risk management presentation september 3 2012

7/28/2019 Risk Management Presentation September 3 2012

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International Association of Risk and ComplianceProfessionals (IARCP)

1200 G Street NW Suite 800 Washington, DC 20005-6705 USATel: 202-449-9750www.risk-compliance-association.com

Top 10 risk and compliance management related news storiesand world events that (for better or for worse) shaped the week's

agenda, and what is next

George LekatisPresident of the IARCP

Dear Member,

Is part of your job to predict the future?

Do you live in the new forward looking perspective in risk management?

In 1964, Arthur C. Clarke, science fiction writer, inventor and futurist

observed:

Trying to predict the future is a discouraging and hazardous occupation,

becausethe prophet invariably falls between two chairs.

If his predictions sound at all reasonable, you can be quite sure that in 20,or at most 50 years, the progress of science and technology has made himseem ridiculously conservative.

On the other hand, if by some miracle, a prophet could describe the futureexactly as it was going to take place, his predictions would sound soabsurd, so far-fetched, that everybody would laugh him to scorn.

Read more at N umber 7!

Welcome to the Top 10 list.

International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
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Agathe Ct: Modelling risks to the financial system

Remarks by Ms Agathe Ct, Deputy Governor of

the Bank of Canada, to the Canadian Association forBusiness Economics, Kingston, Ontario, 21 August2012.

Solvency I I

In 2011, E IOPA focusedon preparing the final set of regulatory measures for Solvency I I , the draftstandards and guidelines.

Credit Risk in the Shared National CreditPortfolio Declines, but Remains High

The credit quality of large loancommitments owned by U.S. banking

organizations, foreign bankingorganizations (FBOs), and nonbanksimproved in 2012 for the third consecutive year, according to the SharedNational Credits (SNC) Review for 2012.

Progress note on the Global LEIInitiative

This is the first of a series of notes on the implementation of the legalentity identifier (LEI) initiative. The G-20 in Los Cabos endorsed the FSBrecommendations and asked the Board to take forward the work to launchthe global LEI system by March 2013.

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OCC Updates Stress Testing I mplementationTimeline

The Office of the Comptroller of the Currency (OCC)today announced it is considering changesto theimplementation timeline for the company-run stresstesting required by the Dodd-Frank Wall StreetReform and Consumer Protection Act.

Security First: New NIST Guidelines on

Securing BIOS for Servers

From NIST Tech Beat: August 21, 2012

The National Institute of Standards and Technology (NIST) is requestingcomments on new draft guidelines forsecuring BIOS systems for servercomputers.

Understanding threats

Statement by Dr. Kaigham J. GabrielDeputy Director, Defense Advanced Research Projects AgencySubmitted to the Subcommittee on Emerging Threats and CapabilitiesUnited States House of Representatives

FSA statement regarding CRD I V implementation

CRD IV has been under discussion between theEuropean Parliament, European Commission and Council of Ministers.



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Understanding better

Information Operations, Electronic Warfare, Computer NetworkOperations

Information Operations - The integrated employment of the corecapabilities of electronic warfare, computer network operations,psychological operations, military deception and operations security, inconcert with specified supporting and related capabilities, to influence,disrupt, corrupt or usurp adversarial human and automated decisionmaking while protecting our own.

An interesting article about China. We will beglad to discuss other opinions in our nextnewsletter.

Chinas Slowdown May Be WorseThan Official Data Suggestby Janet Koech and Jian Wang



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NUMBER 1

Agathe Ct: Modelling risks to the financialsystem

Remarks by Ms Agathe Ct, Deputy Governor ofthe Bank of Canada, to the Canadian Association forBusiness Economics, Kingston, Ontario, 21 August2012.

* * *

Introduction

It has become a summer tradition for the Bank of Canada to address the

Canadian Association for Business Economics.

This year it is my pleasure and I thank you for the kind invitation.

An audience of colleagues and fellow economists offers me anopportunity to delve into a complex subject, and one that is particularlytimely: financial system risk.

We continue to see today the enormous costs to the global economy of thefinancial crisis that started five years ago.

Of the many lessons we have learned from the crisis, a key one is this: weneed to pay more attention to the stability of the financial system as awhole.

This meansunderstanding betterhow risks get transmitted acrossfinancial institutions and markets, and understanding better the feedbackloop between the financial system and the real economy.

From a policy perspective, this means taking a system-wide approach tofinancial regulation and supervision.

Major reforms of the global financial system now under way address thisneed.



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System-wide risk has been a focus of attention at the Bank of Canada, andat other central banks, for some time.

Ten years ago, the Bank issued the first edition of its semi-annualFinancial System Review in which it identifies key sources of risks to theCanadian financial system and highlights the policies needed to addressthem.

A year later, in 2003, we organized our annual conference on the theme offinancial stability.

In the wake of the global financial crisis, the Bank has intensified itsresearch efforts in this area.

In particular, a priority is to improve the theoretical and empirical modelswe use to analyze elements of the financial system that can lead to theemergence of risks and vulnerabilities.

With more finely tuned quantitative models and tools, the Bank will bebetter able to identify risks on a timely basis so that the private sector andpolicy-makers can take corrective action to support financial stability.

Let me acknowledge upfront that this task is complex.

While macroeconomic models have long been used to guide monetarypolicy decisions by central banks, models of financial stability andsystemic risk are much less advanced.

In my remarks today, I want to talk about the progress that we have madeat the Bank in modelling risks to the financial system.

I will start by briefly describing the notion of systemic risk and variousapproaches used to identify and measure it.

I will then discuss two state-of-the-art quantitative models that we havedeveloped to improve our assessment of risks to the Canadian financialsystem.



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The multiple dimensions of systemic risk

Systemic, or system-wide, risk goes beyond individual institutions andmarkets.

It is the risk that the financial system as a whole becomes impaired andthat the provision of key financial services breaks down, with potentiallyserious consequences for the real economy.

Systemic risk manifests itself in different ways.

There is a time dimension, which refers to the accumulation ofimbalances over time, and a cross-sectional dimension, which refers tohow risk is distributed throughout the financial system at a given point in

time.

Procyclicality is the key issue in the time dimension.

It reflects the tendency to take on excessive risk during economicupswings too much punch from the punchbowl, if you will and tobecome overly risk averse during the downturns.

Procyclicality makes the financial system and the economy morevulnerable to shocks, and increases the likelihood of financial distress.

Risk concentrations and interconnections are the key issues in thecross-sectional dimension.

Financial institutions can have similar exposures to shocks or be linkedthrough balance sheets.

As a result, losses in one institution can lead to fears of contagion thatamplify the adverse effects of the initial shock.

For instance, uncertainty about the viability of counterparties can lead tohoarding of liquidity, which may seem like an appropriate action for theindividual institution but can have disastrous consequences for thefinancial system as a whole.



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System-wide surveillance requires that we regularly assess the importanceof various types of systemic risk.

How we judge a particular risk will be based on the probability that it willlead to financial system distress, and on the extent of its impact shouldthat distress materialize.

Early-warning indicators

A fundamental challenge is to detect the risks arising from both globaland domestic sources in an environment with a vast number of potentialindicators.

Therefore, one direction of research at the Bank has been to isolate the

key signals from this broad information set by identifying a smaller groupof variables that can serve as early-warning indicators of emergingimbalances.

Since financial crises in Canada have been rare, international data areused to help establish numerical thresholds for each domestic indicator.

For example, if international evidence suggests that credit growth above acertain rate tends to be associated with increased risk, then a period withcredit growth above the threshold would suggest an elevated probabilityof financial stress.

Selecting the level of thresholds involves a difficult trade-off between falsealarms and failure to signal an event, so in practice the early-warningindicators are used mainly to identify areas where more detailedinvestigation may be warranted.

They provide an objective, practical starting point to detect the buildup ofimbalances in the financial system.

One early-warning indicator that we regularly track is the deviation of theaggregate private sectorcredit-to-GDP ratio from its trend (thecredit-to-GDP gap), which serves as a rough measure of excessiveleverage across the financial system (Chart 1).



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This indicator has been shown to provide some leading information as apredictor of banking crises, and has been proposed by the BaselCommittee on Banking Supervision (BCBS) as a useful guide fordecisions about when to activate the countercyclical capital buffer animportant macroprudential policy instrument in the Basel II I agreement.

Given the complexity of systemic risk, it is unrealistic to expect a singlemeasure or indicator to serve all purposes.

Combining indicators can produce better signals with fewer false alarmsand undetected crises.

For example, research shows that combining the Credit - to - GDP gapwith a measure of real estate prices produces an indicator that performsbetter than either variable on its own.

Our own work at the Bank reinforces findings elsewhere that aggregateprivate sector credit and real estate prices are among the most reliableindicators of financial stress.



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Identifying sources of risk is essential, but so is determining thelikelihood that these risks will materialize.

Therefore, another important aspect of ongoing research is thedevelopment of statistical models to help us forecast the probability that acrisis will occur based on a group of indicators.

Macro stress tests

Early-warning indicators are useful to gauge the probability of financialstress, but a thorough assessment also requires an analysis of what couldhappen if the risk materializes.

This is the goal of macro stress testing.

A good part of the Banks efforts in recent years has been devoted todeveloping and refining stress-testing models.

This class of models takes a large but plausible macroeconomic shock asa starting point and analyzes its impact on the balance sheets of banks orother sectors of the economy.

The Bank now has two main stress-testing models to help monitor risksto the financial system.

These models can also be used to assess the potential impact of policytools or regulatory actions in mitigating financial system risks.

Assessing risks from elevated household debt

The first, the Household Risk Assessment Model, or HRAM, is amicrosimulation model that assesses how the debt burden of Canadianhouseholds can affect financial stability.

Using microdata from household balance sheets, the model allows us toestimate how various shocks would affect the distribution of debt withinthe household sector.



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The simulations take into account changes over time in individual debtlevels, as well as changes in household wealth from savings andfluctuations in the value of financial assets.

Tracking the asset side of household balance sheets gives us a moreaccurate picture of systemic risk since changes in wealth affecthouseholdsability to pay their debt.

Household vulnerabilities depend not only on the average level of debt,but also on how debt is distributed across individuals.

One strength of the model is precisely its ability to account for thisdistribution.

For instance, while record-low interest rates in recent years havecontributed to a relatively low aggregate household debt-service ratio, theshare of Canadian households that are considered most vulnerable thosewith a debt-service ratio equal to or higher than 40 per cent has climbedto above-average levels, as has the proportion of debt held by thesevulnerable households (Chart 2).



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Using HRAM, we estimate that if interest rates were to rise to 4.25 percent by mid-2015, the share of highly indebted households would rise fromslightly above 6 per cent in 2011 to roughly 10 per cent by 2016, while theproportion of debt held by these households would rise from 11.5 per centto about 20 per cent over the same period.

So while the aggregate household debt-service ratio paints a somewhatrosy picture, taking into account distributions gives us a clearer and morecautionary indication of how vulnerable our financial system actually is tohousehold debt.

Another strength of the model is that it provides a flexible tool forsimulating the impact on household solvency of a wide range of potentialshocks, such as an increase in unemployment.

HRAM indicates that household loans in arrears would more than doubleunder a severe labour market shock similar to that observed in therecession of the early 1990s.

Despite the modelsstrengths, we continue to enhance our analysis byimproving HRAM.

Expanding the behavioural aspects of the model is one way to do this.

For instance, the model currently allows distressed households to paytheir debts by selling their liquid assets, but not their homes.

Work is also under way to improve the design of the shock scenarios.

Results of stress tests using HRAM are regularly reported in the BanksFinancial System Review and constitute an important element of ouroverall assessment of the risks associated with household finances.

Assessing contagion effects in the banking system

HRAM provides invaluable information on vulnerabilities in thehousehold sector, but the Bank is also interested in assessing risks morebroadly within the Canadian financial system.



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To this end, we have been working for several years on developing aMacro Financial Risk Assessment Framework (or MFRAF).

Drawing on detailed data from bank balance sheets, MFRAF is aquantitative model that tracks the contribution of individual banks tosystemic risk.

Traditional stress-testing models focus exclusively on solvency risk, andestimate the overall risk to the financial system by simply aggregatingcredit (or other asset) losses that would materialize at individual banks inthe event of a severe shock.

MFRAF goes beyond this traditional approach by taking into accountlinkages among banks arising from counterparty exposuresor network

spillover effects as well as funding liquidity risk, that is, the risk ofmarket-based runs on banks.

The financial crisis illustrated the significant risks associated with adeterioration of funding liquidity.

The collective reactions of market participants led to mutually reinforcingsolvency and liquidity problems at banks around the world.

As funding liquidity evaporated, many well-capitalized institutions had to

take writedowns on illiquid assets, or sell them at a loss, creatinguncertainty in the market about their solvency and adding to thedownward pressure on asset prices.

MFRAF has been built to integrate funding liquidity risk as anendogenous outcome of the interactions between solvency concerns andthe liquidity profiles of banks.

This strong microeconomic foundation constitutes a major innovation inmacro stress-testing models.

MFRAF also incorporates network externalities caused by the defaults ofcounterparties, with the size of a counterpartys interbank exposuresincreasing the likelihood of spillover effects.



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A key lesson from the model is that failure to account for either fundingliquidity risk or interbank exposures could lead to significantunderestimation of the risks to the financial system as a whole if thebanking system is undercapitalized and relies extensively on theshort-term funding market.

Importantly, the loss distributions generated by the model exhibitfat tails, a key feature of the actual distribution of financial system risks(Chart 3).

The fact that the model is able to replicate this important stylized factdemonstrates that it has significant potential as a tool for assessingsystemic risk.

Nevertheless, while MFRAF is already somewhat complex, the layers ofinteraction will need to be further augmented.

For instance, the model misses any negative feedback that could occurbetween heightened risks to the banking system and the real economy.

The model could also be expanded over time to include other types offinancial institutions and markets.



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Compared with other approaches that use market-based data, such as theasset-pricing approach, the transmission channel in models like MFRAFis transparent, and this improves our interpretation of results.

Because of this story-telling ability, many central banks have begun touse this type of framework in their financial stability analysis.

In addition to assessing risks, MFRAF can be used to examine the meritsof policy or regulatory initiatives such as capital and liquidity rules.

As the model becomes more refined, the objective is to use it more tocomplement other existing macro stress-testing exercises and to sharpenour analysis and communication of risks in the Banks Financial SystemReview.

Conclusion

Let me conclude.

The Bank of Canada is conducting extensive research into findingmethodologies and tools to identify and measure systemic risk.

While work in this area is extremely complex, the Bank has madesubstantial progress in recent years.

We now have two state-of-the art models. And with H RAM, the Bank ofCanada is one of the few central banks at the leading edge of usingmicrosimulation models to assess vulnerabilities in the household sector.

Our efforts to build these models have provided us with importantlessons.

First, distributions matterwe cannot rely solely on aggregate data:

distributional features and complex interactions are very important forassessing risks.

This means developing models that capture these effects.



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Our household simulation model is aimed directly at understanding howthe distribution of debts, assets and income affects financial stability.

MFRAF uses information about the interconnections of individualfinancial institutions because these can lead to non-linear network effectsthat are also important for assessing systemic risks.

Second, predicting behaviour under stress conditions is very difficult.

Models need to be able to handle a variety ofwhat-ifscenarioscorresponding to different assumptions about behaviours under stress.

Finally, we need to consider the many different sources of risk to thefinancial sector and take into account their cumulative effects and

interactions; otherwise we may underestimate risks.

Obviously, quantitative measures alone will never be enough to get acomplete picture, especially since the financial system evolves rapidly.

Intelligence gathered from discussions with the financial sector, as wellas information shared with other policy-makers and supervisors here inCanada and in the international community, will always be critical to theoverall assessment of the risks.

While we are making progress, it is important to remember that financialsystem modelling is still in its infancy.

The goal understanding, preventing, and reducing systemic | riskdeserves our attention, diligent research and hard work. It has been mypleasure to share some of the Banks efforts with you today. Thank youvery much.



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NUMBER 2

Solvency I I

In 2011, E IOPA focused

on preparing the final set of regulatory measures for Solvency I I , thedraft standards and guidelines.

One of the main achievements of EIOPA in 2011 was the report on theFifth Quantitative Impact Study (QIS5) summarising the potentialimpact of the detailed implementing measures to be drafted for theSolvency I I regulatory framework.

QIS5 has been the most ambitious and comprehensive impact study ever

carried out in the financial sector, with the direct involvement of morethan 2500 entities and 100 supervisors from member states and E IOPA,working together for almost a full year.

EIOPA launched official public consultations in 2011 in two areas inwhich early discussion with and preparation by the industry areparticularly important.

These consultations were on the draft standards and guidelines onreporting and disclosure, and on guidelines on Own Risk and Solvency

Assessment (ORSA).

At the end of 2011, E IOPA submitted additional advice to the EuropeanCommission on the calibration of the non-life underwriting risk module.

In the area of catastrophe risk, EIOPA made its final recommendation forthe implementing measures on a number of outstanding non-life andhealth catastrophe risk issues.

Several task forces concluded their work in 2011, resulting in thepublication of the following reports: Calibration of the Premium andReserve Risk Factors in the Standard Formula of Solvency IIand theReport of the Task Force on Expected Profits arising from FuturePremiums.



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Finally, since the creation of EIOPAs Insurance and ReinsuranceStakeholder Group, EIOPA has benefited from their expertise and widerange of views and interests, and actively involved its members in majoraspects ofSolvency I I .

Occupational pensions

The main focus of EIOPAs work on occupational pensions in 2011 wasdeveloping EIOPAs response to the Call for Advice from the EuropeanCommission on the review of Directive 2003/ 41/EC on the activities andsupervision of institutions for occupational retirement provision (IORPDirective).

The work on the Call for Advice was organised in four sub-groups, all

working in parallel, but all reporting to the Occupational PensionsCommittee (OPC).

In 2011, E IOPA also completed number of survey-based reports onreporting requirements, risks related to DC schemes and pre-enrolmentinformation.

These surveys were conducted to provide a common technical basis forresponding to the Call for Advice.

During 2011, EIOPA carried out two public consultations on its draftadvice.

The first between 8 July 2011 and 15 August 2011 on selected aspects of theCall for Advice.

The second, between 25 October 2011 and 2 January 2012 on the entiredraft advice.

EIOPA also submitted during the year 2011 its input to the ESRB on datarequirements for IORP and published its recurrent report on marketdevelopments.



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Consumer protection and financial innovation

EIOPA has considered, from day one, consumer protection as acornerstone of its work and an area where a difference has to be made,

and EIOPA has been proactive in the area of consumer protection andfinancial innovation.

In the course of 2011, the Authority prepared The Proposal forGuidelines on Complaints- Handling by Insurance Undertakings, theReport on Best Practices by Insurance Undertakings in handlingcomplaints and finalised a Report on Financial Literacy and EducationInitiatives by Competent Authorities.

EIOPA also collected data on consumer trends among its members to

prepare an initial overview, analysing and reporting on those trends.

The Authority also provided relevant input to the EuropeanCommissions revision of the Insurance Mediation Directive (IM D) bycarrying out an extensive survey of sanctions (both criminal andadministrative) provided for in national laws for violations of IM Dprovisions.

External commitment, including benefiting from the expert input ofEIOPAs two Stakeholder Groups and holding EIOPAs first Consumer

Strategy Day, was also crucial to E IOPA achieving its goals in 2011.

Colleges of Supervisors and cross-border crisis management andresolution

EIOPAs tasks go beyond pure regulatory work, and include concreteoversight responsibilities, including an enhanced role as members of thedifferent colleges of supervisors.

The overall strategic target of E IOPAs College work is to consolidate theposition of the European Economic Area (EEA) supervisory communityvis-a-vis insurance groups operating across borders for the benefit of both



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group and solo supervision. I n 2011, around 89 insurance groups withcross border undertakings were registered in the EEA.

During the year, Colleges of Supervisors having at least one actualmeeting or teleconference were organised for 69 groups.

A total of 14 national supervisory authorities acted as group supervisors toorganise the events.

During the setup phase in the first year after its establishment, EIOPAattended College meetings and/ or teleconferences of 55 groups.

In early 2011, a set of interim procedures for dealing with emergencysituations was developed by EIOPA in conjunction with the other ESAs.

A seconded national expert in crisis management was appointed inMarch 2011, and work then commenced on the development of apermanent crisis management framework by EIOPA.

Key to this was the development of a strategic policy on crisismanagement.

In the end of 2011 a Task Force on Crisis Management delivered acomprehensive, decision-making framework on crisis pre-emption andcrisis management.

Financial stability

The common theme of EIOPAs financial stability initiatives in 2011 wasto identify, at an early stage, trends, potential risks and vulnerabilitiesstemming from micro and macroeconomic developments, and, wherenecessary, to inform the relevant EU institutions.

This was achieved by specific and regular market monitoring,information sharing and discussions on mitigating measures in theFinancial Stability Committee (FSC).



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In line with this objective, EIOPAs FSC set up its first (pilot) riskdashboard in October 2011, containing a common set of quantitative andqualitative indicators that help to identify and measure systemic risk.

This dashboard is to be developed further as a joint effort of the ESAs andthe ESRB.

In the course of 2011 EIOPA has been an active member of the ESRBSteering Committee that was established in order to assist in thedecision-making process of the ESRB.

EIOPA also was taking part in the ESRB Advisory Technical Committee(ATC) and its technical subcommittees with the main focus onidentifying potential systemically important issues in the sectors of

insurance and IORPs.

Furthermore, EIOPA participated in thejoint ATC and AdvisoryScientific Committee (ASC) expert group dealing with the regulatorytreatment of sovereign exposures.

In 2011, the three ESAs and the ESRB signed a joint Agreement on theestablishment at the ESRB Secretariat of specific confidentialityprocedures in order to safeguard information regarding individualfinancial institutions and information from which individual financial

institutions can be identified.

EIOPA also began designing a database of current and historical data forIORPs and insurance and reinsurance undertakings in the EuropeanUnion.

During 2011, EIOPA conducted harmonised, pan-European core andlow-yield stress tests for the insurance sector in cooperation with theESRB, ECB and EBA.

In June and December 2011, EIOPA published its two semiannualFinancial Stability Reportscontaining an assessment of the economicsoundness of the European insurance, reinsurance and IORPs.



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In December 2011, E IOPA put out for public consultation a set of datareporting templates necessary for regularly assessing sectoral risk andmonitoring financial developments once Solvency I I enters into force.

EIOPA OverviewIntroduction

The European Insurance and Occupational Pensions Authority (EIOPA)was established as a result of the reforms of the structure of supervision ofthe financial sector of the European Union (EU) that followed thefinancial crisis of 2007, as the crisis demonstrated that the pre-existing3L3 Committees (CEIOPS, CEBS and CESR) had reached their limit.

Before and during the financial crises of 2007 and 2008, the European

Parliament called for a move towards greater European supervisoryintegration in order to ensure a true level playing field for all players at thelevel of the European Union and to reflect the increasing integration ofthe financial markets of the EU.

In response to the global financial crisis, the European Commissiontasked a High Level Group (Committee of Wise Men), chaired by MrJacques de Larosiere, to consider how the European supervisoryarrangements could be strengthened, both to better protect EU citizensand to rebuild trust in the financial system.

Among its many conclusions, the Group stressed that supervisoryarrangements should not only concentrate on the supervision ofindividual firms, but also place emphasis on the stability of the financialsystem as whole.

Following the recommendations of the Committee of Wise Men, theEuropean Commission initiated a reform, which was supported by theEuropean Council and the European Parliament.

As a result, the supervisory framework was strengthened to mitigate therisk and severity of future financial crises.



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EIOPA is part of a European System of Financial Supervision (ESFS), thepurpose of which is to ensure supervision of the EU financial system.

The ESFS comprises the three European Supervisory Authorities (ESAs):the European Banking Authority (EBA), based in London, the EuropeanSecurities and Markets Authority (ESMA), based in Paris, and EIOPA,based in Frankfurt, as well as the European Systemic Risk Board (ESRB),based in Frankfurt, and the competent or supervisory authorities in theEU Member States as specified in the legislation establishing the threeESAs.

EIOPAs main goals are:

To better protect consumers, thus rebuilding trust in the financial

system;

To ensure a high, effective and consistent level of regulation andsupervision, taking account of the varying interests of all Member Statesand the different nature of the financial institutions;

To achieve a greater harmonisationand coherent application of the rulesapplicable to the financial institutions & markets across the EuropeanUnion;

To strengthen oversight of cross-border groups;

To promote a coordinated European Union supervisory response.

EIOPAs core responsibilities are to support the stability of the financial

system, ensure the transparency of markets and financial products andprotect policyholders, pension scheme members and beneficiaries.

EIOPA is commissioned to monitor and identify trends, potential risksand vulnerabilities at the micro-prudential level, across borders and

across sectors.

EIOPA is an independent advisory body to the European Parliament, theCouncil of the European Union and the European Commission.



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To account for the specific conditions in the national markets and thenature of the financial institutions, the European System of FinancialSupervision is an integrated network of national and Europeansupervisory authorities that provides the necessary links between themacro and micro prudential levels, leaving day-to-day supervision to thenational level.

EIOPA is governed by its Board of Supervisors, whose members are theheads of the relevant national authorities in the field of insurance andIORPs in each Member State.

The European Unions national supervisory authorities are a source ofexpertise and information in the field of insurance and IORPs.

Policy Working Groups

The majority of Policy Working Groups dealt with insurance andreinsurance-related issues,in particular Solvency I I .

Two other Working Groups in the policy area dealt with IORPs(IORP Directive) and equivalence-related issues.

Solvency I I Working Groups

The Solvency II project is completely reshaping the supervisory andregulatory framework for insurance and reinsurance companies, bringinga modern risk oriented, economic and principle based set of rules.

One of the main tasks for EIOPA in the coming years is to prepare thenew supervisory regime for insurance and reinsurance undertakings andparticularly to conduct all the necessary work for implementation of theEU Directive on the taking-up and pursuit of the business of insuranceand reinsurance (Solvency II ).

During 2011, the Solvency I I Working Groups developed draft standardsand guidelines which are likely to be required by the Omnibus I IDirective,and which E IOPA considers as essential for ensuring the



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existence of convergent supervisory practicesfrom Solvency I I s first dayof entry into force.

Pre-consultations with selected stakeholders were held as part of thecontinuous informal discussion with stakeholders while awaitingconfirmation of the formal legal basis for public consultation on thestandards.

Each Working Group contributed to EIOPAs training programme forsupervisors and, where relevant, Working Groups were involved in thediscussions conducted by the European Commission on implementingmeasures.

Working Groups contributed to those areas of each others work that

required a cross-working group perspective, such as governance orreporting.

Insurance Groups Supervision Committee (IGSC)

The Insurance Groups Supervision Committee (IGSC) focused ondeveloping draft technical standards and guidelines for the convergentimplementation of Solvency II in the areas of group solvency calculations,intra-group transactions and risk concentration, the cooperation andexchange of information in Colleges, and the treatment of third country

branches.

Financial Requirements Committee (FinReq)

The Financial Requirements Committee (FinReq) focused on developingdraft technical standards and guidelines for the convergentimplementation ofSolvency I I in the areas of own funds, technicalprovisions, and the standard formula for capital requirements, includingthe use of undertaking-specific parameters.

FinReq contributed to the development of calibration factors for non-lifeunderwriting risk and catastrophe risk.



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Internal Governance Supervisory Review and ReportingCommittee (IGSRR)

The Internal Governance, Supervisory Review and Reporting Committee

(IGSRR) focused on developing draft technical standards and guidelinesfor the convergent implementation ofSolvency I I in the areas of system ofgovernance, including Own Risk and Solvency Assessment (ORSA),transparency and accountability of supervisory authorities, publicdisclosure and supervisory reporting, and valuation of assets andliabilities (other than technical provisions).

Public consultation on the ORSA guidelines and reporting and disclosurerequirements was launched at the end of 2011.

IGSRR also started working on guidelines for external audit, thesupervisory review process, capital add-ons, and the extension of therecovery period in the exceptional fall in financial markets.

IGSRR prepared EIOPAs contribution to the International FinancialReporting Standard (IFRS) setting process and to the EU endorsementprocess.

Internal Models Committee (IntMod)

The Internal Models Committee (IntMod) focused on developing drafttechnical standards and guidelines for the convergent implementation ofSolvency I I in the areas of tests and standards for full and partial internalmodels, requirements for the approval process, and the policy forintroducing changes to the model.

In order to increase supervisory convergence and to prepare industry andsupervisors for the use of internal models under Solvency I I , IntModimplemented initiatives for enhancing supervisory consistency across

Europe in the pre-application process for internal models, and forensuring adequate cooperation between supervisors when assessinginternal models.



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These initiatives involved practical meetings between operationalsupervisors and training activities.

Task Force on Expected Profits arising from Future Premiums

(EPIFP)

This task force was created to develop a common understanding of theelement of expected profits included in future premiums (EPIFP) so as toadvise the Commission on the drafting of implementing measures afterthe fifth quantitative impact study (Q IS5).

It was composed of representatives of industry, the EuropeanCommission and EIOPA members and discussed possible ways ofharmonising the calculation of EPIFP under Solvency I I.

EIOPA submitted a report to the European Commission whichultimately only represented the views of its own members.

Occupational Pensions Committee (OPC)

The main focus of the Occupational Pensions Committee (OPC) workbetween April 2011 and the end of the year was developing E IOPAs adviceto the European Commission on the review of the IORP Directive in

response to the Call for Advice.

Beyond this, OPC own initiative projects in 2011 included the publicationof a number of survey - based reports as follows:

Report on reporting requirements to supervisory authorities for

IORPs

Report on market developments 2011

Two reports on risks relating to members of defined contributionpension schemes (risks faced by members and mechanisms mitigatingthose risks)



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Report on pre-enrolment informationas part of a wider OPCmandate on Packaged Retail Investment Products (PRIPs) and pensionsOther inputs included a contribution to a report on the EuropeanSystemic Risk Board (ESRB) data requirements in respect of IORPs.

Equivalence Committee

In January 2011, the Equivalence Committee was set up with its main taskbeing to respond to requests from the European Commission for finaladvice, after full consultation, on the equivalence of third countriessupervisory systems.

On 26 October 2011, upon request of the European Commission, EIOPAdelivered its final advice, after full consultation, on the Solvency II

equivalence assessments of the supervisory systems in the followingcountries:

- Switzerland,- Bermuda and- Japan.

The supervisory systems of Switzerland and Bermuda were assessed withreference to reinsurance, inclusion of the third country undertaking in the

group solvency calculation and group supervision, while the supervisorysystem of Japan was assessed only with reference to reinsurance.

The equivalence assessment was based on respective questionnairesfilled in by the relevant supervisory authorities(Swiss FinancialSupervisory Authority FINMA; Bermuda Monetary AuthorityBMA;and the Japan Financial Services Authority JFSA), followed by adesk-based analysis using E IOPAs methodology, and onsite visits byEIOPA experts to each of the three countries.

Regulatory Working GroupsCommittee on Consumer Protection and Financial I nnovation

(CCPFI)



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In 2011, the Committee on Consumer Protection and FinancialInnovation (CCPFI) supported EIOPA in fulfilling the requirement laiddown in its Regulation of taking a leading role in the area of consumerprotection and financial innovation, as follows:

preparingGuidelines on Complaints-Handling by InsuranceUndertakingsand Report on Best Practices by Insurance Undertakingsin handling complaints.

preparing theReport identifying Good Practices for Disclosure andSelling of Variable Annuities.

finalising the Report on Financial Literacy and Education Initiativesby Competent Authorities.

collecting data on consumer trends among its members so as to preparean initial overview, analysing and reporting on those trends.

carrying out an extensive survey of sanctions (both criminal andadministrative) provided for in national laws for violations of IM Dprovisions.

Task Force on Insurance Guarantee Schemes (TF-IGS)

This task force met in the course of 2011 to prepare the report on thecross-border cooperation mechanisms between IGSs in the EU.

In accordance with EIOPAs mandate to contribute to assessing the needfor a European network of IGSs that is adequately funded and sufficientlyharmonised, the report was EIOPAs input to the European Commissionspolicy - making on IGSs.

It summarised the findings from a mapping exercise of the existing

mechanisms on cross-border cooperation between the IGSs of MemberStates, and provided general recommendations to the EuropeanCommission in the area of cooperation between IGSs and with theirsupervisors.



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Oversight Working GroupsReview Panel

At the beginning of 2011, the Review Panel , using the experience and

lessons learned from its first peer review exercise completed in 2010,reviewed the methodology for peer reviews in line with the EIOPARegulation.

In the middle of the year, the Review Panel started work on three peerreview projects on supervisory practices for pre-application of internalmodels, supervision of branches of EEA insurance undertakings, andsupervision of IORPs.

These peer reviews are due to be completed in 2012.

Task Force on Crisis Management

In 2011 a Task Force on Crisis Management was established to developEIOPAs structures for crisis prevention, management and resolution.

In December 2011, this task force delivered a comprehensive,decision-making framework that was endorsed by the Board ofSupervisors.

This framework sets out in detail the processes that EIOPA will follow indischarging its crisis pre-emption and crisis management responsibilitiesunder the EIOPA Regulation.

Financial Stability Working GroupsFinancial Stability Committee (FSC)

The Financial Stability Committee (FSC) focused on monitoring andanalysing developments in the insurance and IORPs sectors.

This included in particular the impact of sovereign debt situation in someEuropean countries and also that of other events such as natural



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catastrophes, including the impact of the Japanese earthquake in March2011 and the subsequent devastating tsunami.

Furthermore, the FSC developed a 2011 stress test exercise for theEuropean insurance sector, including a subsequent satellite exercise for alow-yield environment.

The FSC also developed and implemented the EIOPA risk dashboardbased on quarterly information collected from national supervisors.

The FSC contributed to the work of the cross-sector risk subcommittee ofthe Joint Committee.

FSC also contributed to the two half-year Financial Stability Reports

monitoring both sectors (IORPs and insurance undertakings), whichwere also submitted to the EU Economic and Financial Committee(EFC) and the ESRB.

Corporate support Working GroupsInformation Technology and Data Committee (ITDC)

In 2011, the IT and Data Committee (ITDC) focused on developingEIOPAs IT and data strategy and, following on from this, it worked onIT specifications and implementation plans.

The IT strategy set out the IT-related goals needed to fulfil E IOPAsmission.

The Board of Supervisors adopted the IT and data strategy reports at itsOctober 2011 meeting and mandated EIOPA to implement the IT-relatedgoals set out therein.

The Board of Supervisors required the ITDC to produce high - level and

outline IT plans and specifications, with particular focus on an EIOPA ITimplementation plan.



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Update on Solvency II

Solvency I I is a new regulatory framework providing supervisors withthe appropriate tools for assessing the overall solvency of insurance and

reinsurance undertakings by quantitative and qualitative means, thusimproving understanding and management of these undertakings risks.

I t is based on three pillars:quantitative requirements (pillar I);governance, risk management and supervisory review (pillar I I ); andsupervisory reporting and public disclosure (pillar I I I).

The framework directive was published on 17 December 2009.

The Omnibus I I Directive is under discussion in the European

Parliament and Council of the European Union following the legislativeproposal from the European Commission on 19 January 2011.

Implementing measures have been discussed between the EuropeanCommission and Member States since the end of 2009.

Standards are being drafted by EIOPA to be endorsed by the EuropeanCommission.

Guidelines are being drafted by EIOPA to ensure the convergentapplication of the regulation.

Date of entry into force of Solvency II: 1 January 2014.

Omnibus I I Directive and implementing measures

Following the creation of EIOPA, the Solvency II Directive requiredrevision to reflect the new supervisory structure; these revisions will formpart of the Omnibus I I Directive (OMDII).

OMDII will introduce into the Solvency I I Directive the necessaryregulatory and supervisory powers for E IOPA to discharge itsresponsibilities.



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In addition, OMDII also includes transitional measures allowing gradualimplementation of Solvency I I .

This extension means that the beginning of the regime would be alignedwith the end of the financial year for most insurance undertakings.

During 2011 EIOPA continued to provide technical and analytical supportto the Commission and gave further input to clarify its previous advice onthe development of the implementing measures for Solvency II .

While deliberations were taking place in the European Parliament andthe Council of the European Union on OMDII , the Commission,Member States and stakeholders also examined the draft implementingmeasures.

Key areas under discussion were the sustainability of long-term insuranceguarantees, the volatility of elements in undertakingssolvency balancesheets, and reporting and disclosure requirements.

Standards and guidelines

In 2011, EIOPA focused on preparing the final set of regulatory measures,the draft standards and guidelines.

Solvency I I will be one of the first projects to benefit directly fromEIOPAs regulatory powers to draft standards and subsequently to ensureconsistent implementation of legislation through binding mediation andoversight of Colleges of Supervisors.

Until there is agreement on the proposals for OMDII Directive, EIOPAwill not have complete certainty on the scope of its powers for drafting thestandards for Solvency II and the detail of the regulatory provisions whichthe standards and guidelines are intended to support.

Consequently, it was important for EIOPA to monitor the various OMDIIproposals and thus identify the standards which the Authority expects itwill have to draft before Solvency I I enters into force on 1 January 2014.



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During 2011, E IOPA also identified those areas in which it is essential tohave guidelines in place before the entry into force of Solvency II.

EIOPA is committed to effective consultation and communication withits stakeholders to improve the quality of the regulatory provisions andassist the industry in preparing for the new regime.

Subject to the conclusion of the negotiations on OMDII and theimplementing measures, EIOPA plans public consultation on thepackages of draft standards and guidelines during 2012.

In 2011, EIOPA launched official public consultations in two areas inwhich early discussion with and preparation by the industry areparticularly important.

These consultations were on the draft standards and guidelines onreporting and disclosure, and on guidelines on Own Risk and SolvencyAssessment (ORSA).

In other areas, EIOPA continued its informal pre- consultations withselected stakeholders (European Insurance and Reinsurance Federation(CEA), Association of Mutual Insurers and Insurance Cooperatives inEurope (AMICE), Chief Risk Officers (CRO) Forum and Chief FinancialOfficers (CFO) Forum, Groupe Consultatif Actuariel Europeen), thushaving an ongoing dialogue with the industry ahead of the publicconsultation.

A number of other initiatives were set up specifically to improve EIOPAscooperation and exchange of information with its stakeholders.

Several task forces completed their work in 2011, which resulted in thepublication of the Report on the Calibration Factors in the StandardFormula of Solvency I Iand the Report of the Task Force on Expected

Profits arising from Future Premiums.

Finally, following the creation of E IOPAs Insurance and ReinsuranceStakeholder Group, EIOPA actively involved its members in majoraspects of Solvency II .



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Areas in which E IOPA prepared draft standards and guidelinesduring 2011:

Solvency capital requirements for standard formula as well as for

internal model users; own funds; valuation of technical provisions;valuation of assets and liabilities.

Group supervision.

Supervisory transparency and accountability, reporting and disclosure,external audit.

Governance, ORSA.

Supervisory review process; capital add-ons; extension of recovery period(Pillar 2 dampener); finite reinsurance; special purpose vehicles.

Quantitative Impact Study 5

One of the key achievements of E IOPA in 2011 was completion of thereport on the Fifth Quantitative Impact Study (QIS5) in March 2011.

The results of the QIS5 exercise were taken into account in discussions

on the implementing measures and are being reflected in the drafting ofstandards and guidelines.

The QIS5 exercise

In March 2011, EIOPA delivered to the European Commission a report onthe results of the fifth pan-European quantitative impact study organisedto inform policymakers on the potential effects of the detailedimplementing measures which are being drafted for the Solvency IIregulatory framework.

More than 2 500 individual undertakings and 160 groups from the 30



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members of the European Economic Area participated voluntarily in thissimulation exercise, providing detailed quantitative and qualitative inputson the various elements of the future regulation.

The study confirmed that overall the industry remained well capitalisedunder the draft provisions and options tested.

The studygathered useful input on transitional provisions fordiscounting, the grandfathering of specific elements of own funds, andthe transitional equivalence of third-country regimes, for example.

Valuable insight was gained about the characteristics of internal modelsunder development by undertakings, the difficulties in calculating theloss - absorbing capacity of technical provisions and deferred taxes, and

the potential impact of the introduction of an illiquidity premium in thevaluation of technical provisions.

The study also covered the treatment of participations; it gatheredinformation on the relevance of expected profit in future premiums, andon the group solvency assessment under the consolidation and deductionand aggregation methods.

The study results highlighted the areas in which further work would bedesirable.

This

risk management presentation september 3 2012

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