange information between all relevant authorities that have a role in resolution, subject to appropriate safeguards to protect the confidentiality of non-public information, is fundamental to coordinated and effective planning, preparation and implementation of resolution.Point of Sale disclosure in the insurance, banking and securities sectors - consultative reportAugust 2013

Point of Sale disclosure in the insurance, banking and securities sectors identifies and assesses differences and gaps in regulatory approaches to point of sale (POS) disclosure for investment and savings products across the insurance, banking and securities sectors.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 9The impact of payments system and prudential reforms on the Reserve Bank of Australias provision of liquidityAddress by Mr Guy Debelle, Assistant Governor(Financial Markets) of the Reserve Bank of Australia, to the Australian Financial Markets Association (AFMA) and Reserve Bank of Australia (RBA) Briefing, Sydney.

Today, I wish to talk about several important changes that will be made to the framework under which the Reserve Bank operates in domestic financial markets.

These changes will be introduced at different points during the next 18 months and will have significant implications for the size of the Reserve Banks balance sheet and the way in which the Bank provides liquidity to financial institutions.INTERNATIONAL COOPERATION AND INFORMATION EXCHANGE

It is globally recognized that cross border cooperation and coordination of efforts are the most viable tools in the international response toorganized crime and, in particular, money laundering, terrorism andterrorist financing, and more recently the financing of proliferation of weapons of mass destruction.

Those bent on perpetrating and perpetuating organized crime often use the legitimate institutions and facilities established and recognized underInternational Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 10

law to disguise their transactions and give them a semblance of legitimacy.

In many instances the results of such transactions, where they are successful, are employed to further other criminal activities.

The nature of organized crime is such that it permeates national borders and assumes an international character.Consultation Paper on Local Implementation of Basel III LiquidityRules Liquidity Coverage Ratio

On 6 January 2013, the Group of Central Bank Governors and Heads of Supervision (GHOS) endorsed the Basel III Liquidity Rule - Liquidity Coverage Ratio (LCR) as the global minimum standard for liquidity risk.

The LCR framework aims to improve the short-term resilience of a bank's liquidity risk profile.

It does this by ensuring that a bank has an adequate stock of unencumbered high quality liquid assets (HQLA) that can be converted into cash at little or no loss of value to meet its liquidity needs for a 30 calendar day liquidity stress scenario.

Under the timeline for implementation, the LCR requirement starts at 60% on 1 January 2015 and increases 10% annually to reach 100% by 1January 2019.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 11Joint ForumMortgage insurance: market structure, underwriting cycle and policy implications

Executive summary

The events of the last few years, particularly those in the global financial crisis that began in 2007, indicate that mortgage insurance (MI) is subject to significant stress in the worst tail events.

This report examines the interaction of mortgage insurers with mortgage originators and underwriters, and makes a set of recommendations directed at policymakers and supervisors which aim at reducing the likelihood of MI stress and failure in such tail events.

A summary of these recommendations follow:1.Policymakers should consider requiring that mortgage originatorsand mortgage insurers align their interests;2.Supervisors should ensure that mortgage insurers and mortgageoriginators maintain strong underwriting standards;3.Supervisors should be alert to and correct for deterioration inunderwriting standards stemming from behavioural incentives influencing mortgage originators and mortgage insurers;

Supervisors should require mortgage insurers to build long-term capital buffers and reserves during the troughs of the underwriting cycle to cover claims during its peaks;

Supervisors should be aware of and take action to prevent cross-sectoral arbitrage which could arise from differences in the accounting between insurers technical reserves and banks loan lossInternational Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 12

provisions, and from differences in the capital requirements for credit risk between banks and insurers;

Supervisors should be alert to potential cross-sectoral arbitrage resulting from the use of alternatives to traditional mortgage insurance; and

Supervisors should apply the FSB Principles for Sound Residential Mortgage Underwriting Practices (FSB Principles) to mortgage insurers noting that proper supervisory implementation necessitates both insurance and banking expertise.

Introduction and background

Mortgage insurance is used to protect mortgage lenders (ie originators and/or underwriters) by transferring mortgage risk, and notably tail risk, from lenders to insurers.

Insurers by their nature provide services for events in the tail of distributions, whereas the banking sector tends to provide services closer to the mean of distributions.

The events of the last few years, particularly those in the global financial crisis that began in 2007, indicate that MI is subject to significant stress in the worst tail events.

In the worst cases, failure of a mortgage insurer may occur leading to resolution of the insurer, whereby some of the most extreme tail risk may revert to the lender at the very time that the insurance would be most needed, potentially creating systemic risk.

At its most fundamental level, this report examines the interaction of mortgage insurers with mortgage originators and underwriters, and makes a set of recommendations directed at policymakers and supervisors which aim at reducing the likelihood of MI stress and failure in such tail events.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 13

The original impetus for this work can be traced back to the Joint Forums Review of the Differentiated Nature and Scope of Financial Regulation (DNSR January 2010).

As is often the case, making recommendations about interactions is fraught with difficulty: any complex system tends to react to changes in ways that are not always predictable.

Nonetheless, the Joint Forum has considered the effects of the crises over the last few years and endeavoured to identify steps that should help mitigate some of the problems and help to ensure consistently strong standards where MI is used.

Market structure overview

MI provides additional housing finance flexibility for lenders and consumers by expanding the underwriting envelope usually along the loan-to-value (LTV) dimension (Blood, 2001).

Even though MI is available in many countries, it is currently used extensively in only a few: Australia, Canada, France, Hong Kong, Netherlands, and the United States.

In a number of countries, MI is either mandatory for high LTV loans, incentivised by capital requirement relief on the underlying mortgages, or the government participates in its provision:

In Canada and Hong Kong, MI is required on high LTV loans made by regulated deposit-taking institutions, while in the United States, the government-sponsored housing enterprises (GSEs) require MI on loans they purchase that have LTV ratios above 80%.

In Australia, Canada, France, Mexico, Spain, and the United Kingdom, MI is (in effect) incentivised through a lowering ofrisk-weights for the capital requirements of lenders, although this hasnot necessarily led to significant MI use.

The governments of Canada, Hong Kong, Indonesia, Mexico, the Netherlands, and United States participate in the provision of MI.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 14

In many countries, the government or government agency is in fact the dominant or sole provider of MI.

In some countries that dominance is in certain sectors and socially targeted, such as the US Federal Housing Administration (FHA) that specialises in subprime loans.

In other countries, such as Canada, the government provides a back-stop guarantee against mortgage insurance obligations.

The Joint Forum surveyed various jurisdictions to discover the types of insurance generally sold with mortgages: the reason was that both the terminology, and the purpose, of the protections differed in different regions.

When examining the cross-sectoral intersection of products and risks, the Joint Forum considered the entire expected payment stream from the borrower to the lender: this of course consists of both interest and principal.

Different products protect the interest income stream (or the interest and amortisation of principal) and the default risk on the principal (with interest arrears sometimes added to the principal).

Please refer to Annex B for greater detail on the market structure in various jurisdictions.

Because mortgage default risk is inherently correlated with the housing market and the broader economic environment, the efficacy of MI can decline during a crisis precisely when it is most needed.

For example, the US MI industry was severely affected by the recent global financial crisis.

Two of the five big US mortgage insurers (PMI and Republic) are under orders of supervision (proceedings in a spectrum of preventative regulatory actions), and the other three are sub-investment grade, whereas all five were investment grade prior to the crisis.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 15

Furthermore, because insurers bear substantially all of theloss-given-default on foreclosed loans, their losses are more sensitive to mortgage default than for the original lenders.

This is especially the case given the common practice of only insuring loans with high LTV ratios.

Typical policies limit losses by insuring only losses in excess of certain LTV ratios.

In some countries, MI coverage is limited to losses up to the first 10% to 30% of outstanding balance.

Coverage limits are useful in incentivising prudent lender loan screening and monitoring and controlling adverse selection problems.

The adverse selection problem relates to the superior information that lenders may have on borrowers repayment capacity (DSousa and Sinha, 2006).

The structure of the premium payments varies by country.

In some countries, the MI premium is paid as a single up-front payment (or capitalised over the life of the loan), while in other countries the premium is paid directly by the borrower on a monthly basis so long as the loan is active and the LTV remains above a particular limit like 80%.

Strong prudential supervision of MI is essential.

In this regard, mortgage insurers are usually regulated and supervised separately, by legal entity, by the local insurance supervisor.

Also to contain the risk, in many countries mortgage insurers are required to be monolines.

While one could make a monoline argument for other types of insurance, the potential for catastrophic mortgage losses sets MI apart (Jaffee, 2006).International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 16

The issue of recourse or non-recourse loans9 within the United States received much press coverage during the financial crisis.

While throughout the US, states with non-recourse and anti- deficiency laws are in the minority, it happened that some of the greatest difficulties in the housing markets were in states such as California and Florida that do have non-recourse laws.

Such laws tend to increase the risk inherent in loans to the lenders, and by extension to the mortgage insurers who insure the highest LTV layers.

Summary of February 2012 MI roundtable

As an adjunct to the Joint Forum Plenary meeting in Miami in February 2012, the Joint Forum sponsored a roundtable discussion on MI with representation from industry, regulation and academia.

Themes and lessons from the discussion included:In jurisdictions where it is used, MI may constitute a positive partof a safe mortgage system.

Where wrongly or poorly used, however, it may mask risks.

MI is subject over the years to occasional catastrophic loss.

In such circumstances, there is a significant possibility that insured losses may exceed the insurers resources leading to insolvency.

Maintenance of a monoline system protects the overall financial stability of the insurance sector: problems in MI are ring-fenced against other general insurance risk.

Nonetheless, whether monoline or not, if mortgage insurers fail, the credit risk will revert to, and crystallise in, the banking sector.

It is likely that wide-scale failure will only occur if weak and pervasive mortgage origination standards have previously passed contagion from the banking sector to the insurance sector.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 17Otherwise failures are likely to be occasional and idiosyncratic.Alignment of interests between the government and private sectorsis important.

Some of the problems arising in the financial crisis were due to misalignments of interests, and public sector incentives can heighten risk concentrations.

Political will is needed to create appropriate macro-prudential and counter-cyclical measures, which during boom times may seem to be the opposite of otherwise desirable social goals such as increasing public ownership of housing.

Such measures may include loan to value restrictions, restrictions on ownership, debt to income limits and restrictions on source of down payments.

These measures may be introduced in response to the identification of a growingrisk rather than being part of the standard operating environment.

Mandatory MI is used in some jurisdictions. It is one possibility that avoids adverse selection although it must be recognised as an extreme answer to this issue.

MI is less necessary and less beneficial in jurisdictions where mortgage origination is characterised by low loan-to-value ratios (and therefore high down payments).

The Differing Roles of Governments in MI Markets

MI provides additional financing flexibility for lenders and consumers.

As mentioned at the roundtable, MI is less necessary and therefore less beneficial in jurisdictions where mortgage origination is characterised by low loan-to-value ratios (and therefore high down payments).International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 18

Government policymakers should consider whether MI can be used prudently in conjunction with LTV requirements to meet housing goals and needs in their respective markets.

In some countries the use of MI is achieved by direct participation and in others through indirect incentives.

For example, the Canadian MI market is dominated by a single public insurer (Canada Mortgage and Housing Corporation - CMHC) and a small number of private firms.

To make it possible for private mortgage insurers to compete effectively with CMHC, the Canadian government guarantees the obligations of private mortgage insurers to lenders through legislation that protects lenders in the event of default by the insurer.

The governments backing of private insurers business is subject to a deductible equal to 10% of the original principal amount of the mortgage loan.

Loans insured by government-backed mortgage insurers must adhere to specific underwriting parameters established by the government.

Through this institutional arrangement, the government influences sound mortgage underwriting practices for the industry.

A similar proposal is one option under a report to US Congress Reforming Americas Housing Finance Market.

In some countries, capital relief is applied to mortgages covered by government guarantee schemes aimed at providing incentives for lenders to serve more vulnerable categories.

Although these schemes, which are in place in a few jurisdictions especially in Europe (eg France, Netherlands), provide protection to lenders against borrowers default, they are different from mortgage insurance in the common usage of the term.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 19

Regulatory framework that applies to mortgage insurers

The Joint Forum investigated the types of insurers that provide MI, and whether they are monolines.

A monoline requirement protects the remainder of the insurance sector from an adverse event in mortgage insurance.

On the other hand, a monoline mortgage insurer and the mortgage originators have increased risk due to the lack of diversification.

Views differ regarding which outcome is preferable.

The Joint Forum also looked at whether mortgage insurers are regulated under the normal insurance prudential rules in the jurisdiction, or whether specialised rules are applied.

While MI underwriters can be regulated under normal insurance prudential rules, for the most part additional specialised rules are required to recognise the risks posed by MI.

Mortgage underwriting standards and the underwriting cycle

The Joint Forum considers certain types of loans to be considerably more risky than others, and these may concentrate risk both in the banking and the insurance sectors.

For example, negative amortisation loans or 100% LTV loans are likely to be high risk, although these may in the future be addressed by the FSB Principles (recommendation 6.3) with respect to absolute minimum standards.

Jurisdictions should consider whether such loans should qualify for MI, or should only qualify with special conditions or in specific targeted circumstances.

Nonetheless, the Joint Forum recognised that there may be circumstances where such loans are judged to be appropriate for MI coverage.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 20

Examples include very high closing cost loans and loans to enable labour mobility where homeowners have negative equity.

There are both macro- and micro-prudential aspects that might be examined with respect to what is generically regarded as MI.

From a micro-prudential standpoint, the behavioural issues touched on earlier are relevant: there is a danger that the existence of MI may lead both the lender and the insurer to relax standards because the other party is looking at it precisely counter to the benefits of a second pair of eyes.

From a more macro-prudential standpoint, there are dangers that over- concentration of default risk in mortgage insurers may exacerbate systemic or near-systemic problems in the underlying market.

These behavioural issues are likely to be key in identifying and dealing with problems arising in the MI arena: by the time the financial statements of a mortgage insurer begin to indicate serious problems, there is likely to already be a significant pipeline of losses.

If on the other hand the behavioural issues that lead to such losses can be identified, it is likely that any such problems could be mitigated far earlier in the process.

It is worthwhile considering four extreme cases, and then considering how migrations are likely to occur between the situations.

The four situations are where the originator/lender has strong or weak underwriting, and the mortgage insurer has strong or weak insurance underwriting standards.

This can be shown in a matrix as follows, together with a high level summary of the expectations under each of the four circumstances.

From a supervisory point of view, ideally both origination and mortgage underwriting standards should be strong.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 21

Nonetheless, supervisors need to be aware that it is also likely to be a somewhat unstable equilibrium with both originators/lenders and mortgage underwriters tempted to lower their standards to increase business volume thereby taking advantage of an apparently stable market which, though profitable, does not generate high returns.

This equilibrium might also be further weakened where changing macro-economic forces add to these behavioural trends unless theseforces are mitigated by prudential requirements (see Box 1 above dealing with Governments role in the MI market).

Over time, migration to neighbouring matrix elements can occur.

If the originators/lenders lower their standards while the mortgage insurers maintain their high underwriting standards, MI will be scarce.

This scarcity, however, is likely itself to create pressure.

That pressure may influence mortgage insurers to lower their standards on a net basis, either by a weakening of pre-existing mortgage underwriting standards, or the entrance into the market of new MI underwriters convinced that they spot an opportunity.

Brokers will then tend to discover the MI underwriters with the comparatively weaker standards, leading to business being placed with those companies.

Alternatively, the pressure may create a regulatory arbitrage resulting in alternatives to MI being utilised such as piggy-back loans, financial guarantees, securitisation or credit default swaps (CDS).

Either case may cause a further migration whether directly or indirectly to the worst scenario, where both originator/lender and mortgage insurer underwriting standards are weak.

In the recent financial crisis, it could be argued that the MI underwriters did not lower their underwriting standards while the originators/lenders, nonetheless, utilised alternatives and the resulting housing bubble caused significant losses for MI underwriters.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 22

On the other hand, MI underwriters may lower their underwriting standards while the originators/lenders maintain high standards.

This is unlikely to cause immediate problems, as the originators/lenders standards would effectively protect the mortgage insurers from themselves.

However, under such circumstances, the originators/lenders may begin to take advantage of the nave insurance capital while weakening their previously high standards.

As such, we can see plausible reasons why over time there may be a migration from the strong/strong scenario to the weak/weak.

It is clear that either the weak/weak scenario or a migration thereto was representative, for example, of the overall markets in the United States in the run-up to the financial crisis beginning in 2008.

A weak/weak scenario is of course the worst case scenario both from a regulatory standpoint and for the stability of the economy as a whole, with the possibility of systemic effects.

A weak/weak scenario is likely to migrate to a strong/strong scenario as corrections are applied.

Hence overall we can construct a plausible set of stories that would create a cyclicality overlaying the matrix as follows:International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 23It is not clear that experimentation by mortgage insurers and originators that moves outside of the top left hand matrix element (strong/strong) to either strong/weak or weak/strong should always be prevented by policymakers and supervisors.

Rather further migration into weak/weak should be constrained.

The aim should be to shorten the cycle by creating incentives that would move insurers and originators back to strong/strong from strong/weak or weak/strong such that the weak/weak quadrant is not entered (or if it is only for very short periods):International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 24

Recommendations for policymakers and supervisors

Policymakers should consider requiring that mortgage originators and mortgage insurers align their interests.

Outcomes should improve if as many of the parties as possible share the financial consequences of a transaction.

Policymakers should consider various means of aligning interests.

For example, an effective means of aligning financial interests in the insurance sector is partial risk retention.

Also, the FSB Principles recommendation 3.2 that down payments are substantially drawn from the borrowers own resources helps align the interests of the lender and the borrower.

Jurisdictional banking and insurance supervisors should also consider jointly collaborating to investigate whether there may be any sharing mechanisms that would be viable and useful in their jurisdiction.

When losses are shared, it is important that claims costs are controlled by the party with the greatest exposure.

In most cases, this will be the mortgage insurer.

Supervisors should ensure that mortgage insurers and mortgage originators maintain strong underwriting standards

There will always be pressures on mortgage originators or mortgage insurers to lower their underwriting standards.

Lower standards by a single player in either sector will increase the pressure on other parties within that sector to lower their standards.

Lower standards in one sector will in turn increase the pressure on the other sector to lower its standards ultimately resulting in a potential crisis.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 25

Supervisors must therefore remain vigilant to ensure that strong underwriting practices are maintained by all parties and that the underwriting cycle does not enter the weak/weak quadrant described above.

Supervisory examinations should verify such practices.

Where supervisors do not have the legal authority to do so, supervisory powers should be requested.

Relevant policymakers should also ensure that supervisors have the appropriate legal authority to be able to make such verifications.

3.Supervisors should be alert to and correct for deterioration in underwriting standards stemming from behavioural incentives influencing mortgage originators and mortgage insurers.

Behavioural incentives such as tensions between the sales force and the administrative functions are a recurring concern that should be monitored: volume, which may incentivise front office personnel especially during good times, may come at the expense of good controls in the back office.

Such incentives can affect both originators and mortgage insurers.

Supervisors and mortgage insurers should be alert to such behaviour as it can influence the overall quality of risks offered, and therefore ultimately underwriting standards and the underwriting cycle across both sectors.

As sound residential mortgage underwriting practices are fundamentally linked with responsible conduct of business, supervisors should consider whether behavioural incentives are appropriately aligned with the fair treatment of consumers.

For example, originators may have significant market power and, in some jurisdictions, be able to demand commission or other sales incentives in return for recommending or selecting a specific mortgage insurer.A bundled distribution and lending model contains significant distortionsand potential conflicts of interest.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 26Supervisors may need to address the incentives that may be created by such remuneration practices by, for example, requiring choices of mortgage insurer to be provided to the homeowners, or other actions.

4.Supervisors should require mortgage insurers to build long-term capital buffers and reserves during the troughs of the underwriting cycle to cover claims during its peaks.

Long term capital buffers are needed in dealing with the tail event losses of MI.

MI tends to have a relatively consistent level of risk for many years, and then is subject to (typically short) extreme tail events creating much worse loss experience.

This cyclicality then repeats over a long cycle.

In the United States for example, approximately 75 years had elapsed between two severe financial crises; however, less severe cycles of 10 to 20 years are common in many countries.

Higher capital standards in normal times will provide additional resources to mitigate the effect of the serious downturns when they occur.

In addition, supervisors could regularly require mortgage insurers to run specific stress tests or other capital adequacy tests against their portfolios. Such stress tests are helpful in assessing an insurers solvency position as a result of certain stresses.

They also help supervisors compare the abilities of insurers individually, as well as collectively, to withstand a specific stress scenario.

In the United States, supervisors required that so-called contingency reserves be set up at mortgage insurers that would prevent otherwise distributable profits being declared as dividends for 10 years.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 27

Half of each premium dollar earned goes into the contingency reserve and remain unavailable for a 10-year period unless losses in a calendar year exceed 35% of earned premiums, depending upon the state.

These contingency reserves play the same role as a capital buffer and allow insurers to build reserves during the normal part of the risk cycle to cover claims during peak years.

Different approaches are needed in other jurisdictions where the MI product differs, and in the United States these provisions may require recalibration based on recent experience.

In light of concerns arising from the financial crisis, US state insurance supervisors have adopted a charge to determine and make a recommendation on what changes are necessary, if any, to the solvency regulation of mortgage insurers, including changes to the Mortgage Guaranty Insurers Model Act.

It is expected that this work will consider a broad range of financial solvency-related issues, including but not limited to leverage and capital statutory standards, accounting and loss reserving methods, and reinsurance requirements for such insurers

To the extent that alternatives to mortgage insurance arise, supervisors should consider whether there is a need for equivalent capital buffers for those alternatives.

5.Supervisors should be aware of and take action to prevent cross-sectoral arbitrage which could arise from differences in the accounting between insurers technical reserves and banks loan loss provisions, and from differences in the capital requirements for credit risk between banks and insurers.

While IFRS and US GAAP requirements for insurance contracts and financial instruments were not yet finalised at the time of this reports publication, it would appear that there may be differences between the timing and level of losses depending on whether a loan loss provision is recognised or the same potential loss is evaluated under the insurance contracts standard.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 28This may particularly be the case for expected losses on a portfolio where no specific defaults have been identified: IASBs financial instrument impairment is projected to use a loss provision based on expected lifetime losses on loans expected to become impaired in the next 12 months, whereas insured loans would be reserved at a full lifetime loss level (equivalent to the second level of impairment under the IASBs current tentative decisions regarding financial instrument impairment).

Supervisors need to be aware of this issue, and monitor it as the accounting standard setters move towards concluding the Insurance Contracts and Financial Instrument standards.

Depending on the conclusions, supervisors should take action to prevent any related cross-sectoral arbitrage arising from these accounting differences.

Further, different measurements of credit risk in the capital requirements for banks and mortgage insurers may be another source of cross-sectoral arbitrage which should be mitigated by supervisors.

6.Supervisors should be alert to potential cross sectoral arbitrage resulting from the use of alternatives to traditional mortgage insurance

Alternatives to MI may exist for the mortgage originator. Examples include:

capital markets products (eg structured finance and credit derivatives);

lender self-insurance; and

structured loan arrangements, in which loans of senior and junior priority are originated simultaneously, with the junior loan providing the credit enhancement on the senior loan.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 29

To the extent that such alternatives exist or are used, supervisors should be alert to, and prepared to adjust for, any cross sectoral arbitrage that may arise.

Supervisors should seek to mitigate cross sectoral arbitrage.

For example, one way to mitigate regulatory arbitrage between types of guarantee and business sectors is to ensure that capital requirements that apply to the lender/originator and the guarantee provider, when considered in conjunction, are:

equivalent,

indexed to the actual risk level observed by them, and

not dependent on the type of guarantee used by the originator or on the business sector.

7.Supervisors should apply the FSB Principles for Sound Residential Mortgage Underwriting Practices to mortgage insurers noting that proper supervisory implementation necessitates both insurance and banking expertise.

If the FSB Principles are fully applied, supervisors expect that a number of the most systemic or potentially systemic problems that may occur in MI are likely to be mitigated significantly.

Moreover, a number of the FSB Principles should be applied by mortgage insurers themselves.

For example, FSB Principles 5.1 and 5.2 require lenders to carry out appropriate due diligence on both the borrower and the mortgage insurers.

Mortgage insurers, likewise, should ensure that lenders are undertaking effective verification of income and other financial information, maintaining reasonable debt service coverage and appropriate gross and net LTV ratios, while making reasonable inquiries themselves regarding these issues.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 30

Application of these principles would not prevent problems ever arising at a mortgage insurer, but any such problems would be more likely to be resolvable within the usual supervisory framework without significant market disruption.

United States

The NAIC Mortgage Guaranty Insurance Model Act 630-1 (Mod el) was created for the purpose of providing for the effective regulation and supervision of mortgage guaranty insurers.

The Model defines mortgage guaranty insurance as insurance against financial loss by reason of nonpayment of principal, interest, or other sums agreed to be paid on any note secured by a mortgage, deed of trust, or other instrument constituting a lien or charge on real estate.

Mortgage guaranty insurance may also cover against financial loss by reason of nonpayment of rent under the terms of a written lease.

As of April 2012, eight states have adopted the most recent version of the Model in a substantially similar manner.

An additional twelve states have adopted an older version of the Model, legislation, or regulation derived from other sources such as bulletins and administrative rulings.

Current state of the Mortgage Guaranty Industry

As a result of the downturn in the housing market, the mortgage guaranty industry continues on a depressed note.

Although signs of improvement in the housing industry may signal increased premiums production, stricter mortgage underwriting standards may have a contrary effect on mortgage guaranty premium production.

In addition, record unemployment and poor overall economic conditions add further pressures to the depressed real estate market and mortgageguaranty activity.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 31

As of year-end 2011 there were a total 39 active mono-line writers of mortgage guaranty products within 11 insurance groups.

Of these 11 insurance groups, six groups account for 94.5% of gross mortgage guaranty premiums.

Currently, S&Ps highest rating of a mortgage guaranty insurer is AA- for only one company.

Gross premiums written for mono-line mortgage guarantors have fluctuated over the past five- years from low of USD 5.3 billion in 2011 to a high of USD 7.4 billion in 2008.

Gross paid losses peaked in 2010 at UDS 12.9 billion (77.4% of which was reported within the six largest guarantors) compared to USD 2.8 billion for 2007.

Contingency reserves were nearly exhausted over the past five years, totalling USD 615 thousand at year-end 2011 compared to USD 13.4 billion in 2007.Regulation based on the Model Capital RequirementsA mortgage guaranty insurance company shall not transact the business of mortgage guaranty insurance unless, if a stock insurance company, it has paid-in capital of at least USD 1,000,000 and paid- in surplus of at least USD 1,000,000, or if a mutual insurance company, a minimum initial surplus of USD 2,000,000.

A stock company or a mutual company shall at all times thereafter maintain a minimum policyholders surplus of at least USD 1,500,000.

Geographic Concentration

Mortgage guaranty insurers are not allowed to insure loans, by a single risk, that are in excess of 10% of the companys aggregate policyholderssurplus and contingency reserves.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 32Also, mortgage guaranty insurers are prohibited from having more than 20% of total insurance in force in any one Standard

Metropolitan Statistical Area, as defined by the United States Department of Commerce.

Both of these provisions take effect only after a mortgage insurer has possessed a certificate of authority in a state for a time period of three years.

Coverage Limitation

Coverage provided by mortgage guaranty insurers, net of reinsurance ceded to a reinsurer in which the company has no interest, is limited to 25% of the entire indebtedness to the insured.

In the event of default, the mortgage guaranty insurer has the option of paying the entire indebtedness to the insured, therefore acquiring title to the real estate.

Policy Form and Premium Rates

All policy forms and endorsements shall be filed with and be subject to the approval of the commissioner.

In addition, each mortgage insurer shall file with the department the rate to be charged and the premium to be paid by the policyholder.

Outstanding Total Liability

Mortgage guaranty insurers are prohibited from having an outstanding total mortgage guaranty in-force liability, net of reinsurance, in excess of twenty-five times of aggregate policyholders surplus and contingency reserves.

In the event that a mortgage guaranty insurer exceeds this threshold, the company must cease writing new mortgage guaranty business until the situation is corrected.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 33

Total outstanding liability is calculated on a consolidated basis.

Unearned Premium and Loss Reserves

Mortgage guaranty insurers shall compute and maintain unearned premium reserves along with adequate case basis and other loss reserves that accurately reflect loss frequency and loss severity.

Case basis and other loss reserves shall include components for claims reported and for claims incurred but not reported, including estimated losses on:

Insured loans that have resulted in the transfer of property that remains unsold;

Insured loans in the process of foreclosure;3.Insured loans in default for four months or for any lesser period thatis defined as default for such purposes in the policy provisions; and4.Insured leases in default for four months or for any lesser periodthat is defined as default for such purposes in policy provisions.

Contingency Reserves

Each mortgage guaranty insurer shall establish a contingency reserve out of net premium remaining (gross premiums less premiums returned to policyholders net of reinsurance) after establishment of the unearned premium reserve.

The mortgage guaranty insurer shall contribute to the contingency reserve an amount equal to 50% of the remaining unearned premiums.

Contributions to the contingency reserve made during each calendar year shall be maintained for a period of 120 months.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 34

An exception allows for releases to be made by the company, from contingency reserves, in any year in which the actual incurred losses exceed 35% of the corresponding earned premiums.

However, releases are not allowed without prior approval by the commissioner of insurance of the insurance companys state of domicile.

Extract from the NAIC Center For Insurance Policy Research paper Financing Home Ownership: Origins and Evolution of Mortgage Securitisation - Public Policy, Financial Innovations and Crises dated 12 August 2012.

Mortgage Insurers

The financial crisis found private mortgage insurers exposed on the front lines as they were directly underwriting the risk of borrowers defaulting on their mortgage loans.

Particularly, since mortgage insurers provided coverage on highloan-to-value mortgages with very thin equity slices, they were vulnerable to potential losses in the event of rising delinquencies and defaults.

While mortgage insurers avoided many of the now worst-performing loans during the credit boom, they still added significant exposure to mortgage risk, including material subprime exposure.

Mortgage insurers shift toward affordability products and subprime loans increased their exposure to the rise in mortgage defaults during the crisis.

Insurance for adjustable rate products jumped from 13 percent atyear-end 2001 to about 25 percent at year-end 2006, while subprime loans made up about 12 percent of the industry aggregate risk-in-force.

The private mortgage insurance industry recorded its best year in terms of new insurance volume in 2007, with total new insurance written exceeding $300 billion for the first time.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 35

A short two years later, new insurance written had declined to $81 billion as the market for mortgage insurance shrunk, following the collapse of the housing market and the subprime crisis.

As home prices plummeted, the wave of mortgage defaults and home foreclosures weakened mortgage insurers capital position and resulted in substantial losses.

Having to set aside substantial capital to cover future claims severely constrained mortgage insurers ability to write new business.

The very challenging market conditions that the mortgage insurance industry experienced since the eruption of the crisis are reflected in the sharp rise of the industrys loss and combined ratios (Figure 6).

The industrys loss ratio (losses over net premiums earned) jumped from 41 percent in 2006 to a record high 218 percent in 200815 (Figure 6).Although market and economic trends appear to have generally stabilised in the last couple of years, this trend has not yet helped mortgage insurers to materially improve their financial situation.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 36

As Table 3 shows, losses paid are still very high compared to 2007, even though there was some minor improvement recorded in 2011.

Poor industry results could be partly attributed to the losses of two insurers, PMI Mortgage Insurance Co. (PMI) and Republic Mortgage Insurance Co.

(RMIC), which were placed under state supervision due to mounting losses and the resultant capital shortfalls.Mortgage guarantors reported losses in 2011 were still at high levels, stressing their already weakened capital positions.

According to Standard & Poors, the losses generated from the insurers 2005-2007 books of business still outweigh any profits that have resulted from newer, higher credit quality business.

The underwriting experience for mortgage insurers over the past five years (2007-2011) is shown below in Table 4.

Premiums in 2007 and 2008 climbed to historical highs, buoyed by the rapidly expanding housing market.

With the collapse of the housing market, underwriting slumped by almost 30 percent between the peak year (2008) and 2011 (Table 4).International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 37The cushion provided by contingency reserves that mortgage insurers are required to maintain against catastrophic losses during an economic crisis has thinned considerably over the last five years.

These reserves are built during good times and drawn only in the event losses exceed certain statutory thresholds or otherwise directed by state regulators.

Although the structure of capital requirements for mortgage insurers was more stringent, it still proved inadequate given the wholesale meltdown.

What once was a very comfortable cushion seems to be near depleted through the financial crisis and needs to be built back up.

The aggregate contingency reserves of the mortgage insurance industry shrunk more than 95 percent in the period between 2007 and 2011 (Table 5).As of March 2012, both Standard & Poors and Moodys have rated mortgage insurers BBB (Baa) and below while they have maintained aInternational Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 38

negative outlook for the industry for the rest of 2012 and possibly well into 2013 (Table 6).

Credit rating agencies believe that new business writings will not be sufficient to offset expected losses into 2013.Although the 20052007 vintage loans in mortgage insurers books have shown some signs of delinquency burnout, default rates have remained at elevated levels, causing significant losses (Figure 7).

While in the medium term the run-off of the legacy risk will help improve the quality of mortgage insurers portfolios, rating agencies expect default rates to remain at these high levels even beyond 2013.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 39At the same time, as the economy and the housing market recover, the performance of at least the better-capitalised insurers should show gradual improvement.

The mortgage insurance industrys future prospects hinge, in great part, on the changes in the mortgage finance system, and especially on the future status and role of the GSEs. For the time being, given mortgage insurers weakened position, the market still largely relies on the Federal Housing Administration for insurance.

The possible winding-down of GSEs operations could potentially shift credit risk to the private sector, which might enhance mortgage insurers role in the housing finance market by increasing the reliance on mortgage insurance.

On the other hand, the issuance of the credit risk retention proposal in 2011, allowing the exemption of qualified residential mortgages (high credit quality) from risk retention requirements if they include a 20 percent down payment (allowing mortgage originators to avoid retainingInternational Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 40

a portion of the risk being securitised), could adversely impact the mortgage insurers current business model.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 41FMA Liechtenstein

Facts and figures on the financial intermediaries supervised by the FMA 2013 edition

Interesting parts

As an integrated supervisory authority, the FMA Liechtenstein supervises banks and insurances as well as other participants in the Liechtenstein financial market such as asset managers, funds, professional trustees, and auditors.

In this publication, we have presented the most important facts and figures on the financial centre in a compact form.

Attractive results were achieved in the individual sectors of the financial centre in 2012.

Earnings in the banking sector improved again.

The Liechtenstein financial system has proven to be very reliable in a demanding environment.

It maintained its high degree of stability even during the global financial crisis and offered security to clients.

The banks have surpassingly high capital resources compared to other banks internationally, and with private banking, they pursue a conservative business model.

Factors such as political stability, sound public finances, and the Swiss franc also promote the stability and attractiveness of the financial centre.

Great challenges remain, however.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 42

The financial centre is undergoing a phase of reorientation, requiring the development of new areas of business.

The earnings and growth outlook is restrained in the prevalent market environment.

The far-reaching regulatory reform in the financial centre is also requiring more work of financial intermediaries.

Finally, the European economy has been developing unfavourably, and serious public debt crises in several countries with stability risks for the financial system must be overcome.

This environment also demands much of the FMA.

With the increasing density of regulation, the FMA's responsibilities are also increasing.

By guaranteeing stability, protecting clients, combating abuse, and implementing international regulatory standards, the FMA performs fundamental functions for the finan- cial centre.

In this way, it strengthens the reputation of and trust in the financial centre, promotes interna- tional recognition, and accordingly contributes to securing the international market access that is essential for Liechtenstein.Mario Gassner CEO

International Economy and Financial Markets

Five years after the bursting of the credit bubble and the associated outbreak of the global financial crisis, the world economy is characterized by a massive surplus of debt and stagnating economic growth.

The central banks have continued their expansive policies and in some cases supplemented them by unconventional monetary policy measures.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 43

The financial markets are being determined by the conti- nuingly extraordinarily low interest level and the European debt crisis, which spread further in 2012.

World economic growth slowed down over the course of 2012.

This resulted in an unfavourable development of the European economy, which slipped into a deep recession.

In light of the high interna- tional linkage of the world economy and a broadly weakening demand for exports, economic growth in China and in other important emerging markets also slowed down, while the US economy has grown only modestly.

The group of countries affected by the debt crisis has expanded.

In June 2012, Cyprus submitted an application for financial assistance.

Spain was promised assistance to restructure its banking sector in July 2012.

In summer 2012, the crisis reached a temporary climax when the tension on the bond markets of the two large economies Italy and Spain hardened.

Finally, the burden of dealing with the crisis has shifted further to the central banks.

With the increasing mixing of monetary and financial policy, the risks and side effects of the permanent crisis management since the outbreak of the financial crisis have increased.

The European Central Bank (ECB) was able to prevent a further escalation of the debt crisis:

In September 2012, it announced the purchase of short-term government bonds issued by certain countries, with the intent to lower market interest rates.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 44

The precondition for buying the government bonds is that the country in question must obtain funding as part of a European rescue programme and use it to consolidate its budget.

In October, the European governments also agreed on a time table to introduce a uniform European supervisory mechanism, which assigns the ECB far-reaching competences and responsibilities to secure financial stability.

Since the beginning of 2013, the crisis on the financial markets has meanwhile worsened again some- what.

The political uncertainty after the elections in Italy and the worsening of the crisis in Cyprus have, after an extended phase of quieter markets, made clear that the region is still far from a true solution to the crisis.

However, the overall restrained reaction of the financial markets has also shown that the measures for calming the markets and combating the crisis adopted by the ECB and the governments have certainly had a stabilizing effect.

While the risk premiums for Italian government bonds rose slightly in the interim, they were slightly lower at the end of April again than in January, and far below the level of summer of last year.

Risks continue to arise from the linkages between banks and their home countries, which can aggravate problems in both directions.

In the countries directly affected by the debt crisis, banks have increased investments in the government bonds of their own countries.

Thanks to this, the financial situation of the affected states has eased, though the risk potential for the financial institutions due to credit and market risks has grown.

On the other side, the linkages increase the danger that a crisis of a major financial institution could spread to the state, and that the bailout would be more than the state could afford.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 45

Apart from the European debt crisis, the low interest rate environment also represents a risk for the long-term maintenance of Liechtenstein's financial stability.

The low interest rate environment gives investors incentives to invest in riskier market segments in their search for higher yields and in that way unavoidably to build up risk positions, which might have an adverse impact especially on institutional investors such as pension schemes and insurances.

The massive equity price gains in 2012 in some areas and the achievement of new records in a real economic environment of stagnation or even recession (Eurozone) can be seen as a sign of the potentially misguided incentives.

The low interest rate environment has also favoured the increase in real estate prices. For this reason, the FMA has strengthened risk controlling in the real estate and mortgage market.

Liechtenstein Financial Centre

The Liechtenstein financial system has functioned reliably over the past five years in an extremely demanding market environment.

The earnings situation improved again in 2012, after earnings fell to a historic low in the previous year.

Assets under management in the fund sector grew in 2012, benefiting from the increase in securities prices.The challenges for the Liechtenstein financial centre are great, however: The cost ratio of the banks is unfavourable.The short- and medium-term earnings and growth outlook in the financial sector continues to be restrained.

Persistently difficult market conditions and an increase in regulatory and administrative efforts must be expected.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 46

For the insurance industry, the low interest rate level represents a challenge, although Liechtenstein insurances mainly market fund-linked life insurance pro- ducts characterized by the fact that the investment risk remains with the policyholder.

The Liechtenstein banking system has further improved its risk capacity since the outbreak of the global financial crisis.

Core capital resources have increased, and equity ratios exceed the international standards.

Also, the banks have good liquidity buffers, so that the resilience of the Liechtenstein financial sector can continue to be deemed high.

Banks: At the end of 2012, Liechtenstein banks including foreign group companies managed client assets in the amount of CHF 184 billion.

This represents an increase of 11.1% compared with the previous year.

The net inflow of new assets in 2012 was CHF 13.2 billion, comparedwith CHF 7.0 billion in the previous year.

Insurance undertakings: Premium income in 2012 fell by 12% to CHF 4.2 billion, of which CHF 3.3 billion was generated by life insurances, CHF 0.84 billion by non-life insurances, and CHF 0.05 billion by reinsurances.

The balance sheet total of the insurance undertakings was about CHF32.3 billion (previous year: CHF 30.5 billion).Investment undertakings (funds): The total net assets rose by 5% in2012 to CHF 37.2 billion.Asset management companies: The assets managed by thecompanies rose by 8% to CHF 23.5 billion.

Of that amount, CHF 17.1 billion are invested at Liechtenstein banks.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 47

Regulatory developmentsImplementation of CRD IV and CRR rules

With the upcoming banking regulation the most substantial so far which will incorporate the international standards also known as Basel III into EU law, the EU banking sector is to be made more resilient.

For this purpose, new rules on capital resources, a new governance framework, and a uniform regulatory framework are being created.

These comprehensive and technically demanding rules will be instituted in the form of a directive (CRD IV) to be transposed into national law and a directly applicable regulation (CRR).

The enormous scope covers far more than 1,000 pages of new rules, additionally supplemented by more than 70 standards of the European Banking Authority, most of which are binding.

Implementation of crisis management rules

With the crisis management rules, a uniform framework in Europe for crisis management and reso- lution (restructuring and orderly dissolution) in respect of banks and investment firms is to the crea- ted. Implementation some of which is complex will be in the form of a directive.

In mid-2012, the European Commission published a proposal for a directive of the European Parliament and the Council establishing a framework for the recovery and resolution of credit institutions and investment firms.

Prevention, early intervention, and also the resolution of banks and investment firms are being harmonized by law for the first time.

This project with substantial market impact enjoys top priority on the part of the European Commission, so that a decision is expected already in 2013.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 48

Implementation of market abuse rules

With the market abuse rules, the existing framework for ensuring market integrity and investor protection, established by the Market Abuse Directive 2003/6/EC, is being adjusted to the current market reality and strengthened.

An important component is an expansion of the scope such as inclusion of spot markets and the competences of the competent authorities as well as European harmonization and tightening of penalties.

Implementation of the Mortgage Directive

The global financial market crisis has exposed weaknesses in the regulation of lending.

For this reason, a new EU directive is intended to improve the protection of borrowers.

The new rules govern issues such as solicitation, pre-contractual information, advising, credit assessments, and early repayment.

Foreign Account Tax Compliance Act ( FATCA )

This US legislation provides that foreign financial intermediaries must identify their US clients and deliver information concerning them to the US tax authorities.

Non-cooperative financial intermediaries are threatened with a 30% withholding tax on income from US financial instruments and on income from the sale thereof.

At the beginning of 2013, the US Treasury and the Internal Revenue Service (IRS) published the Final Regulations, defining various key points such as the registration portal of the IRS, information reporting, and first-time deductions on certain payments starting 1 January 2014.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 49

Partial transposition of Directive 2009 / 14 / EC ( deposit guarantee, 2nd phase)

In the 2nd phase of implementation of the Deposit Guarantee Directive, the time periods for deter- mining claims and making payouts under the deposit guarantee scheme are to be reduced and the coverage amounts slightly increased.

The implementation draft is available and is planned for trans- position into Liechtenstein law at the beginning of 2014

Implementation of the AIFM Directive

On 19 December 2012, Liechtenstein adopted the Law on Alternative Investment Fund Managers (AIFM Act).

The AIFM Act and the associated ordinance (AIFM Ordinance) entered into force on 22 July 2013.

Liechtenstein has accordingly transposed the AIFM Directive 2011/61/EU into national law before the deadline applicable to EU member states.

For European market access, EEA/EFTA states must incorporate the AIFM Directive into the EEA Agreement.

The EU passport, which is necessary for cross-border management and marketing of alternative funds throughout Europe, will become part of the authorization only once the incorporation is completed.

Short sales

On 14 March 2012, the European legislative power adopted the Regulation on short selling and certain aspects of credit default swaps.

Uncovered short sales of shares and sovereign debt of the EU states and the EU are now prohibited.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 50

Additionally, credit default swaps on such government bonds that do not serve a hedging purpose are also prohibited.

The regulation entered into force on 25 March 2012, and its essential parts have been directly applicable since 1 November 2012.

The process of incor- poration into the EEA Agreement is underway.

European Market Infrastructure Regulation ( EMIR )

On 4 July 2012, the European legislative power adopted the Regulation on OTC derivatives, central counterparties and trade repositories (EMIR).

EMIR provides that starting in 2013, standardized OTC derivative contracts may no longer be concluded bilaterally, but must necessarily be cleared through central counterparties and reported to trade repositories.

Instruction on the head office

By way of an instruction, the FMA has defined the requirements for the head office of an insurance undertaking or pension fund in Liechtenstein.

The instruction serves to further specify the super- visory requirements and set out a minimum standard.

Amendments to the Insurance Supervision Ordinance ( ISO )

As part of the completed revision of the ISO, amendments were made to the provisions governing group and conglomerate supervision.

The minimum guarantee fund in life, non-life, and reinsurance was also increased.

Transposition of the Solvency II Directive 2009 / 138 / EC

Solvency II establishes a new European supervisory system providing appropriate qualitative and quantitative tools to the supervisoryInternational Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 51

authorities so that they can sufficiently evaluate the overall solvency of an insurance undertaking.

Methods for the risk-based control of the overall solvency of insurance undertakings are to be created.

The existing static system for determining capital resources is to be replaced by a risk-based system.

Additionally, new requirements relating to governance, risk management, and reporting are being defined.

Because of delays in the European schedule, the time of entry into force of Solvency II is still unclear.

Transposition of the Financial Conglomerates Directive 2011 / 89 / EU

The EU has adopted an amendment to Directive 2011/89/EU as regards the supplementary supervision of financial entities in a financial conglomerate.

In light of the lessons learned in the financial crisis, the national supervisory authorities are to be endowed with new competences to supervise financial conglomerates (especially parent companies such as holding companies).

To implement the requirements, various Liechtenstein laws have to be amended.

Entry into force of the amendments is planned for 1 August 2013.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 52Longevity risk transfer markets: market structure, growth drivers and impediments, and potential risks - consultative report, August 2013

The ageing population phenomenon being observed in many countries poses serious social policy challenges.

Longevity risk - the risk of paying out on pensions and annuities longer thananticipated - is significant when measured from a financial perspective.

Longevity risk transfer markets: market structure, growth drivers and impediments, and potential risks is a forward-looking report released by the Joint Forum on longevity risk transfer (LRT) markets.

It makes the following recommendations to policymakers and supervisors:

Supervisors should communicate and cooperate on LRT internationally and cross-sectorally in order to reduce the potential for regulatory arbitrage.

Supervisors should seek to ensure that holders of longevity risk under their supervision have the appropriate knowledge, skills, expertise and information to manage it.

Policymakers should review their explicit and implicit policies with regards to where longevity risk should reside to inform their policy towards LRT markets.

They should also be aware that social policies may have consequences on both longevity risk management practices and the functioning of LRT markets.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 53

Policymakers should review rules and regulations pertaining to the measurement, management and disclosure of longevity risk with the objective of establishing or maintaining appropriately high qualitative and quantitative standards, including provisions and capital requirements for expected and unexpected increases in life expectancy.

Policymakers should consider ensuring that institutions taking on longevity risk, including pension fund sponsors, are able to withstand unexpected, as well as expected, increases in life expectancy.

Policymakers should closely monitor the LRT taking place between corporates, banks, (re)insurers and the financial markets, including the amount and nature of the longevity risk transferred, and the interconnectedness this gives rise to.

Supervisors should take into account that longevity swaps may expose the banking sector to longevity tail risk, possibly leading to risk transfer chain breakdowns.

Policymakers should support and foster the compilation and dissemination of more granular and up-to-date longevity and mortality data that are relevant for the valuations of pension and life insurance liabilities.

Comments on this consultative report should be submitted by Friday 18 October 2013 by e-mail to baselcommittee@bis.org.

Alternatively, comments may be sent by post to: Secretariat of the Joint Forum (BCBS Secretariat), Bank for International Settlements, CH-4002 Basel, Switzerland.

All comments may be published on the websites of the Bank for International Settlements, IAIS and IOSCO unless a commenter specifically requests confidential treatment.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 54

Longevity risk transfer markets: market structure, growth drivers and impediments, and potential risksIssued for comment by 18 October 2013 August 2013

Executive Summary

The ageing population phenomenon being observed in many countries poses serious social policy and regulatory/supervisory challenges.

Not only are people living longer, but longevity risk the risk of paying out on pensions and annuities longer than anticipated is also becoming more of a concern in terms of sustainability of existing saving for retirement products.

Total longevity risk is significant when measured from a financial perspective, with each additional year of life expectancy adding3-4 percent to the present value of the liabilities of a typical defined benefit pension fund (IMF, 2012).

Estimates of the total global amount of annuity- and pension-related longevity risk exposure ranges from $15 trillion to $25 trillion (CRO Forum, 2010, and Biffis and Blake, 2012).

Hence, a one year longevity underestimation will in aggregate, cost risk holders from $450 billion to $1 trillion.

To manage this risk, pension funds in some countries are increasingly looking to transfer their longevity risk.

There are basically three types of transactions that are being used to transfer longevity risk that differ in terms of the types of risk transferred and the types of risk created:

A buy-out tran sact ion tran sfers all of the pen sion plan s asset s an d liabilities to an insurer in return for an up-front premium.Hence there is full risk transfer (investment and longevity, plus inflation in the case of indexed plans).International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 55

However, pensioners become exposed to the risk of insurer (as opposed to sponsor or pension guarantor) failure.In a buy-in, the pension plan sponsor retains the assets and liabilities, but pays an up-front premium to an insurer to receive periodic payments that match the pension payments.In this case, the risk transfer is only partial because there is still counterparty risk to the insurer, and the sponsor remains directly responsible to pensioners.In a longevity swap (or insurance) transaction, periodic fixed payments are made to the swap counterparty (or (re)insurer) in exchange for periodic payments based on the difference between the actual and expected pension or annuity mortality experience.

As in the case of a buy-in there is counterparty risk and the sponsor remains directly responsible to pensioners, but retains the investment risk.

Longevity risk transfer (LRT) markets are a rather uncharted territory for analysts, academics as well as for supervisors.

The objective of this report prepared by the Joint Forum is to give a first and preliminary analysis of the size and structure of the LRT markets, the factors affecting their growth and development, and to raise awareness of the associated potential risks and cross-sectoral issues for market participants, policymakers and supervisors.

Until recently, virtually all LRT activity had occurred in the United Kingdom, but 2012 saw three large non-UK transactions a $26 billion pension buy-out deal between General Motors and Prudential Insurance, a 12 billion longevity swap between Aegon and Deutsche Bank, and a $7 billion pension buy-out between Verizon Communications and Prudential.

However, as impressive as these volumes are, they represent only a small fraction of the aforementioned multi-trillion dollar potential market size.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 56

An important explanation for the small size of LRT markets is the relatively lenient regulatory treatment of longevity risk in pension funds compared to (re)insurers in many jurisdictions.

Other obstacles to LRT include selection bias (lemons) risk, and in the case of some longevity swaps, basis risk.

While LRT markets are not sizeable enough to present immediate systemic concerns yet, their massive potential size and growing interest from investment banks to mobilise this risk make it important to ensure that these markets are safe, both on a prudential and systemic level.

In that regard, the Joint Forum puts forward the following recommendations:Supervisors should communicate and cooperate on LRT internationally and cross-sectorally in order to reduce the potential for regulatory arbitrage.

Supervisors should seek to ensure that holders of longevity risk under their supervision have the appropriate knowledge, skills, expertise and information to manage it.

Policymakers should review their explicit and implicit policies with regards to where longevity risk should reside to inform their policy towards LRT markets. They should also be aware that social policies may have consequences on both longevity risk management practices and the functioning of LRT markets.

Policymakers should review rules and regulations pertaining to the measurement, management and disclosure of longevity risk with the objective of establishing or maintaining appropriately high qualitative and quantitative standards, including provisions and capital requirements for expected and unexpected increases in life expectancy.

Policymakers should consider ensuring that institutions taking on longevity risk, including pension fund sponsors, are able to withstand unexpected, as well as expected, increases in life expectancy.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 57

Policymakers should closely monitor the LRT taking place between corporates, banks, (re)insurers and the financial markets, including the amount and nature of the longevity risk transferred, and the interconnectedness this gives rise to.

Supervisors should take into account that longevity swaps may expose the banking sector to longevity tail risk, possibly leading to risk transfer chain breakdowns.

Policymakers should support and foster the compilation and dissemination of more granular and up-to-date longevity and mortality data that are relevant for the valuations of pension and life insurance liabilities.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 58Overview

In this chapter, the basic transaction types will be explained buy-outs, buy-ins, longevity swaps, and longevity bonds.

Who uses which technique depends greatly on the type of counterparty (Figure 3).

Insurers are associated with pension buy-ins, buy-outs and longevity insurance, whereas longevity swap transactions are associated with investment banks and reinsurers.

Also, in most jurisdictions, banks are not allowed to issue or take on longevity risk in the form of annuities, buy-ins and buy-outs, but can take it indirectly via swap transactions.

On the other side of the transactions, the choice of transaction type can have very different implications for the plan sponsor.

Longevity bonds remain only a concept for now there have been several attempts at issuing them, but none successfully.

Longevity risk can also be transferred to capital markets via life settlement securitisations.International Association of Risk and Compliance Professionals (IARCP) www.risk-compliance-association.comP a g e | 59

A life settlement occurs when the owner of a life insurance policy sells the policy for an amount below the face value of the policy (i.e., the amount paid when the policyholder dies).

The purchaser becomes responsible for making premium payments in return for collecting death benefits.

Although life settlement volumes have been recently growing, they have not reached the point at which securitisation becomes viable on a large scale.

For example, credit rating agencies have been reluctant to rate life settlement securitisation transactions because the pools are comprised of too few heterogeneous policies to estimate statistically stable cash flows (A.M. Best, 2009, S&P, 2011).

Also, A.M. Best (2009) expresses concerns about the wide range of opinions on life expectancies of legacy portfolios.

(Life settl