Another week, another constraint

Let us suppose that one wanted to make banks and insurance companies take a more predictive approach to estimating the credit risks within their portfolios, wishing to address the not unreasonable criticism that what happened during the Financial Crisis post-2007 made it clear that loss estimates (and, therefore, credit provisions and reserves) were often reactive and inadequate. What would one do?

Well, if you were the International Accounting Standards Board (IASB), you would spend 5 years, revising and refining IAS 39 and create IFRS 9, the final version of which was published earlier this week, to come into mandatory effect for all those entities subject to IFRS accounting rules  on 1st January, 2018. Of course, if you were the US’s Financial Accounting Standards Board (FASB), you would try and fail to create a joint standard with the IASB; and still be working on your own version of IFRS 9.

Why should anyone care about this new accounting standard? Perhaps because at least some global banks think it may require them to increase and disclose loan loss provisions up to 50% above current levels- and (re)insurance companies cannot ignore IFRS 9, because it also impacts their own investment portfolios, which tend to consist largely of bonds, loans and other forms of credit extension.

The reason for this potentially significant change is that IFRS 9 focusses on an entity’s business model for managing its financial assets and the contractual cashflow characteristics of those financial assets; and requires an entity to recognize expected credit losses at all times and to update the amount of expected credit losses recognized at each reporting date to reflect changes in their credit risk. In other words, one must not just take an initial reserve for an “expected” level of credit loss, but must constantly look forward and regularly re-assess and revise the calculation, using available information and judgement. This is very different from IAS 39, which did not permit any forward assessment. Disclosure requirements are also toughened: affected entities will have to publish how they calculate their credit losses and assess changes in risk.

In reality, any prudently run financial institution should be and is already doing the work described in IFRS 9; although it will have to consider whether its approach and methodology are supportable and will stand public scrutiny- no doubt the consultants will have a field day, even though there is no magic to any of this, just basic, prudent risk management.

Of course, the implementation of IFRS 9 may also have an impact on how entities invest and take credit risk. That remains to be seen, but bears watching as we come closer to 1st January, 2018. The leadtime means that there can be no excuse for being caught out. You have been warned!

-The Awbury Team


Who’d be a mortgage insurer…?

On July 10th, the Federal Housing Finance Agency (FHFA), which regulates and supervises the USA’s housing GSEs, Fannie Mae and Freddie Mac, published a paper entitled “Draft Private Mortgage Insurer Eligibility Requirements” (PMIERs, or “P-Myers” for the aficionado) as a consultation document setting out its proposals for new guidelines that any entity that wishes to provide mortgage insurance to the GSEs will have to meet.

To say that the publications provoked an industry reaction would be an understatement: share prices of a number of PMIs fell; several announced that they believed that they would already be compliant with the PMIERs; and others that they would have to take material steps to become compliant over what they expected to be a two-year phase-in period once the guidelines were finalized. From what we have read, it seems clear that the PMIs were aware of what the FHFA intended and made representations to it; but also that the FHFA did not accept at least some of what the PMIs sought.

So, what provoked such a reaction?

The key component of the paper is a new requirement  that all PMIs who wish to be accepted by  the GSEs as eligible to provide mortgage insurance must maintain a minimum level of 5.6% of Eligible Assets (a fairly narrowly defined term) as a percentage of their Risk In Force (RIF), using tables and criteria set out in the paper, which in turn were sourced from the GSEs’ own analytics via the FHFA’s Mortgage Analytics Platform. The rub is that even if a portfolio calculation produces an outcome below 5.6% (and some of the weightings go down to 1%), 5.6% is the minimum requirement. Another factor to consider for those PMIs with significant legacy books is that some of the portfolio weightings can reach over 100%.

Thus, PMIs are going to have to assess their legacy, current and future business for what the required level of Eligible Assets will be; which will also indirectly drive how much regulatory capital they need and thus have an impact on returns and pricing.

One of the mitigants that many of the PMIs will be considering is reinsurance; which, as long as it is risk-bearing, is permitted under the draft PMIERs. At Awbury, in our quest to continue to provide innovative products to our clients, we have developed ways in which, with our (re)insurance partners, we can assist the PMIs in dealing with the potential consequences of the FHFA’s goals; and believe that our approach will be both effective and cost and capital efficient.

As the US PMI market adjusts, adapts and grows, we stand ready to help our clients, as in other areas, to continue to achieve their goals.

-The Awbury Team


What’s next in the jargon-happy world of insurance regulatory supervision?

Historically, regulation of insurance companies has tended to follow developments and approaches which originated in banking. The EU’s Solvency II is a classic example.

Similarly, the minimum capital  and “systemically important” concepts now prevalent in banking have also begun to migrate to the insurance arena, through the Basic Capital Requirement (BCR) and Global Systemically Important Insurers (G-SII) designation being advanced by the International Association of Insurance Supervisors (IAIS), which performs a role equivalent to that of the Basel Committee on Banking Supervision (BCBS) of the BIS.

The most recent example of this congruence was the publication on July 9th of the IAIS’s Consultation Document on a BCR for G-SIIs. Work on setting a BCR is intended to underpin the creation of group-wide global capital standards- in other words a structure equivalent to that of the various iterations of “Basel” from the BCBS. Similarly, the IAIS intends to develop a Higher Loss Absorbency (HLA) requirement for G-SIIS before the end of 2015. Once that is in place, IAIS will develop a risk-based, group-wide, global insurance capital standard (ICS) before the end of 2016, to be applied to Internationally Active Insurance Groups (IAIGs) in 2019.

Now that we have all the jargon and prospective timing out of the way, why should anyone care about this? In our view, the Board and Executive Management of any multi-national (re)insurance group need to pay attention to these developments for a number of reasons:

  • To ensure that regulators do not go “off track” in assessing the real risks within a (re)insurance business
  • To avoid the “death by a thousand cuts” that the Solvency II process became in the EU
  • To try to minimize the risk of ICS becoming the sort of mind-numbing, absurdly complex imposition that Basel III or its national derivations have mutated into
  • To be able to head off any false analogies that insurance regulators may try to apply from the banking industry- Insurance LCR, perhaps?

We are, of course, completely supportive of regulation that is intended to create a “level playing field” and to ensure that the we and our (re)insurance partners are able to continue to deliver appropriately capitalized and supported solutions to our diverse range of global clients. However, in observing the consequences, many of them unintended or counter-productive, caused by trends in banking regulation, and knowing how insurance regulators have frequently “followed” a banking-style approach, we believe that the (re)insurance industry needs to remain vigilant and engaged in a dialogue with the IAIS and local regulators to help achieve a rational framework that is “fit-for-purpose” and not some monstrous offshoot of Basel III.

-The Awbury Team


Criminalizing Banks…What is justice?

The news is full of the misdeeds, both proven and alleged, of an increasingly large number of multi-national banks in a range of areas- some market-related, others linked to regulation.

As we have written before, it is clear that banking regulators have embarked on a course of action that is intended to exact increasingly significant economic penalties from those targeted, as well as, more recently, forcing them to admit some form of criminal wrongdoing.

This has become more than an attritional “cost of doing business”, as the amounts now involved can easily wipe out a year or more’s profits; and one has the sense that regulators and government legal officers have a range of possible activities still to be comprehensively targeted, such as LIBOR, FX and commodities pricing.

And yet, with few exceptions (and those only at a low level), they have not gone after bank executives for either civil or criminal penalties. In the case of BNP Paribas, a number of executives have supposedly been forced out, but there is no evidence that they have suffered any material penalties. Of course, such outcomes do beg the question of whether regulators are trying to achieve a goal without having to resort to the courts and the need to meet a burden of proof. So, one does wonder what would happen if a bank actually resisted and sought its day in court, as some are now urging, or was willing to meet the costs incurred by its officers in defending themselves before a tribunal. Could this lead to retribution in the form of threatened loss of essential banking licences?

With a few obvious exceptions, such as the infamous BCCI, banks are not criminal enterprises. They are vulnerable to the malfeasance of individuals, even at a senior level; and to sins of omission (“turning a blind eye”) and of commission; as well as to the idiosyncrasies of government political sanctions and the conflicts between them (such as between the US and the EU, for example.) Yet they also perform essential utility-like functions without which no modern economy, nor global trade can function, so enforcement activity is inherently a balancing act to ensure that wrongdoing is appropriately punished and justice achieved, while essential functions are not compromised.

-The Awbury Team