CHAPTER 13 Supervision of Financial Conglomerates in the European Union

MICHAEL GRUSON

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MICHAEL GRUSON

MICHAEL GRUSON
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Keywords:: SEM; government; country; central bank; financial conglomerate; securities affiliate; IMF's article; remittance system; IMF surveillance; Securities; Financial conglomerates; Central bank autonomy; Digital currencies; Exchange restrictions; Global; Europe; Asia and Pacific; Middle East; Africa; Solvency; South America; Central America; Caribbean

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Abstract

The Legal Department and the Institute of the IMF held their ninth biennial seminar for legal advisors of IMF member countries’ central banks, and the papers published in this volume are based on presentations made by officials attending this seminar. The seminar covered a broad range of topics, including sovereign debt restructuring, money laundering and the financing of terrorism, financial system and banking supervision, conflicts of interest and market discipline in the financial sector, insolvency, and other issues related to central banking.

The Purpose of Supplementary Supervision

On November 20, 2002, the European Parliament adopted Directive 2002/87/EC¹ introducing supplementary supervision of financial conglomerates (hereinafter the Supplementary Supervision Directive).

The principal reason for this Directive was the need to face the accelerating pace of consolidation in the financial industry and the intensification of links between financial markets. Over the past years, a number of cross-sector groups combining insurance companies, banks, and investment firms have been created and have become of significant importance in the European Union (EU).² Combined financial operations may create new prudential risks or exacerbate existing ones.³ Laws and regulations dealing with different financial sectors were not able to deal with these developments and such laws have traditionally adopted different approaches with different definitions of capital, different types of risks, and different capital requirements.⁴ For instance, insurance supervisors have historically been primarily concerned with the liability side of the balance sheet as the main source of risk, although assets are of course monitored too. Regulations in the banking sector regard the asset side of the balance sheet as the principal source of risk, although an examination of the source of funding is an important aspect of the supervisory process. Securities supervisors require securities firms to have sufficient liquid assets to repay promptly all liabilities at any time. The scope for potential supervisory problems increases if a financial conglomerate spans a number of financial markets due to the web of financial interrelationships characteristic of financial conglomerates. On the other hand, such conglomerates may gain financial solidity by diversifying that risk.⁵ The Supplementary Supervision Directive intends to ensure the stability of the European financial market, establish common prudential standards for the supervision of such financial groups throughout Europe, and introduce level playing fields and legal certainty between financial institutions.⁶

Relationship to Existing Solo and Consolidated Supervision

The basic philosophy of the Supplementary Supervision Directive is that the solo supervisions of individually regulated entities should continue to be the foundation for effective supervision. Furthermore, the Supplementary Supervision Directive does not replace the existing consolidated or supplementary supervision of groups that operate in one sector of the financial industry, but introduces an additional supplementary supervision of the regulated entities in groups that straddle more than one financial sector. The Supplementary Supervision Directive is based on the notion that the various supervisory authorities of different sectors of the financial industry and the supervisory authorities of the different member states need to establish a coordinated approach in order that prudential assessment can be made from a group-wide perspective.⁷

In addition to solo supervision, consolidated supervision applies on a sectoral basis to groups of credit institutions, investment firms, and financial institutions.⁸ The Banking Directive⁹ requires consolidated supervision of (1) every credit institution¹⁰ that has another credit institution or a financial institution¹¹ as a subsidiary¹² or that holds a participation¹³ in such institution, and (2) every credit institution whose parent is a financial holding company.¹⁴ The Capital Adequacy Directive expands consolidated supervision to groups including investment firms.¹⁵ Consolidated supervision applies to (1) every investment firm that has a credit institution, an investment firm, or another financial institution as a subsidiary or that holds a participation in such entity and (2) every investment firm whose parent is a financial holding company.¹⁶ Investment firms are in effect brokers, dealers, investment managers having discretion, and underwriters.¹⁷ Only credit institutions, investment firms, and financial holding companies can head a group subject to consolidated supervision. Thus, consolidated supervision is not required for credit institutions or investment firms that are subsidiaries of companies that are neither credit institutions, investment firms, nor financial holding companies. Financial institutions (other than investment firms) are part of a group subject to consolidated supervision only if they are subsidiaries of credit institutions, investment firms, or financial holding companies; they are not part of a group subject to consolidated supervision if they are subsidiaries of other financial institutions that are neither investment firms nor financial holding companies.

Supervision on a consolidated basis of groups that include credit institutions means supervision on the basis of the consolidated financial situation in the following areas:¹⁸ consolidated calculation of own funds, consolidated computation of the solvency ratio, consolidated control of adequacy of own funds to cover market risks, consolidated control of large exposures, and consolidated restriction on investments in the nonbank sector. Supervision on a consolidated basis of groups that include investment firms (but not credit institutions) means supervision on the basis of the consolidated financial situation in the areas mentioned above, except that it does not apply to the restriction on investments in the nonbank sector.¹⁹

The Banking Directive hesitates to regulate directly non-EU entities. For this reason, application of the principle of supervision on a consolidated basis to credit institutions whose parents have their head offices in non-EU countries and to credit institutions situated in non-EU countries whose parents (credit institutions or financial holding companies) have their head offices in a member state shall be made possible by virtue of reciprocal bilateral agreements to be entered into between the competent authorities of the member states and the non-EU countries concerned.²⁰

The Supplementary Supervision Directive, however, amended the Banking Directive to deal with the situation of an EU-authorized credit institution or investment firm that is a subsidiary of a non-EU credit institution or financial institution but is not subject to consolidated supervision—presumably because no agreement was entered into with the non-EU country of the parent. If an EU-authorized credit institution is a subsidiary of a non-EU credit institution or financial institution, the competent authority shall verify whether the EU-authorized credit institution is subject to consolidated supervision by the home country of the non-EU parent that is equivalent to that governed by the principles laid down in Art. 52, Banking Directive.²¹ In the absence of such equivalent supervision, member states shall apply the provisions of Art. 52, Banking Directive to the credit institution by analogy. As an alternative, member states shall allow their competent authorities to apply other appropriate supervisory techniques that achieve the objectives of the supervision on a consolidated basis.²² The competent authorities, which would be responsible for consolidated supervision, must agree on those methods; they may, in particular, require the establishment of a financial holding company that has its head office in the European Union and apply the provision on consolidated supervision to the consolidated position of that financial holding company.²³

Insurance groups are subject to a more limited supplementary supervision under the Insurance Group Directive.²⁴ Supplementary supervision applies to any EU-authorized life or non-life insurance undertaking²⁵ that has at least one subsidiary²⁶ that is an EU-authorized life or non-life insurance undertaking, reinsurance under-taking,²⁷ or non-EU insurance undertaking,²⁸ or holds a participation²⁹ in any such entity or is linked by a horizontal structure with any such entity.³⁰ Supplementary supervision also applies to every EU-authorized life or non-life insurance undertaking the parent³¹ of which is an insurance holding company,³² a reinsurance undertaking, or a non-EU insurance undertaking.³³ Lastly, supplementary supervision applies to every EU-authorized life or non-life insurance undertaking the parent of which is a mixed-activity insurance holding company.³⁴ The supplementary supervision of all insurance groups relates to intra-group transactions,³⁵ the computation of an adjusted or analogous solvency calculation,³⁶ adequate internal control mechanisms for the production of any data and information relevant for the purposes of such supplementary supervision,³⁷ and the sufficiently good repute and sufficient experience of the management of an insurance holding company.³⁸

Determination of Financial Conglomerates and the Addressees of Supplementary Supervision

Sectoral and Cross-Sectoral Supervision

The EU legal framework for the supervision of financial institutions before the adoption of the Supplementary Supervision Directive was incomplete because it only covered the so-called sectoral supervision; that is, supervision over institutions within a particular sector of the financial industry. Except in the case of credit institutions and investment firms, cross-sectoral supervision of financial groups (combining institutions from different financial sectors) existed only to a very limited extent.³⁹ The Supplementary Supervision Directive changes this situation by, generally speaking, introducing supplementary supervision of regulated entities in financial conglomerates that straddle several financial sectors. Since cross-sectoral supervision of groups including credit institutions and investment firms already existed, the Supplementary Supervision Directive in effect adds insurance companies to the system of cross-sectoral supervision.

Table 1 sets forth the entities that are part of the financial sectors.

^{Table 1.}

Financial Sector Entities

^{Table 1.}

Financial Sector Entities

	Banking Sector	Investment Sector	Insurance Sector	Mixed Financial Holding Company
Regulated Entities	Credit institution Asset management company	Investment firm Asset management company	Life insurance undertaking Non-life insurance undertaking Asset management company
Nonregulated Entities	Financial institution (other than an investment firm) Ancillary banking service undertaking	Financial institution (other than an investment firm)	Reinsurance undertaking Insurance holding company	Mixed financial holding company

^{Table 1.}

Financial Sector Entities

	Banking Sector	Investment Sector	Insurance Sector	Mixed Financial Holding Company
Regulated Entities	Credit institution Asset management company	Investment firm Asset management company	Life insurance undertaking Non-life insurance undertaking Asset management company
Nonregulated Entities	Financial institution (other than an investment firm) Ancillary banking service undertaking	Financial institution (other than an investment firm)	Reinsurance undertaking Insurance holding company	Mixed financial holding company

A regulated entity is defined as a credit institution, an insurance undertaking, or an investment firm. ⁴⁰ The definition of “regulated entity” itself does not require that the regulated entity be located in the European Union and therefore also includes non-EU entities that would have to be authorized under one of the sectoral Directives if they were located in the European Union. However, only regulated entities that have obtained an authorization pursuant to one of the sectoral Directives⁴¹ are subject to supplementary supervision within the meaning of the Supplementary Supervision Directive.⁴² Such an authorization is only required for undertakings that are located in the European Union.⁴³ Thus, supplementary supervision only applies to regulated entities that are established and authorized in the European Union, except that EU-regulated entities with a parent outside the European Union are not subject to supplementary supervision. As further discussed below under the section dealing with equivalent supervision for parent undertakings outside the European Union, if the parent of an EU-regulated entity has its head office in a country outside the European Union, the Supplementary Supervision Directive yields in favor of the supervision by the home country of the parent if that supervision is equivalent to the supervision under the Supplementary Supervision Directive. The EU-regulated entities are subject to analogous or appropriate supplementary supervision under the Supplementary Supervision Directive only if the parent’s home country does not have an equivalent supervision.

Financial Conglomerates

The Supplementary Supervision Directive applies to certain EU-regulated entities (credit institutions, insurance undertakings, and investment firms) that have obtained an authorization pursuant to one of the sectoral Directives.⁴⁴ If such entities are part of a financial conglomerate, they may be subject to supplementary prudential supervi-sion.⁴⁵ In order to determine whether a regulated entity is subject to supplementary supervision, three inquiries must be made: first, whether the regulated entity is part of a group; second, whether the group meets the requirements of a financial conglomerate; and third, whether the regulated entity is one that is the addressee of supplementary supervision.

Definition of Group

A “group” is determined (1) by a parent-subsidiary relationship,⁴⁶ (2) by a relationship based on a participation,⁴⁷ or (3) by a horizontal structure.⁴⁸

Whereas, generally speaking, a “subsidiary” is an undertaking in which a shareholder (the parent) has a majority of the voting rights or the right to exercise a controlling influence, and a “participation” is an equity investment of 20 percent or more, a “horizontal structure” exists without an equity relationship if undertakings are managed on a unified basis pursuant to a contract or charter provision or if the administration, management, or supervisory bodies of both undertakings consist for the major part of the same persons. A horizontal structure is a case of control without equity investment.

A U.S. observer would say that a “group” in the meaning of the Supplementary Supervision Directive is determined by concepts very similar to the U.S. Bank Holding Company Act’s concept of control, which determines whether a parent-subsidiary relationship exists.⁴⁹

Definition of Financial Conglomerate

A group constitutes a financial conglomerate if it meets certain conditions. For purposes of determining a financial conglomerate, the Supplementary Supervision Directive distinguishes between groups that are headed by an EU-regulated entity and groups that are not headed by an EU-regulated entity (in the case of the latter, the group would be headed either by a non-EU-regulated entity or by a non-regulated entity).

In both cases (financial conglomerate headed by an EU-regulated entity and financial conglomerate not so headed), the activities of the entities in the insurance sector and the activities of the entities in the banking and investment services sector (taken together) must be significant (i.e., based on ratios of balance sheets and solvency ratio requirements, each financial sector must represent at least 10 percent of the group or the balance sheets of the smallest sector in the group must exceed €6 billion).⁵⁰

A group that is not headed by an EU-regulated entity only qualifies as a financial conglomerate if the group’s activities mainly occur in the financial sector (that is, based on the balance sheets, the financial sector entities must represent at least 40 percent of the group). On the other hand, a group that is headed by an EU-regulated entity qualifies as a financial conglomerate even though its activities do not mainly occur in the financial sector.⁵¹

The Supplementary Supervision Directive introduces and defines the term “mixed financial holding company” to cover financial conglomerates headed by a nonregulated entity holding company. In fact, every nonregulated entity head of a financial conglomerate by definition is a mixed financial holding company.⁵² The Supplementary Supervision Directive could have called such entities “nonregulated entity holding companies.” The mixed financial holding company could be a nonregulated financial sector entity, such as a financial institution other than an investment firm (a mere holding company without its own activities would likely be a financial institution) or a reinsurance undertaking, or it could be a commercial or industrial company. The definitions of “financial conglomerate” and “mixed financial holding company” do not require that the head of the financial conglomerate or the mixed financial holding company must be established or have its head office in the European Union. However, if a financial conglomerate headed by a mixed financial holding company is to be covered by supplementary supervision, the mixed financial holding company must be located in the European Union.⁵³ In the same way, if the financial conglomerate is headed by a regulated entity, it is subject to supplementary supervision only if the regulated entity is an EU-regulated entity.⁵⁴ A financial conglomerate headed by a non-EU-regulated entity and a financial conglomerate headed by a mixed financial holding company having its head office outside the European Union are still financial conglomerates, but the regulated entities in those financial conglomerates are not subject to supplementary supervision; as discussed below under the section dealing with equivalent supervision for parent undertakings outside the EU, they may, however, be subject to equivalent supplementary supervision by the home country of the non-EU-regulated entity or the mixed financial holding company or to analogous or appropriate supplementary supervision by a member state under the Supplementary Supervision Directive.⁵⁵ Figure 1 sets forth the entities that are part of a financial conglomerate.

From the U.S. perspective, it is surprising that conglomerates that are headed by a mixed financial holding company are subject to supplementary supervision only if the group is mainly engaged in the financial sector, that is, banking, insurance, or investment services, and that in all financial conglomerates the banking sector and the insurance sector must be significant. If it is the purpose of the Supplementary Supervision Directive to protect regulated entities, the relative size of such regulated entities should not be a relevant factor. However, the Supplementary Supervision Directive goes further than the rules on consolidated supervision. The rules on consolidated supervision require consolidated supervision for credit institutions in which another credit institution holds a participation or that are subsidiaries of another credit institution or of a financial holding company, that is, a company the subsidiaries of which are exclusively or mainly credit institutions or financial institutions and that has at least one credit institution subsidiary.⁵⁶ Consolidated supervision does not extend to a group headed by a mixed-activity holding company, which is defined as a parent other than a financial holding company, a credit institution, or a mixed financial holding company, whose subsidiaries include at least one credit institution.⁵⁷ Thus, neither the proverbial steel company that acquires a bank nor the acquired bank is subject to consolidated supervision under EU law because the steel company is not a financial holding company.

However, if the steel company is located in the European Union and acquires a bank and an insurance company, and their combined balance sheet total of both amounts to 40 percent of the balance sheet total of the group, the steel company would be a mixed financial holding company heading a financial conglomerate and the financial conglomerate would be subject to supplementary supervision under the Supplementary Supervision Directive. A holding company without its own business activities whose principal activity consists of acquiring holdings in industrial and financial companies is a financial institu-tion⁵⁸ and if the subsidiaries of such financial institution mainly consist of credit institutions or financial institutions, it is a financial holding company⁵⁹ and the group headed by it is subject to consolidated supervision.⁶⁰ If the subsidiaries do not mainly consist of credit or financial institutions, it is not a financial holding company subject to consolidated supervision. If the above holding company holds a credit institution and an insurance company, one of which is a subsidiary, and both of which are significant and if the group’s activities mainly (based on the 40 percent test) consist of financial sector activities, it is a mixed financial holding company that heads a financial conglomerate subject to supplementary supervision. If its activities do not consist mainly of financial sector activities, it is subject neither to consolidated nor to supplementary supervision.⁶¹

Discretionary Expansion of Financial Conglomerate

The Supplementary Supervision Directive gives the competent authorities discretion to apply supplementary supervision to groups that do not meet the definition of financial conglomerate or even the definition of group and to carry out supplementary supervision “as if they constitute a financial conglomerate.”⁶²

The competent authorities may exercise supplementary supervision over regulated entities that are controlled by another entity or in which another entity has a capital investment, even though the relationship does not qualify as a group or as a financial conglomerate. Regulated entities in such quasi-financial conglomerates are, in the discretion of the relevant competent authorities, subject to supplementary supervision if (1) at least one of the regulated entities is an EU-regulated entity, (2) at least one of the entities in the quasi-financial conglomerate is within the insurance sector and at least one is within the banking or investment services sector, and (3) the consolidated and/or aggregated activities of the entities in the quasi-financial conglomerate within the insurance sector and the consolidated and/or aggregated activities of the entities within the banking and investment services sector are each significant.⁶³

Determination of Financial Conglomerate

The Supplementary Supervision Directive does not impose on financial conglomerates a duty to report to or file with any supervisory authority the fact that they are financial conglomerates. The competent authorities themselves must make that determination. If a competent authority is of the opinion that a regulated entity authorized by it is a member of a group that may be a financial conglomerate, which has not already been identified according to the Supplementary Supervision Directive, the competent authority shall communicate its view to the other competent authorities concerned. The coordinator, as discussed below, shall inform the parent of the group (or in the absence of a parent, the regulated entity with the largest balance sheet held in the most important financial sector in the group) that the group has been identified as a financial conglomerate and of the appointment of the coordinator.⁶⁴ The coordinator shall also inform the competent authorities that have authorized regulated entities in the group and the competent authorities of the member states in which the mixed financial holding company has its head office, as well as the EU Commission.⁶⁵

The high degree of discretion given to the member states and their supervisory authorities in determining whether a group or a financial conglomerate exists could lead to substantial differences among the member states in the determination of whether supplementary supervision applies. This would not only create legal uncertainties but could also cause competitive distortions.

Undertakings in a Financial Conglomerate That Are the Addressees of Supplementary Supervision

The Supplementary Supervision Directive does not envision that all companies in a financial conglomerate be subject to supplementary supervision, and the scope of supplementary supervision differs among certain categories of companies in a financial conglomerate. The Supplementary Supervision Directive distinguishes between entities that are the addressees of supplementary supervision, entities that are subject to certain obligations under the Supplementary Supervision Directive, and entities that are only indirectly affected by the Supplementary Supervision Directive.

The Supplementary Supervision Directive refers to entities that are the addressees of the supplementary supervision as entities that are “subject to supplementary supervision at the level of the financial conglomerate.”⁶⁶ Only certain EU-regulated entities (hereinafter the Responsible Entities) are “subject to supplementary supervision at the level of the financial conglomerate”:

every EU-regulated entity that is at the head of a financial conglomerate;
every EU-regulated entity whose parent undertaking is a mixed financial holding company having its head office in the European Union; and
every EU-regulated entity linked with another financial sector entity by a relationship of a horizontal group, that is, every EU-regulated entity in a horizontal financial conglomerate.

These Responsible Entities must verify compliance with the requirements of supplementary supervision and are responsible for compliance by the financial conglomerate. In particular, the Responsible Entities must submit reports to the coordinator.⁶⁷ If a financial conglomerate is headed by an EU-regulated entity, only that entity (and not the other regulated entities in the financial conglomerate) must meet the requirements that must be met “at the level of the financial conglomerate.” In this case, supervision “on the level of the financial conglomerate” means supervision on the holding company level. On the other hand, if a financial conglomerate is headed by a mixed financial holding company having its head office in the European Union, each EU-regulated entity in the financial conglomerate must meet the requirements that must be met “at the level of the financial conglomerate.”⁶⁸

The Supplementary Supervision Directive imposes certain obligations on all regulated entities in a financial conglomerate in order to make supplementary supervision at the level of the financial conglomerate possible.⁶⁹ However, to the extent the regulated entities are non-EU-regulated entities, the supplementary supervision at the level of the financial conglomerate does not imply that the competent authorities play a supervisory role with respect to such non-EU-regulated entities.⁷⁰ Furthermore, the Supplementary Supervision Directive assigns duties and obligations in connection with supplementary supervision at the level of the financial conglomerate to mixed financial holding companies.⁷¹ Again, this does not imply that the competent authorities play a supervisory role with respect to mixed financial holding companies.⁷²

Finally, supplementary supervision of a financial conglomerate will indirectly affect all entities in a financial conglomerate, including non-EU-regulated entities, nonregulated entities, and the mixed financial holding company in the financial conglomerate. For instance, “intra-group transactions”⁷³ and “risk concentrations”⁷⁴ are defined to include relations between regulated entities (EU-regulated or non-EU-regulated) in a financial conglomerate and other entities or undertakings in the financial conglomerate. For purposes of calculating the capital adequacy requirements of a financial conglomerate, mixed financial holding companies, non-EU-regulated entities, and even nonregulated financial sector entities are included.⁷⁵ This does not imply that the competent authorities play a supervisory role with respect to those unregulated entities.⁷⁶

Not all EU-regulated entities in a financial conglomerate are subject to supplementary supervision. EU-regulated entities that are members of a financial conglomerate headed by an EU-regulated entity⁷⁷ are not addressees of supplementary supervision, although they are included in the supplementary supervision of the EU-regulated entity head of the financial conglomerate. EU-regulated entities that are members of a financial conglomerate headed by a mixed financial holding company are subject to supplemental supervision only if the mixed financial holding company has its head office in the European Union.⁷⁸

EU-regulated entities in a financial conglomerate headed by a non-EU-regulated entity or by a mixed financial holding company that has its head office outside the European Union are not at all subject to supplementary supervision.⁷⁹ If the parent undertaking of an EU-regulated entity is a regulated entity having its head office outside the European Union or is a mixed financial holding company having its head office outside the European Union, the EU-regulated entity, as discussed below under the section dealing with equivalent supervision for parent undertakings outside the EU, is either subject to equivalent supervision by the home country of the parent or subject to analogous or appropriate supplementary supervision by a member state pursuant to Art. 18, Supplementary Supervision Directive.⁸⁰

Where a financial conglomerate is a subgroup of another financial conglomerate (the main financial conglomerate), member states may apply the provisions of the Supplementary Supervision Directive relating to supplementary supervision⁸¹ only to regulated entities within the main financial conglomerate and not to the subgroup.⁸² The nonfinancial activities of a nonregulated entity heading a group could have the effect that the group does not meet the financial conglomerate tests.⁸³ In that case, one has to determine whether the nonqualifying group comprises subgroups that qualify as financial conglomerates.⁸⁴

In order to avoid possible moral hazards,⁸⁵ the Supplementary Supervision Directive emphasizes that the exercise of supplementary supervision at the level of the financial conglomerate shall not imply that the competent authorities are required to play a supervisory role in relation to mixed financial holding companies, unregulated entities, or non-EU-regulated entities in a financial conglomerate, on a standalone basis, even though such entities are affected by the supplementary supervision.⁸⁶ However, certain entities in a financial conglomerate that are not EU-regulated entities are subject to supervision in their relations with the EU-regulated entities—for instance, in the computation of capital adequacy at the level of the financial conglomerate or in the evaluation of intra-group transactions.

The Supplementary Supervision Directive requires the inclusion of asset management companies in the sectoral and supplementary supervision. The Supplementary Supervision Directive provides that member states shall include asset management companies in the scope of consolidated supervision of credit institutions and investment firms, and/or in the scope of supplementary supervision of insurance undertakings in an insurance group, and—where the group is a financial conglomerate—in the scope of supplementary supervision within the meaning of the Supplementary Supervision Directive.⁸⁷ Asset management companies that are part of a financial conglomerate must be regarded as regulated entities.⁸⁸

Supplementary Supervision

The Supplementary Supervision Directive introduces a series of rules with regard to the supplementary supervision of regulated entities in a financial conglomerate. They relate in particular to capital adequacy, intra-group transactions, and risk concentration, and to the management. The Supplementary Supervision Directive also requires that for each financial conglomerate a single coordinator be appointed from among the competent authorities of the member states concerned who shall be responsible for coordination and exercise of supplementary supervision.⁸⁹ The competent authorities are also required to cooperate and exchange information.⁹⁰

It must be emphasized that supplementary supervision does not mean supervision on a consolidated basis like the supervision provided by some of the sectoral rules. The Supplementary Supervision Directive follows a so-called “solo-plus” approach to supervision. The basis of supervision is the supervision of individual group entities on a solo basis by their respective sectoral regulators. The solo supervision of individual entities is complemented by a general quantitative assessment of the group as a whole and by a quantitative group-wide assessment of the adequacy of capital.⁹¹ The Supplementary Supervision Directive does not require any additional consolidation of the accounts of the financial conglomerate as a whole if existing Directives do not impose such consolidation.

Capital Adequacy

One of the most important issues regarding the supervision of financial conglomerates is the supervision of the group’s financial condition. Therefore, Article 6 and Annex I of the Supplementary Supervision Directive require the competent authorities to exercise supplementary supervision of the capital adequacy of the regulated entities in a financial conglomerate.⁹² Eliminating any inappropriate intra-group creation of own funds,⁹³ such as double or multiple gearing,⁹⁴ or excessive leveraging is the major goal of such supplementary group-wide capital adequacy requirements.⁹⁵ In such situations, the same own funds are used simultaneously as a buffer more than once—to cover the capital requirements of the parent company, as well as those of a subsidiary (and possibly also those of a subsidiary of a subsidiary).⁹⁶ Thus, the member states must require regulated entities in a financial conglomerate to ensure that there are own funds at the level of the financial conglomerate that are always at least equal to the capital adequacy requirements as calculated in accordance with Annex I.⁹⁷ That means that all Responsible Entities in a financial conglomerate must see to it that at the level of the financial conglomerate, the capital adequacy requirements calculated in accordance with Annex I are met. In addition to the regulated entities in a financial conglomerate, certain specifically mentioned nonregulated financial sector entities in the financial conglomerate that may not be subject to capital adequacy requirements on a stand-alone basis must nonetheless be included for the purpose of calculating capital adequacy at the level of the financial conglomerate.⁹⁸ The solvency requirements for nonregulated financial sector entities that are not included in the sectoral solvency requirement computation are computed on a notional basis.⁹⁹

The solvency requirements for each separate financial sector represented in a financial conglomerate continue to be covered by own funds elements in accordance with the corresponding sectoral rules.¹⁰⁰ In case of a deficit of own funds at the financial conglomerate level, only own funds elements that are eligible according to each of the sectoral rules (cross-sector capital) shall qualify for the verification of the compliance with the solvency requirements at the financial conglomerate level.¹⁰¹

Methods for Calculating the Solvency Position

Annex I sets forth three different methods for calculating the solvency position on the level of a financial conglomerate. The competent authorities or the coordinator have the authority to choose which method shall be applied to a financial conglomerate¹⁰² and they may also apply a combination of the three methods.¹⁰³ These methods are (1) accounting consolidation, (2) deduction and aggregation, and (3) requirement deduction.

Method 1. Accounting consolidation uses the consolidated accounts as a basis for calculating the supplementary capital adequacy. Thus, it is only applicable for consolidated groups. According to this method, the supplementary capital adequacy shall be calculated as the difference between (i) the own funds of the financial conglomerate calculated on the basis of the consolidated position of the group, and (ii) the sum of the solvency requirements for each different financial sector represented in the group.¹⁰⁴ The supplementary capital adequacy according to Method 1 can be expressed in the following formula:

{SCA=OF}_{Consolidated} - {(S}_{Bank} {+S}_{Insurance} {+S}_{Investment} {+S}_{Nonregulated}) .^{105}

Because this method’s starting point and basis are the fully consolidated accounts of the financial conglomerate, by definition, all intra-group on- and off-balance sheet accounts or exposures have been eliminated and the effects of double or multiple gearing and excessive leverage are equated. Thus, calculating the group-wide capital adequacy simply consists of the deduction of the solvency requirements of the group’s financial sectors from the consolidated own funds.

Method 2. The calculation of the supplementary capital adequacy pursuant to the deduction and aggregation method is carried out on the basis of the separate accounts of each entity in the group that is included in the calculation of capital adequacy. According to this method, the supplementary capital adequacy shall be calculated on the basis of the accounts of each of the entities in the group as the difference between the sum of the own funds of each regulated and nonregulated entity in the financial conglomerate;¹⁰⁶ and the sum of (i) the solvency requirements for each regulated and nonregulated entity in the group¹⁰⁷ and (ii) the book value of the participations in other entities of the group.¹⁰⁸ The supplementary capital adequacy according to Method 2 can be expressed in the following formula:

{SCA=(OF}_{1} {+OF}_{2} {+OF}_{3} + \dots) - {[(S}_{1} {+S}_{2} {+S}_{3} + \dots {)+(BV}_{1} {+BV}_{2} {+BV}_{3} \dots)] .^{109}

The effect of this method is to pretend the situation of consolidated accounts, and therefore to eliminate multiple gearing, excessive leverage, and the misuse of accounting margins relating to the book value of participations by deducting those participations.

Method 3. The requirement deduction method is based on the balance sheet of each entity within the group. According to this method, the calculation of the supplementary capital adequacy shall be carried out on the basis of the accounts of each of the entities in the group as the difference between the own funds of the parent undertaking or the entity at the head of the financial conglomerate¹¹⁰ and the sum of (i) the solvency requirement of the relevant parent undertaking or the head and (ii) the higher of the book value of the parent undertaking’s or the head’s participation in other entities in the group and these entities’ solvency requirement.¹¹¹ The supplementary capital adequacy according to Method 3 can be expressed in the following formula:

{SCA=OF}_{Parent} - {[S}_{Parent} {+(BV}_{1} {orS}_{1} {+BV}_{2} {orS}_{2} {+BV}_{3} {orS}_{3} + \dots)] .^{112}

This method, which does not take into account the own funds of the subsidiaries, provides for an easy way to assess potential double gearing within the group.¹¹³

Capital Policies and Supervision

The member states shall require regulated entities to have in place adequate capital adequacy policies at the level of the financial conglomerate. The requirement that regulated entities in financial conglomerates must ensure that on the level of the financial conglomerates the capital adequacy requirements of Annex I are met and that regulated entities have in place adequate capital adequacy policies on the level of the financial conglomerate must be subject to supervisory overview by the coordinator. The regulated entities or the mixed financial holding company must calculate the sufficiency of own funds on the level of the financial conglomerate at least annually. The EU-regulated entity at the head of the financial conglomerate or the mixed financial holding company at the head of the financial conglomerate must submit the result of the calculation to the coordinator.¹¹⁴

One can question the rationale for requiring adequate capital for a financial conglomerate on the group level, because in case of need of a regulated entity in the group, the group capital is not available to the needy regulated entity. The Supplementary Supervision Directive does not establish what is known as a “source of strength doctrine.” Under that doctrine a U.S. bank holding company and indirectly its subsidiaries are expected to support a deposit-taking subsidiary in case of need. The Gramm-Leach-Bliley Act of 1999 amendments to the U.S. Bank Holding Company Act of 1956 affirm this doctrine with certain limitations.¹¹⁵

Intra-Group Transactions and Risk Concentration

Another core regulation of the Supplementary Supervision Directive is the requirement of supplementary supervision on intra-group transactions and risk concentration of regulated entities in a financial conglomerate.¹¹⁶

Intra-Group Transactions

Intra-group transactions may cause supervisory concerns when they (1) result in capital or income being inappropriately transferred from the regulated entity; (2) are on terms or under circumstances that parties operating at arm’s length would not allow and may be disadvantageous to a regulated entity; (3) can adversely affect the solvency, the liquidity, and the profitability of individual entities within a group; or (4) are used as a means of supervisory arbitrage, thereby evading capital or other regulatory requirements altogether.¹¹⁷ Monitoring intra-group transactions is also an important factor in dealing with the risk of contagion within a financial conglomerate. Contagion entails the risk that, if certain parts of a conglomerate are experiencing financial difficulties, they may infect other healthy parts of the conglomerate as a result of which the operation of the healthy parts may be hampered or even made impossible.¹¹⁸ Therefore, intra-group transactions can significantly exacerbate problems for a regulated entity once contagion spreads.¹¹⁹

“Intra-group transactions” as defined in the Supplementary Supervision Directive are transactions by a regulated entity in a financial conglomerate with any other undertaking in the financial conglomer-ate.¹²⁰ However, intra-group transactions go beyond transactions with members of the group. Intra-group transactions include transactions “with natural or legal persons linked to the undertakings within the group by close links,” even though such linked persons are not members of the group, and, consequently, not members of the financial conglomerate.¹²¹ The intra-group transactions are not limited to transactions of EU-regulated entities within a financial conglomerate but are transactions of any regulated entity.¹²² The Supplementary Supervision Directive does not provide for quantitative limits or qualitative requirements with regard to intra-group transactions within a financial conglomerate. The introduction of such limits and requirements or the introduction of other supervisory measures that would achieve the objectives of supplementary supervision with regard to intra-group transactions is left to the member states.¹²³

The scope of the provisions in the Supplementary Supervision Directive that deals with intra-group transactions is broader than the scope of the equivalent U.S. rules, Sections 23A and 23B, Federal Reserve Act,¹²⁴ because the Supplementary Supervision Directive applies to all transactions between all regulated entities within a financial conglomerate and other entities in the group,¹²⁵ whereas Sections 23A and 23B, Federal Reserve Act apply only to transactions between an insured depository institution, that is, a U.S. bank, and its affiliates.

Risk Concentration

As to the problem of risk concentration,¹²⁶ supervisors of the different financial sectors use various approaches to monitor large exposures, due to the different risks they are facing. In all three sectors, financial institutions face an increased risk of loss when their assets, liabilities, or business activities are not diversified. As not all risk concentrations are inherently bad (a certain degree of concentration is the inevitable result of a well-articulated business strategy as well as product specialization, the targeting of a customer base, or a sound strategy of outsourcing data processing activities), supervisors need to balance the benefits against the risks of concentrations at the conglomerate level. In identifying risks, the competent authorities have to take into account the different ways in which large losses can develop in a conglomerate as a result of risk concentration.¹²⁷

Risk concentration means all exposures with a loss potential borne by entities (the exposures are not limited to those borne by regulated entities) within a financial conglomerate that are large enough to threaten the solvency, or the financial position in general, of the regulated entities in the financial conglomerate. Such exposures may be caused by counterparty risk/credit risk, investment risk, insurance risk, market risk, other risks, or a combination or interaction of these risks.¹²⁸

Like in the case of intra-group transactions, the Supplementary Supervision Directive does not provide for quantitative limits or quantitative requirements with regard to risk concentration at the level of the financial conglomerate. The introduction of such limits and requirements or the introduction of other supervisory measures that would achieve the objectives of supplementary supervision with regard to risk concentration is left to the member states.¹²⁹

Common Provisions

To avoid the risks resulting from intra-group transactions and risk concentration, the member states shall require regulated entities to have in place at the level of the financial conglomerate adequate risk management processes and internal control mechanisms—including sound reporting and accounting procedures.¹³⁰ In addition, regulated entities that are Responsible Entities must have adequate internal control mechanisms for the production of any data and information that would be relevant for the purpose of supplementary supervision.¹³¹

In addition, the member states shall require regulated entities or mixed financial holding companies to report on a regular basis and at least annually to the coordinator any significant risk concentration at the level of the financial conglomerate and significant intra-group transactions of regulated entities within a financial conglomerate.¹³² The necessary information shall be submitted to the coordinator by the EU-regulated entity that is at the head of the financial conglomerate or, where the financial conglomerate is not headed by an EU-regulated entity, by the mixed financial holding company or by the regulated entity in the financial conglomerate identified by the coordinator after consultation with the other relevant competent authorities and with the financial conglomerate.¹³³ The intra-group transactions and risk concentrations shall be subject to supervisory overview by the coordinator.¹³⁴ Therefore, the coordinator, after consultation with the other relevant competent authorities, shall identify the type of transactions and risks regulated entities in a particular financial conglomerate shall report in accordance with the provisions on reporting of intra-group transactions and risk concentration.¹³⁵ Thus, the Supplementary Supervision Directive provides for the development of reporting requirements that are specific for each financial conglomerate.

Where a financial conglomerate is headed by a mixed financial holding company, the sectoral rules regarding intra-group transactions and risk concentration of the most important financial sector in the financial conglomerate shall apply to that sector as a whole, including the mixed financial holding company.¹³⁶

Management Qualifications

The Supplementary Supervision Directive requires the member states to provide that persons who effectively direct the business of a mixed financial holding company are of sufficiently good repute and have sufficient experience to perform their duties.¹³⁷ This provision is intended to ensure that a manager of a nonregulated entity having a dominant influence on the performance of a regulated entity is reliable, like a manager of the regulated entity, in particular as regards the management of the mixed financial holding company. This provision responds to the recent tendency to manage financial conglomerates along the different business lines of conglomerates instead of the traditional legal entity based approaches.¹³⁸ The Supplementary Supervision Directive also provides that the member states shall require that persons who effectively direct the business of an insurance holding company or a financial holding company are of sufficiently good repute and have sufficient experience to perform their duties.¹³⁹

Measures to Facilitate Supplementary Supervision

One of the principal objectives of the Supplementary Supervision Directive is the introduction of measures to facilitate supplementary supervision.¹⁴⁰ Supplementary supervision requires the exchange of information among the entities in the financial conglomerate and exchange of information and cooperation among the competent authorities involved in the supervision of regulated entities in a particular financial conglomerate.¹⁴¹

The Supplementary Supervision Directive introduces the so-called “coordinator.” The competent authorities of the member states concerned shall appoint from among them a coordinator responsible for the coordination and exercise of the supplementary supervision of the regulated entities in a financial conglomerate.¹⁴² The Supplementary Supervision Directive provides for the automatic identification of the coordinator on the basis of objective criteria; however, the relevant competent authorities may waive by agreement these criteria and appoint a different competent authority as coordinator. The competent authorities shall give the financial conglomerate an opportunity to state its opinion on that decision.¹⁴³ The coordinator functions merely as a primus inter pares of the competent authorities of the member states involved with the regulated entities of a financial conglomerate. A coordinator must be nominated not only for cross-border financial conglomerates but also for financial conglomerates that have several regulated entities in one member state and at least two supervisory authorities of that member state are involved.¹⁴⁴

The tasks of the coordinator with regard to supplementary supervision are (1) the coordination of gathering and disseminating of relevant or essential information in going concern and emergency situations; (2) the supervisory overview and assessment of the financial situation of a financial conglomerate; (3) the assessment of compliance with the rules on capital adequacy, risk concentration, and intra-group transactions; (4) the assessment of the financial conglomerate’s structure, organization, and internal control systems; (5) the planning and coordination of supervisory activities in going concern as well as in emergency situations, in cooperation with the relevant competent authorities involved; and (6) other tasks assigned to the coordinator by the Supplementary Supervision Directive or by coordination arrangements between the coordinator and other relevant competent authorities.¹⁴⁵

The coordinator has no decision-making or enforcement authority to impose measures and sanctions. The presence of a coordinator entrusted with specific tasks concerning the supplementary supervision does not affect the tasks and responsibilities of the competent authorities responsible for the regulated entities in a financial conglomerate as provided for by the sectoral rules.¹⁴⁶

To ensure proper supplementary supervision, the competent authorities responsible for the supervision of regulated entities in a financial conglomerate and the coordinator are required to cooperate closely with each other.¹⁴⁷ The coordinator and the relevant competent authorities may enter into coordination agreements to specify the procedures for the decision-making process and for cooperation among them.¹⁴⁸ They shall provide each other with any information that is essential or relevant for the exercise of the other competent authorities’ supervisory tasks under the sectoral rules and under the Supplementary Supervision Directive. The competent authorities and the coordinator shall communicate on request all relevant information and shall communicate on their own initiative all essential informa-tion.¹⁴⁹ The competent authorities shall consult with each other prior to their decision with regard to the following items, where these decisions are important for the supervisory tasks of other competent authorities: (1) changes in the shareholder, organizational, or management structure of regulated entities in a financial conglomerate that require the approval or authorization of competent authorities; and (2) major sanctions or exceptional measures taken by the competent authorities.¹⁵⁰

If a competent authority wishes to verify information concerning an entity in a financial conglomerate, whether or not it is a regulated entity, that is situated in another member state, it may ask the competent authorities of the other member state to carry out the verification. The requested competent authority must carry out the verification or permit experts or the requesting authority to carry out the verification.¹⁵¹

Equivalent Supplemental Supervision for Parent Undertakings Outside the European Union

If the parent of a financial conglomerate is a regulated entity or a mixed financial holding company having its head office outside the European Union, the EU-regulated entities belonging to such a “non-EU group” are not directly subject to the rules on supplementary su-pervision.¹⁵² The Supplementary Supervision Directive, however, attempts to apply as much supplementary supervision as possible.¹⁵³

The Supplementary Supervision Directive requires a verification whether the EU-regulated entity, the parent of which has its head office outside the European Union, is subject to supervision by the home country of the parent that is equivalent to the supplementary supervision of regulated entities provided for in the Supplementary Supervision Directive. The verification shall be carried out by the competent authority that would be the coordinator if the criteria for the appointment of the coordinator as set forth in the Supplementary Supervision Directive were to apply (hereinafter the hypothetical coordinator). The verification shall be carried out on the request of the parent of the financial conglomerate, by an EU-regulated entity in such financial conglomerate, or by the hypothetical coordinator.¹⁵⁴

The hypothetical coordinator shall consult the other relevant competent authorities and the Financial Conglomerates Committee,¹⁵⁵ and shall take into account any applicable guidance prepared by the Financial Conglomerates Committee.¹⁵⁶

When the U.S. regulations under the BHCA require foreign banks to demonstrate that they are subject to comprehensive supervision on a consolidated basis,¹⁵⁷ they address the question of whether the foreign bank itself is properly supervised by its home country. The Supplementary Supervision Directive, on the other hand, asks whether the EU-regulated entities are subject to supervision by the non-EU home country of the non-EU parent of the financial conglomerate and whether such supervision is equivalent to the supervision under the Supplementary Supervision Directive.

If the supervision by the home country of the non-EU-regulated entity or the mixed financial holding company that has its head office outside the European Union over the EU-regulated entities in such group is found to be equivalent to the supplementary supervision of the Supplementary Supervision Directive, the Supplementary Supervision Directive will yield to the foreign supervision.

In the absence of such equivalent supervision, the member states shall by analogy apply to the EU-regulated entities the provision with regard to supplementary supervision.¹⁵⁸ In the alternative, the member states shall allow their competent authorities to apply other methods that ensure an appropriate supplementary supervision of the EU-regulated entities in a financial conglomerate.¹⁵⁹ In particular, the competent authorities may require the creation of a subholding company (which would be a mixed financial holding company) that has its head office in the European Union, and apply the supplementary supervision required by the Supplementary Supervision Directive to the regulated entities in the financial conglomerate headed by the European subholding company. In any event, the methods selected by the competent authorities to ensure an appropriate supplementary supervision “must achieve the objectives of the supplementary supervision as defined in the [Supplementary Supervision Directive]” and must be notified to the competent authorities involved and the EU Commission.¹⁶⁰

For a U.S. observer, it is quite surprising to note that the Supplementary Supervision Directive hesitates to regulate directly non-EU holding companies of EU-regulated entities. The U.S. banking legislation does not show such hesitation with respect to foreign holding companies. For example, the U.S. Bank Holding Company Act of 1956 (BHCA) applies not only to U.S. banks but also to foreign banks that control a U.S. bank subsidiary¹⁶¹ and foreign banks that maintain a branch, agency, or commercial lending company in the United States.¹⁶²

The EU Commission may also negotiate agreements with third countries regarding the means of exercising supplementary supervision of regulated entities in a financial conglomerate.¹⁶³ In this context, the EU Commission may submit proposals to the EU Council, either at the request of a member state or on its own initiative, for the negotiation of such agreements. The agreements would cover supplementary supervision of financial conglomerates whose parent is situated outside the European Union but that have regulated entities in the European Union and of financial conglomerates whose parent is situated in the European Union but that have regulated entities outside the European Union.¹⁶⁴

Equivalent Consolidated Supervision and Supplementary Supervision of Groups Headed by U.S. Entities

If the parent of a financial conglomerate is a regulated entity or a mixed financial holding company having its head office outside the European Union, the competent authorities must verify whether the EU-regulated entities in the financial conglomerate are subject to supplementary supervision by the home country of the parent that is equivalent to the supplementary supervision required by the Supplementary Supervision Directive.¹⁶⁵ The question arises whether an EU-regulated credit institution, investment firm, or insurance undertaking subsidiary that is part of a cross-sectoral financial conglomerate headed by a U.S. parent is subject to equivalent supplementary supervision under U.S. law.

Supplementary supervision applies to financial conglomerates that straddle several financial sectors. Supplementary supervision under the Supplementary Supervision Directive applies to capital adequacy at the level of the financial conglomerate, intra-group transactions by regulated entities in a financial conglomerate with other undertakings in the financial conglomerate, and risk concentration in the financial conglomerate.

Financial Holding Companies

In the United States financial conglomerates are permitted subject to various restrictions by the Gramm-Leach-Bliley Act of 1999 (GLBA) amendments to the BHCA.¹⁶⁶ These amendments permit the creation of financial holding companies (FHCs) that have investments in several financial sectors, mainly the banking, insurance, and broker-dealer sectors.

Whereas the Supplementary Supervision Directive was promulgated to impose additional supervision on cross-sectoral financial conglomerates to deal with the specific risks of such financial conglomerates, the BHCA was enacted to prevent circumvention of the rule of separation of banking from all other commercial activities through the creation of a holding company. Even the GLBA amendments to the BHCA, which permit financial holding companies, are more concerned with the careful delineation of this new permission of banks to affiliate with nonbank financial companies than with the supervision of the newly permitted financial conglomerates. Furthermore, different from the Supplementary Supervision Directive, the GLBA was written to protect the banks in financial holding company groups, not to deal with the specific risks of such groups. The GLBA gives the Federal Reserve Board an “umbrella supervision”¹⁶⁷ over the financial holding company. It remains to be seen whether this umbrella authority will lead to a true supervision of the conglomerate as such.

Capital Adequacy

The Board of Governors of the Federal Reserve System (the Board) has the authority, based on its general supervisory power over bank holding companies (BHCs), to impose capital and capital adequacy requirements on BHCs. This authority does not diminish once the BHC has effectively elected FHC status.¹⁶⁸ Although Regulation Y does not contain any specific requirement that, as a condition to the effective election of FHC status, a U.S. BHC must meet the capital requirements applicable to all BHCs, there is no doubt that the Board under its general supervisory power over BHCs could deny the effectiveness of an FHC election by a BHC, if the BHC is in violation of applicable laws and regulations, including the rules of capital ade-quacy.¹⁶⁹ The Board may impose capital requirements on a BHC/FHC, not only if it is a mere holding company without its own business activities, but, according to the BHCA, even if the BHC/FHC is a broker-dealer, insurance company, insurance agent, or investment company.¹⁷⁰ It is not clear, however, how the capitalization of a company engaged in financial activities other than banking, for example, a broker-dealer or an insurance company, can be computed in accordance with the Basel Capital Standards, and—unlike the Supplementary Supervision Directive—the Board has not attempted to develop capital adequacy standards for FHCs that are not mere BHCs.¹⁷¹

Intra-Group Transactions

The supplementary supervision of intra-group transactions under the Supplementary Supervision Directive covers all transactions in which EU-regulated or non-EU-regulated entities are involved. In the United States certain regulatory concerns, such as intra-group transactions and risk concentration, are left to the regulators of the constituent parts of the FHC. Transactions between an insured depository institution and its affiliates are subject to strict limitations under Sections 23A and 23B, Federal Reserve Act.¹⁷² A bank’s direct and indirect parent companies, as well as companies controlled by or under common control with the banks, are covered as affiliates.¹⁷³ Sections 23A and 23B, Federal Reserve Act deal only with transactions in which the insured U.S. bank is involved.

Transactions between a U.S. insurance company and other companies in an insurance holding company system may be subject to supervision under state insurance laws. For instance, under the New York Insurance Law intra-group transactions of controlled insurers¹⁷⁴ with other entities in an insurance holding company system¹⁷⁵ are subject to certain substantive standards. Section 1505, New York Insurance Law provides that transactions within a holding company system to which a controlled insurer is a party must be on fair and equitable terms, charges or fees for services performed must be reasonable, and expenses incurred and payments received must be allocated to the insurer on an equitable basis in accordance with customary insurance accounting practices consistently applied.¹⁷⁶ Certain intra-group transactions between a domestic controlled insurer and any person in its holding company system require approval of the Superintendent of Insurance¹⁷⁷ and in the case of other transactions between a domestic controlled insurer and any person in its holding company system, prior notice to the Superintendent is required.¹⁷⁸ The books and records of each party to intra-group transactions must clearly and accurately disclose the nature and details of such transactions.¹⁷⁹ Every controlled insurer must annually report to the Superintendent of Insurance all transactions during the preceding fiscal year with persons within the holding company system.¹⁸⁰ Again, some of these provisions deal only with intra-group transactions involving a U.S. insurer.¹⁸¹

There are no rules dealing with intra-group transactions of U.S. broker-dealers, that is, investment firms in the terminology of the Supplementary Supervision Directive.¹⁸²

Risk Concentration

The Board has stated that as “umbrella supervisor” of FHCs it will assess capital adequacy of FHCs in relation to the risk profile of the consolidated organization and that the Board will review the FHC’s internal risk assessment and related capital analysis process for determining the adequacy of its overall capital position.¹⁸³ Such review will include consideration of present and future economic conditions, future business development plans, possible stress scenarios, and Internet risk control and audit procedures.¹⁸⁴

Consolidated Supervised Entities

The U.S. Securities and Exchange Commission (SEC) recognizes that large broker-dealers typically are owned by holding companies that also own other entities engaged in securities and nonsecurities activities worldwide and that the broker-dealer may incur many types of risks through its affiliations. In recently adopted rules the SEC took a step in the direction of supervision of groups that include broker-dealers.¹⁸⁵ These rules permit a holding company system that includes a broker-dealer (the ultimate holding company and its affiliates are called a “consolidated supervised entity” (hereinafter CSE)) to voluntarily submit to group-wide SEC supervision. The rules were adopted in response to the EU requirement of equivalent supplementary supervision in the Supplementary Supervision Directive.¹⁸⁶

The ultimate holding company of the CSE must have a group-wide internal risk management control system and must agree to provide the SEC with additional information about the financial condition of the ultimate holding company and its affiliates.

For an ultimate holding company that does not have a principal regulator, this financial information includes a monthly computation of group-wide allowable capital and allowances for market, credit, and operational risk calculated in accordance with the Basel Capital Standards. This type of ultimate holding company also must provide the SEC with specified financial, operational, and risk management information on a monthly, quarterly, and annual basis. Moreover, an ultimate holding company that does not have a principal regulator must implement and maintain a consolidated internal risk management control system and procedures to monitor and manage group-wide risk, including market, credit, funding, operational, and legal risks, and make and maintain certain books and records. Both the ultimate holding company and its affiliates that do not have principal regulators must consent to SEC examination.¹⁸⁷

An ultimate holding company that has a principal regulator is subject to substantially fewer requirements than one that does not have a principal regulator. This category of ultimate holding company must consent to provide the SEC, on a quarterly basis, with the capital measurements that it submits to its principal regulator, consolidated and consolidating balance sheets and income statements, and certain regular risk reports provided to the persons responsible for managing group-wide risk. Annually, an ultimate holding company that has a principal regulator must provide audited consolidated balance sheets and income statements and capital measurements, as submitted to its principal regulator. An ultimate holding company that has a principal regulator also is subject to more limited undertaking and information requirements related to the broker-dealer’s application for exemption from the standard net capital rule as well as reduced notification and record keeping requirements.¹⁸⁸

The SEC will not examine an entity that has a principal regulator and will use the reports that such entity files with its principal regulator to the greatest extent possible.¹⁸⁹

In the CSE rules the SEC carefully tries to walk the line between supervision of the group and deference to other regulatory agencies. The proposed CSE rules—different from the Supplementary Supervision Directive—do not envision the role of a coordinator to facilitate supervision of entities in different sectors of the financial industry.

If the CSE of a broker-dealer submits to SEC supervision and complies with the CSE requirements, the broker-dealer in the group may apply to the SEC for an exception from the application of the standard net capital rules and may elect to calculate certain of its market and credit risk capital charges using the firm’s own internal mathematical models for risk measurement, including internally developed value-at-risk models and scenario analysis.¹⁹⁰

Supervised Investment Bank Holding Companies

Section 231, GLBA amended Section 17, Securities Exchange Act of 1934 (hereinafter Exchange Act)¹⁹¹ to create a regulatory framework under which a holding company of a broker-dealer may voluntarily elect to be supervised by the SEC as a supervised investment bank holding company (hereinafter SIBHC).

The SEC recently adopted rules to implement Section 17¹⁹² to create a framework for supervising an investment bank holding company that voluntarily files a notice of intention with the SEC to become an SIBHC and to be subject to supervision on a group-wide basis. These rules also enhance the SEC’s supervision of the SIBHC’s subsidiary broker-dealers through collection of additional information and examinations of affiliates of those broker-dealers. This framework includes qualification criteria for investment bank holding companies that file notices of intention to be supervised by the SEC, as well as record keeping and reporting requirements for SIBHCs. An investment bank holding company that meets the criteria set forth in the rules is not required to become an SIBHC; supervision as an SIBHC is voluntary.¹⁹³ Taken as a whole, the framework permits the SEC to better monitor the financial condition, risk management, and activities of an SIBHC and its affiliates (including broker-dealer affiliates) on a group-wide basis. This regulatory framework for SIBHCs is intended to provide a basis for non-U.S. financial regulators to treat the SEC as the principal U.S. consolidated, home-country supervisor for SIBHCs and their affiliates.¹⁹⁴

Pursuant to the definitions in the Exchange Act,¹⁹⁵ the term “investment bank holding company” means any person, other than a natural person, that owns or controls one or more broker-dealers and the associated persons of the investment bank holding company. The term “associated person of an investment bank holding company” means any person directly or indirectly controlling, controlled by, or under common control with the investment bank holding company.¹⁹⁶ Thus, an investment bank holding company includes the holding company and all other entities within the holding company structure that met the “control” test.

Section 17(i)(1)(A), Exchange Act¹⁹⁷ limits the entities that are eligible to become an SIBHC. Specifically, an investment bank holding company that is (1) an affiliate of an insured bank (with certain exceptions) or a savings association; (2) a foreign bank, foreign company, or a company that is described in Section 8(a), International Banking Act of 1978; or (3) a foreign bank that controls, directly or indirectly, an Edge Act corporation¹⁹⁸ would not be eligible to file a notice of intention.¹⁹⁹ These exclusions of groups that include banks prevent FHCs from electing SIBHC status and substantially limit the number of financial groups that can elect SIBHC status.

Rule 17i-4 requires an SIBHC to establish, document, and maintain a system of internal risk management controls to assist it in managing the risks associated with its business activities, including market, credit, operational, funding, and legal risks.²⁰⁰ Pursuant to Section 17(i)(3)(A), Exchange Act,²⁰¹ an SIBHC would be required to make and keep records, furnish copies thereof, and make such reports as the SEC may require by rule.²⁰² Rule 17i-7 requires an SIBHC to calculate the affiliate group’s allowable capital and allowances for market, credit, and operational risks on a consolidated basis consistent with the Basel Capital Standards. Rule 17i-7 does not set minimum group-wide capital levels for SIBHCs; rather, it requires the SIBHC to perform certain calculations that the SEC will review to gain an understanding of the financial position of the affiliate group and identify any risks it poses to the broker-dealer or other market participants.²⁰³ The rules incorporate a capital computation for the SIBHC that is consistent with the Basel Capital Standards.²⁰⁴

Notes

Directive 2002/87/EC of the European Parliament and of the Council of December 16, 2002 on the supplementary supervision of credit institutions, insurance undertakings, and investment firms in a financial conglomerate and amending Council Directives 73/239/EEC, 79/267/EEC, 92/49/EEC, 92/96/EEC, 93/6/EEC, and 93/22/EEC, and Directives 98/78/EC and 2000/12/EC of the European Parliament and of the Council, O.J. Eur. Comm. No. L 35/1 (2003) [hereinafter the Supplementary Supervision Directive]. For a detailed discussion of the Supplementary Supervision Directive, see Michael Gruson, “Consolidated and Supplementary Supervision of Financial Groups in the European Union,” 2004 Der Konzern 65 (Part I), 249 (Part II) [hereinafter Gruson, “Consolidated and Supplementary Supervision”]; Michael Gruson, “Supervision of Financial Holding Companies in Europe: The EU Directive on Supplementary Supervision of Financial Conglomerates,” 36 International Lawyer 1229 (2002).

Recitals (2) and (3), Supplementary Supervision Directive.

Explanatory Memorandum to the Proposed Supplementary Supervision Directive (April 24, 2001), O.J. Eur. Comm. No. C 213/227 (2001) [hereinafter 2001 Explanatory Memorandum], at 2 sub 1.

Tripartite Group of Bank, Securities and Insurance Regulators, The Supervision of Financial Conglomerates (Bank for International Settlements, July 1995) [hereinafter Tripartite Report], at 39, sub no. 104; The Joint Forum, The Joint Forum Compendium of Documents (July 2001) [hereinafter Joint Forum Report], Capital Adequacy Principles Paper, at 12, sub no. 6. The Tripartite Group was formed at the initiative of the Basel Committee on Banking Supervision (Basel Committee) in early 1993 to address a range of issues relating to the supervision of financial conglomerates. The Joint Forum was established in early 1996 under the aegis of the Basel Committee, the International Organization of Securities Commissions (IOSCO), and the International Association of Insurance Supervisors (IAIS) to take forward the work of the Tripartite Group. The Joint Forum Report is a compilation of papers that have been prepared by the Joint Forum since its inception in January 1996.

Tripartite Report, at 16, sub no. 41.

2001 Explanatory Memorandum, at 2, sub 1.

Tripartite Report, at 16, sub no. 42.

For a detailed discussion of consolidated supervision of banking groups and investment firm groups, see Gruson, “Consolidated and Supplementary Supervision,” at 66.

Directive 2000/12/EC of the European Parliament and of the Council of March 20, 2000 relating to the taking up and pursuit of the business of credit institutions, O.J. Eur. Comm. No. L 126/1 (2000), as amended [hereinafter Banking Directive].

Art. 1(1), Banking Directive.

Art. 1(5), Banking Directive. A financial institution is an undertaking other than a credit institution, the principal activity of which is to acquire holdings or to carry on most of the activities that a credit institution may engage in, other than deposit taking. Investment firms are financial institutions.

Defined in Art. 1(13), second subparagraph, Banking Directive by reference to Art. 1(1), Consolidated Accounts Directive, infra note 46. Subsidiary is, in summary, an undertaking (1) in which a parent (a) has, or controls alone, pursuant to a shareholder agreement, a majority of the shareholders’ or members’ voting rights, or (b) has the right to appoint or remove a majority of the members of the administrative, management, or supervisory board and is at the same time a shareholder or a member; or (2) that can be controlled by the parent (the parent “has the right to exercise a dominant influence”) pursuant to a contract between the parent and the subsidiary or a provision in the subsidiary’s charter, the parent at the same time being a shareholder or a member. In addition, a subsidiary is any undertaking over which, in the opinion of the competent authorities, a parent effectively exercises a dominant influence.

Art. 1(9), Banking Directive (essentially 20 percent or more of the voting rights or capital; a lower percentage suffices if the investment, by creating a durable link between the investor and the target, is intended to contribute to the investor’s activities).

Art. 52(1) and (2), Banking Directive. Art. 1(21), Banking Directive, as amended by Art. 29(1)(b), Supplementary Supervision Directive, defines financial holding company as a financial institution, the subsidiary undertakings of which are either exclusively or mainly credit institutions or financial institutions, at least one of such subsidiaries being a credit institution, and which is not a mixed financial holding company within the meaning of [the Supplementary Supervision Directive].

Art. 7(2) and (3), Council Directive 93/6/EEC of March 15, 1993 on the capital adequacy of investment firms and credit institutions, O.J. Eur. Comm. No. L 141/1 (1993), as amended [hereinafter Capital Adequacy Directive].

Art. 7(2) and (3), Capital Adequacy Directive. “Financial holding company” is defined in Art. 2(8), Capital Adequacy Directive as any financial institution, the subsidiary undertakings of which are either exclusively or mainly credit institutions, investment firms, or other financial institutions, at least one of which is a credit institution or an investment firm.

Art. 2(2), Capital Adequacy Directive.

Art. 52(5) and (6), Banking Directive; Art. 7(2), Capital Adequacy Directive.

Art. 7(3), 5th indent, Capital Adequacy Directive that excludes the application of Art. 52(5), second subparagraph, Banking Directive. Investment firms are not restricted to their investments in the industrial or commercial sector.

Art. 25(1), Banking Directive. Art. 25, Banking Directive is not applicable to investment firms, and the Capital Adequacy Directive does not contain similar provisions.

Art. 56a, first subparagraph, Banking Directive, added by Art. 29(11), Supplementary Supervision Directive. Art. 56a, Banking Directive also applies to investment firm groups. Art. 7(2) and (3), Capital Adequacy Directive.

Art. 56a, fifth subparagraph, Banking Directive, added by Art. 29(11), Supplementary Supervision Directive.

Directive 98/78/EC of the European Parliament and of the Council of October 27, 1998 on the supplementary supervision of insurance undertakings in an insurance group, O.J. Eur. Comm. No. L 330/1 (1998), as amended [hereinafter Insurance Group Directive]. For a discussion of supplementary supervision of insurance groups, see Gruson, “Consolidated and Supplementary Supervision,” at 75.

Art. 1(a), Insurance Group Directive.

Art. 1(e), Insurance Group Directive.

Art. 1(c), Insurance Group Directive.

Art. 1(b), Insurance Group Directive.

Art. 1(f), Insurance Group Directive.

Art. 2(1), Insurance Group Directive. A horizontal structure exists if there is control in the absence of an equity investment, due to management on a unified basis or cross-membership of governing boards. See Art. 1(g), Insurance Group Directive.

Art. 1(d), Insurance Group Directive.

“Insurance holding company” is a parent the main business of which is to acquire and hold participations in subsidiaries, where those subsidiaries are exclusively or mainly EU-authorized insurance undertakings, reinsurance undertakings or non-EU insurance undertakings, at least one of such subsidiaries being an EU-authorized life or non-life insurance undertaking, and which is not a mixed financial holding company within the meaning of the Supplementary Supervision Directive. Art. 1(i), Insurance Group Directive.

Art. 2(2), Insurance Group Directive.

Art. 2(3), Insurance Group Directive. “Mixed-activity insurance holding company” is a parent, other than an EU-authorized insurance undertaking, a non-EU insurance undertaking, a reinsurance undertaking, an insurance holding company, or a mixed financial holding company as defined in the Supplementary Supervision Directive, that includes at least one EU-authorized life or non-life insurance undertaking among its subsidiaries. Art. 1(j), Insurance Group Directive.

Art. 8(1), Insurance Group Directive.

Art. 9(1), referring to Art. 2(1), Insurance Group Directive.

Art. 5(1), Insurance Group Directive.

Art. 10b, Insurance Group Directive, added by Art. 28(4), Supplementary Supervision Directive.

E.g., Art. 55(2) and Art. 56(4), Banking Directive, Art. 7(3), 8th indent, Capital Adequacy Directive, and Art. 7(2), Insurance Group Directive in certain cases requires cooperation and exchange of information between the different supervisory authorities of different sectors.

Art. 2(4), Supplementary Supervision Directive.

Art. 6, First Council Directive 73/239/EEC of July 24, 1973 on the coordination of laws, regulations, and administrative provisions relating to the taking up and pursuit of the business of direct insurance other than life assurance, O.J. Eur. Comm. No. L 228/3 (1973), as amended [hereinafter First Non-Life Insurance Directive]; Art. 6, First Council Directive 79/267/EEC of March 5, 1979 on the coordination of laws, regulations, and administrative provisions relating to the taking up and pursuit of the business of direct life assurance, O.J. Eur. Comm. No. L 63/1 (1979), as amended [hereinafter First Life Insurance Directive]; Art. 3(1), Council Directive 93/22/EEC of May 10, 1993 on investment services in the securities field, O.J. Eur. Comm. No. L 141/27 (1993), as amended [hereinafter Investment Services Directive]; Art. 5(1), Directive 2004/39/EC of the European Parliament and of the Council of April 21, 2004 on markets in financial instruments amending Council Directives 85/611/EEC and 93/6/EEC and Directive 2000/12/EC of the European Parliament and of the Council and repealing Council Directive 93/22/EEC [hereinafter Financial Instruments Markets Directive]; Art. 4, Banking Directive.

See Art. 1 and Art. 5(1), Supplementary Supervision Directive. The Supplementary Supervision Directive uses the term “regulated entity” with two meanings: As defined in Art. 2(4), Supplementary Supervision Directive, the term also includes non-EU-authorized entities. As used in Art. 1, Supplementary Supervision Directive, the term “regulated entities” refers only to entities that have obtained an authorization under a sectoral Directive. The Supplementary Supervision Directive calls EU-authorized regulated entities regulated entities referred to in Article 1. See, e.g., Art. 5(1), Supplementary Supervision Directive. Regulated entities referred to in Article 1 are hereinafter sometimes called “EU-regulated entities” and regulated entities that are not EU-regulated entities are hereinafter sometimes called “non-EU-regulated entities.”

Art. 6, First Non-Life Insurance Directive and Art. 6, First Life Insurance Directive require an authorization of insurance undertakings having established their head office within the territory of a member state. Art. 3(1), in connection with Art. 1(6), Investment Services Directive states that only investment firms having their registered office or head office in a member state are subject to authorization. Art. 5(1), in conjunction with Art. 4(20), Financial Instruments Markets Directive provides that the member state in which the registered office is situated shall grant the necessary authorization for an investment firm. Although Art. 4, Banking Directive provides for the authorization of credit institutions prior to commencement of activities in a member state without expressly referring to the head office or registered office of that credit institution, it is clear from the context of the Banking Directive and Arts. 23–25, Banking Directive (governing relations with third countries) that only credit institutions established under the laws of a member state are subject to authorization pursuant to Art. 4, Banking Directive.

Art. 5(1), Supplementary Supervision Directive.

Art. 1, Supplementary Supervision Directive.

“Parent undertaking” and “subsidiary undertaking” are defined in Art. 2(9) and (10), Supplementary Supervision Directive by reference to Art. 1(1) and (2), Seventh Council Directive 83/349/EEC of June 13, 1983 based on Article 54(3)(g) of the Treaty on consolidated accounts, O.J. Eur. Comm. No. L 193/1 (1983), as amended [hereinafter Consolidated Accounts Directive]. The definitions of “parent” and “subsidiary” are identical with the definitions of such terms in the Banking Directive, except that the Supplementary Supervision Directive (but not the Banking Directive) permits member states to consider an undertaking as a parent undertaking if it has the power to exercise, or actually exercises, a dominant influence or control over another undertaking (a subsidiary) or manages another undertaking (the subsidiary) and the parent on a unified basis. See Art. 1(2), Consolidated Accounts Directive that is included in the subsidiary/parent definition of the Supplementary Supervision Directive, but not in those definitions of the Banking Directive.

“Participation” is defined in Art. 2(11), Supplementary Supervision Directive, referring to Art. 17, first sentence, Fourth Council Directive 78/660/EEC of July 25, 1978 based on Art. 54(3)(g) of the Treaty on the annual accounts of certain types of companies, O.J. Eur. Comm. No. L 222/11 (1978), as amended [hereinafter Annual Accounts Directive]. A participation is (1) a right in the capital of other undertakings which “by creating a durable link with those [other] undertakings, are intended to contribute to the company’s [the holder of the participation] activities,” or (2) the ownership, directly or indirectly, of 20 percent or more of the voting rights or capital of another undertaking.

Art. 2(12), Supplementary Supervision Directive, referring to Art. 12(1), Consolidated Accounts Directive.

Section 2, Bank Holding Company Act of 1956, as amended [hereinafter BHCA], 12 U.S.C. § 1841 (2000). See Michael Gruson, “Nonbanking Activities of Foreign Banks Operating in the United States” [hereinafter Gru-son, “Nonbanking Activities”], § 9.03 in Michael Gruson and Ralph Reisner, eds., Regulation of Foreign Banks, Vol. 1 (4th ed., 2003).

Art. 2(14)(e), Supplementary Supervision Directive.

Art. 2(14)(c), Supplementary Supervision Directive.

Compare Art. 2(15) with Art. 5(2)(b), Supplementary Supervision Directive. If the head of a financial conglomerate is a non-EU-regulated entity, it is not a mixed financial holding company. See Art. 5(3), Supplementary Supervision Directive.

See Art. 5(2)(b), Supplementary Supervision Directive.

See Art. 2(14), in connection with Art. 5(2), Supplementary Supervision Directive. Art. 5(2)(a), Supplementary Supervision Directive refers to regulated entities in Art. 5(1), Supplementary Supervision Directive which covers only EU-authorized regulated entities (regulated entities referred to in Art. 1, Supplementary Supervision Directive).

See Art. 5(3) and Art. 18, Supplementary Supervision Directive. The Supplementary Supervision Directive does not address the case of a horizontal group of which one member has its head office outside the European Union.

Art. 52(1) and (2), Banking Directive.

Art. 1(22), Banking Directive.

Art. 1(5), Banking Directive.

Art. 1(21), Banking Directive.

Art. 52(2), Banking Directive.

It must be noted, however, that the “mainly” test for purposes of the definition of a financial holding company differs from the “mainly” test for purposes of the definition of a mixed financial holding company: a financial holding company must exclusively or mainly hold credit institution or financial institution subsidiaries, whereas a group headed by a mixed financial holding company must mainly be engaged in the financial sector based on the 40 percent test.

Art. 5(4), first subparagraph, Supplementary Supervision Directive.

Art. 5(4), second subparagraph, Supplementary Supervision Directive.

Art. 4(2), Supplementary Supervision Directive.

Id.

Art. 5(2), Supplementary Supervision Directive. See, e.g., Arts. 6(2), 7(2), and 9(1), Supplementary Supervision Directive.

Arts. 6(2), 7(2), and 8(2), Supplementary Supervision Directive.

Art. 5(2)(a) and (b), Supplementary Supervision Directive.

See, e.g., Arts. 6(2), 7(2), 8(2), and 9(1), Supplementary Supervision Directive.

Art. 5(5), Supplementary Supervision Directive.

See, e.g., Art. 6(2), fourth and fifth subparagraphs, Art. 7(2) and Art. 8(2), second subparagraph, Supplementary Supervision Directive.

See Art. 5(5), Supplementary Supervision Directive.

Art. 2(18), Supplementary Supervision Directive.

Art. 2(19), Supplementary Supervision Directive.

Art. 6(3), Supplementary Supervision Directive.

Art. 5(5), Supplementary Supervision Directive.

Art. 5(2)(a), Supplementary Supervision Directive.

See Art. 5(2), Supplementary Supervision Directive.

Art. 2(15), Supplementary Supervision Directive.

Art. 5(3) and Art. 18, Supplementary Supervision Directive.

Arts. 6–17, Supplementary Supervision Directive.

Art. 5(2), second subparagraph, Supplementary Supervision Directive.

See Art. 2(14)(c), Supplementary Supervision Directive. The entity heading the group is not a mixed financial holding company if the group does not constitute a financial conglomerate. See Art. 2(15), Supplementary Supervision Directive.

The prohibition of separate regulation of subgroups set forth in Art. 5(2), second subparagraph, Supplementary Supervision Directive does not apply in that case because the subgroup is not a subgroup of another financial conglomerate.

See 2001 Explanatory Memorandum, at 6, sub 2, Art. 4, and Tripartite Report, at 36, sub no. 96 (the impression that the activities of unregulated entities in the financial conglomerate are in some way being monitored or supervised, even if only informally, creates a moral hazard).

Art. 5(5) and Art. 12(4), Supplementary Supervision Directive.

Art. 30, first and second subparagraphs, Supplementary Supervision Directive.

Art. 30, third subparagraph, Supplementary Supervision Directive.

Art. 10 and Art. 11, Supplementary Supervision Directive.

Art. 12, Supplementary Supervision Directive.

Tripartite Report, at 17, sub no. 43.

Art. 6(1), Supplementary Supervision Directive.

Annex I, sub I, 2(i), Supplementary Supervision Directive.

Double gearing occurs whenever one entity holds regulatory capital issued by another entity within the same group and the issuer is allowed to count the capital in its own balance sheet; multiple gearing occurs when the dependent in the previous instance itself downstreams regulatory capital to a third-tier entity, and the parent’s externally generated capital is geared up a third time. Annex I, sub I, 2(i), Supplementary Supervision Directive refers to multiple gearing as the multiple use of elements eligible for the calculation of own funds at the level of the financial conglomerate. See Joint Forum Report, Capital Adequacy Principles Paper, at 13, sub no. 18.

See 2001 Explanatory Memorandum, at 4, sub 1(b). The Joint Forum Report, Capital Adequacy Principles Paper, at 14, sub no. 23, defines excessive leverage as situations where a parent issues debt (or other instruments not acceptable as regulatory capital in the downstream entity) and downstreams the proceeds as equity or other forms of regulatory capital to its regular subsidiaries.

Tripartite Report, at 17, sub no. 44.

Art. 6(2), first subparagraph, in connection with Art. 5(2), Supplementary Supervision Directive.

Art. 6(3), Supplementary Supervision Directive.

See Annex I, sub II, Method 1, fourth paragraph, Method 2, third paragraph, and Method 3, third paragraph, Supplementary Supervision Directive. “Notional solvency requirement” means the capital requirement with which such an entity would have to comply under the relevant sectoral rules as if it were a regulated entity of that particular financial sector; a mixed financial holding company shall be treated according to the sectoral rules of the most important financial sector in the financial conglomerate. In the case of asset management companies, solvency requirements means the capital requirement set out in Art. 5a(1)(a), Council Directive 85/611/EEC of 20 December 1985 on the coordination of laws, regulations, and administrative provisions relating to undertakings for collective investment in transferable securities (UCITS), O.J. Eur. Comm. No. L 375/3 (1985), as amended [hereinafter UCITS Directive]. Annex I, sub I, 2(ii), last paragraph, Supplementary Supervision Directive.

100

Annex I, sub I, 2(ii), first paragraph, Supplementary Supervision Directive.

101

Annex I, sub I, 2(ii), first and second paragraphs, Supplementary Supervision Directive.

102

It would have been desirable to leave the choice of the calculation method to the financial conglomerate in order to give companies more flexibility.

103

See Annex I, second and third paragraphs, and Annex I, sub II, Method 4, Supplementary Supervision Directive.

104

See Annex I, sub II, Method 1(i) and (ii) and third paragraph, Supplementary Supervision Directive.

105

SCA shall mean the supplementary capital adequacy, that is, the surplus or deficit of the group-wide capital; OF shall mean own funds; and S shall mean the solvency requirements of a financial sector.

106

The elements eligible are those that qualify in accordance with the relevant sectoral rules, Annex I, sub II, Method 2(i), Supplementary Supervision Directive.

107

The solvency requirements shall be calculated in accordance with the relevant sectoral rules, Annex I, sub II, Method 2(ii), Supplementary Supervision Directive. The calculation of own funds and solvency requirement shall take account of the proportional share held by a parent undertaking in a subsidiary or by an undertaking that holds a participation in another entity of the group. Proportional share means the proportion of the subscribed capital that is held, directly or indirectly, by that undertaking. Art. 6(4), second sub-paragraph, and Annex I, sub II, Method 2, third paragraph, Supplementary Supervision Directive. In the case of nonregulated entities, a notional solvency requirement shall be calculated. Annex I, sub II, Method 2, third paragraph, Supplementary Supervision Directive. See supra note 99.

108

Although the wording in this point is not very clear, “participations in other entities of the group” means any participation that is held within the group, for example, participations of the parent in its subsidiaries or cross-participations of the subsidiaries. See Joint Forum Report, Capital Adequacy Principles Paper, at 14, sub no. 20.

109

SCA shall mean the supplementary capital adequacy, that is, the surplus or deficit of the group-wide capital; OF shall mean own funds; S shall mean the solvency requirements of an entity of the group; and BV shall mean the book value of a participation.

110

The elements eligible are those that qualify in accordance with the relevant sectoral rules, Annex I, sub II, Method 3(i), Supplementary Supervision Directive.

111

The calculation of own funds and solvency requirements shall take account of the proportional share held by a parent undertaking in a subsidiary or by an undertaking that holds a participation in another entity of the group. Proportional share means the proportion of the subscribed capital that is held, directly or indirectly, by that undertaking. Art. 6(4), second subpara-graph, and Annex I, sub II, Method 3(ii), Supplementary Supervision Directive. When evaluating the elements eligible for the calculation of supplementary capital adequacy requirements, participations may be valued by the equity method in accordance with the options set out in Art. 59(2)(b), Annual Accounts Directive. Annex I, sub II, Method 3, third paragraph, Supplementary Supervision Directive. In the case of nonregulated entities, a notional solvency requirement shall be calculated. Annex I, sub II, Method 3, third paragraph, Supplementary Supervision Directive.

112

SCA shall mean the supplementary capital adequacy, that is, the surplus or deficit of the group-wide capital; OF shall mean the own funds of the parent on the basis of the single account; S shall mean the solvency requirements; and BV shall mean the book value of the parent’s participation.

113

See Joint Forum Report, Capital Adequacy Principles, at 21 and 26, Annexes 1 and 2.

114

Art. 6(2), Supplementary Supervision Directive.

115

See Michael Gruson, “Foreign Banks and the Financial Holding Company,” [hereinafter Gruson, “Foreign Banks and the Financial Holding Company”], § 10.07[1] in Michael Gruson and Ralph Reisner, eds., Regulation of Foreign Banks, Vol. 1 (4th ed., 2003); Jeffrey D. Berman, Arthur S. Long, and Tomer Seifan, “U.S. Law Conditions Applicable to Foreign Bank Acquisitions of U.S. Banking Institutions,” § 3.06[2] in Michael Gruson and Ralph Reisner, eds., Regulation of Foreign Banks, Vol. 1 (4th ed., 2003).

116

Arts. 7(1) and 8(1), in connection with Annex II, Supplementary Supervision Directive.

117

The Joint Forum Report, Intra-Group Transactions and Exposure Principles, at 134, sub no. 12. See also Tripartite Report, at 21, sub no. 55.

118

Tripartite Report, at 18, sub no. 47.

119

Tripartite Report, at 19, sub no. 50; see Joint Forum Report, Intra-Group Transactions and Exposure Principles, at 131, sub no. 4 for an enumeration of types of intra-group transactions and exposures.

120

Art. 2(18), Supplementary Supervision Directive.

121

Art. 2(18), Supplementary Supervision Directive. “Close link” is defined as a situation in which two or more natural or legal persons are linked by (1) a participation (20 percent of voting rights or capital), (2) control (parent-subsidiary relationship), (3) a similar relationship between any natural or legal person and an undertaking, or (4) each being in a control relationship to the same third person (common control). Art. 2(13), Supplementary Supervision Directive. It is difficult to imagine cases in which an undertaking in a group has a close link to another undertaking by means of a participation or control but the other undertaking is not a member of the group. However, the link with a natural person and the link created through permanent control relationships by two natural or legal persons to a third person does not create a group relationship.

122

See Art. 2(18) and Art. 8(1) and (2), Supplementary Supervision Directive, referring generally to regulated entities.

123

Art. 8(3), Supplementary Supervision Directive.

124

Sections 23A and 23B, Federal Reserve Act, 12 U.S.C. § 371c and 371c-1 (2000). See Robert E. Mannion and Lisa R. Chavarria, “Transactions Between Banks and Affiliated Enterprises” [hereinafter Mannion, “Transactions with Affiliates”], ch. 12 in Michael Gruson and Ralph Reisner, eds., Regulation of Foreign Banks, Vol. 1 (4th ed., 2003); Gruson, “Foreign Banks and the Financial Holding Company,” § 10.07[4].

125

Art. 2(18), Supplementary Supervision Directive. See also Art. 55a, first subparagraph, Banking Directive, added by Art. 29(9), Supplementary Supervision Directive (transactions between a credit institution and its mixed-activity holding company).

126

Defined in Art. 2(19), Supplementary Supervision Directive.

127

The Joint Forum Report, Risk Concentrations Principles, at 141–46, sub nos. 4, 8–10, 11, 22, and 23.

128

Art. 2(19), Supplementary Supervision Directive.

129

Art. 7(3), Supplementary Supervision Directive.

130

Art. 9(1), (2), (3), and (5), Supplementary Supervision Directive.

131

Art. 9(4), Supplementary Supervision Directive.

132

Art. 7(2), second subparagraph, and Art. 8(2), in connection with Annex II, Supplementary Supervision Directive.

133

Art. 7(2) and Art. 8(2), second subparagraph, Supplementary Supervision Directive.

134

Art. 7(2), second subparagraph, and Art. 8(2), third subparagraph, Supplementary Supervision Directive.

135

Annex II, first paragraph, Supplementary Supervision Directive, referring to the reporting provision of Art. 7(2) and Art. 8(2), Supplementary Supervision Directive.

136

Art. 7(4) and Art. 8(4), Supplementary Supervision Directive.

137

Art. 13, Supplementary Supervision Directive.

138

See recital clause No. (8), Supplementary Supervision Directive.

139

Art. 28(4), Supplementary Supervision Directive, amending the Insurance Group Directive by adding Art. 10b; Art. 29(8), Supplementary Supervision Directive, amending the Banking Directive by adding Art. 54a. See Art. 6, Banking Directive, establishing management qualifications for managers of credit institutions.

140

Arts. 10–17, Supplementary Supervision Directive.

141

2001 Explanatory Memorandum, at 7, sub 2 (Arts. 7–13).

142

Art. 10(1), Supplementary Supervision Directive.

143

Art. 10(2) and (3), Supplementary Supervision Directive.

144

See Art. 10(2)(b)(ii), second subparagraph, Supplementary Supervision Directive.

145

Art. 11(1), Supplementary Supervision Directive.

146

Art. 11(3), Supplementary Supervision Directive.

147

Art. 12(1), Supplementary Supervision Directive.

148

Art. 11(1), second subparagraph, Supplementary Supervision Directive.

149

Art. 12(1), Supplementary Supervision Directive.

150

Art. 12(2), Supplementary Supervision Directive.

151

Art. 15, Supplementary Supervision Directive.

152

See Art. 5(3), Supplementary Supervision Directive. Unlike the general approach applied in the United States under the U.S. Bank Holding Company Act of 1956, the Supplementary Supervision Directive does not regulate non-EU holding companies that control EU-regulated entities.

153

Art. 5(3) and Art. 18, Supplementary Supervision Directive. See 2001 Explanatory Memorandum, at 7, sub 2, Art. 14.

154

Art. 18(1), Supplementary Supervision Directive.

155

The Financial Conglomerates Committee established under Art. 21, Supplementary Supervision Directive assists the EU Commission. It may give general guidance as to whether the supplementary supervision arrangements in third countries are likely to achieve the objectives of the Supplementary Supervision Directive, in relation to the regulated entities in a financial conglomerate, the head of which has its head office outside the EU. Art. 21(5), Supplementary Supervision Directive.

156

Art. 18(1), Supplementary Supervision Directive.

157

See 12 C.F.R. § 225.92(e)(1) and (2) (2004) (Regulation Y) (election by foreign bank to become financial holding company); 12 C.F.R. § 211.24(c)(1)(i)(A) (2003) (Regulation K) (establishment of U.S. office by foreign bank); 12 C.F.R. § 225.13(a)(4) (2004) (Regulation Y) (acquisition of U.S. bank by foreign bank).

158

Art. 18(2), Supplementary Supervision Directive. “Analogy” means “similarity in some respects between things that are otherwise dissimilar.” American Heritage Dictionary (4th ed., 2000). In the context of the Supplementary Supervision Directive, this presumably means “to the extent possible.”

159

Art. 18(3), Supplementary Supervision Directive. According to Art. 18(3), second sentence, Supplementary Supervision Directive, those methods must be agreed on by the coordinator, after consultation with the other relevant competent authorities.

160

Art. 18(3), ultimate sentence, Supplementary Supervision Directive.

161

The BHCA applies directly to such foreign banks.

162

Section 8(a), International Banking Act of 1978, 12 U.S.C. § 3106(a) (2000).

163

Art. 19, Supplementary Supervision Directive makes Art. 25(1) and (2), Banking Directive applicable mutatis mutandis to the negotiation of such agreements.

164

Art. 19(1), Supplementary Supervision Directive, in connection with Art. 25(1), Banking Directive.

165

Art. 18, Supplementary Supervision Directive. If an EU-authorized credit institution is a subsidiary of a non-EU credit institution or financial institution, the competent authorities must verify whether the EU-authorized credit institution is subject to consolidated supervision by the home country of the non-EU parent that is equivalent to that required by the Banking Directive. Art. 56a, Banking Directive, added by Art. 29(11), Supplementary Supervision Directive. The question whether an EU-authorized credit institution with a U.S. parent is subject to equivalent U.S. consolidated supervision is discussed in Gruson, “Consolidated and Supplementary Supervision,” at 259–261.

166

GLBA: Pub. L. No. 106-102, 106th Cong., lst Sess. (1999), 113 Stat. 1338–4481 (1999). BHCA: 12 U.S.C. §§ 1841–1850 (2000).

167

See Gruson, “Foreign Banks and the Financial Holding Company,” § 10.07[1].

168

See Gruson, “Foreign Banks and the Financial Holding Company,” § 10.02[7][c]; Joyce M. Hansen, Ivan J. Hurwitz, and Diane L. Virzera, “Capital Regulation and Supervision of International Banking Organizations,” in Michael Gruson and Ralph Reisner, eds., Regulation of Foreign Banks, Vol. 1 (4th ed., 2003) [hereinafter Hansen, “Capital Regulations”], § 4.03[5][b].

169

See Gruson, “Foreign Banks and the Financial Holding Company,” § 10.02[7][b].

170

This follows from § 5(c)(3), BHCA, 12 U.S.C. § 1844(c)(3) (2000), which prohibits the Board from prescribing capital requirements on functionally regulated subsidiaries of a BHC (not functionally regulated BHCs). See Hansen, “Capital Regulations,” § 4.03[5][b].

171

See Gruson, “Foreign Banks and the Financial Holding Company,” § 10.02[7][d]; Hansen, “Capital Regulations,” § 4.03[5][b].

172

12 U.S.C. §§ 371c and 371c-1 (member banks); 12 U.S.C. § 1828(j) (state nonmember banks); 12 U.S.C. § 1468(a) (federally insured savings associations) (2000).

173

For a discussion of affiliates, see Mannion, “Transactions with Affiliates,” 12.02[3][a]. For these purposes, a foreign bank controlling a U.S. bank and the foreign bank’s foreign and domestic subsidiaries would be affiliates of the U.S. bank. Id. Sections 23A and 23B, Federal Reserve Act also apply to U.S. branches and agencies of foreign banks. See Gruson, “Foreign Banks and the Financial Holding Company,” § 10.07[4][d].

174

A “controlled insurer” is an authorized insurer controlled directly or indirectly by a holding company. Section 1501(b)(4), New York Insurance Law (McKinney, 2000).

175

“Holding company system” is a holding company together with its controlled insurers and controlled persons. Section 1501(6), in connection with (1)–(5), New York Insurance Law.

176

Section 1505(a), New York Insurance Law.

177

Section 1505(c), New York Insurance Law. See § 80-1.5(a) and (b), New York Codes, Rules, and Regulations, title 11, pt. 75, ch. IV.

178

Section 1505(d), New York Insurance Law. See § 80-1.5(c), New York Codes, Rules, and Regulations, title 11, pt. 75, ch. IV.

179

Section 1505(b), New York Insurance Law.

180

§ 80-1.4(a), New York Codes, Rules and Regulations, title 11, pt. 75, ch. IV.

181

However, a foreign life insurer that is authorized to do business in New York and is controlled by a person not authorized to do insurance business in New York shall be deemed under certain conditions a domestic insurer. Section 1501(d), New York Insurance Law.

182

But see 17 C.F.R. § 240.17h-1T(2) (2004) and 2T. See Form 17-H, Fed. Sec. L. (CCH), § 33,347.

183

Hansen, “Capital Regulations,” § 4.03[5][b]; Board, SR Letter No. 00-13 (UP) (Aug. 15, 2000) [hereinafter Supervision Letter].

184

Hansen, “Capital Regulations,” § 4.03[5][b]; Supervision Letter.

185

SEC Release No. 34-49830, 82 SEC Docket 3515, 69 Fed. Reg. 34,428 (June 21, 2004) (Alternative Net Capital Requirements for Broker-Dealers That Are Part of Consolidated Supervised Entities) [hereinafter CSE Release]. See proposed rule, SEC Release No. 34-48690, 81 SEC Docket 1208, 68 Fed. Reg. 62,872 (Nov. 6, 2003) [hereinafter CSE Proposed Release].

186

CSE Release, 69 Fed. Reg. at 34,429; CSE Proposed Release, 68 Fed. Reg. at 62,874.

187

See CSE Release, 69 Fed. Reg. at 34,430; see also 69 Fed. Reg. at 34,439 and 34,440–45. See new rule § 240.15c3-1e(a)(1)(viii) and (a)(2) (Appendix E to 17 C.F.R. § 240.15c3-1) and new rule § 240.15c3-1g (a), (b)(1) and (c) (Appendix G to 17 C.F.R. § 240.15c3-1).

188

See CSE Release, 69 Fed. Reg. at 34,430; see also 69 Fed. Reg. at 34,439–41 and 34,445. “Ultimate holding company that has a principal regulator” is defined as an FHC including a foreign bank that has elected to be an FHC (new rule § 240.15c3-1(13)(ii)(A)), or an entity that the SEC determines to be an ultimate holding company that has a principal regulator if that person is subject to consolidated, comprehensive supervision and meets certain other conditions (new rule § 240.15c3-1(13)(ii)(B)). See CSE Release, 69 Fed. Reg. at 34,432. The more limited undertakings that a broker-dealer must submit if its ultimate holding company has a principal regulator are set forth in new rules § 240.15c3-1e(a)(1)(ix) and (a)(3) (Appendix E to 17 C.F.R. § 240.15c3-1). New rule § 240.15c3-1g(b)(2)(i)(B) (Appendix G to 17 C.F.R. § 240.15c3-1) allows an ultimate holding company that has a principal regulator to submit the capital measurement computed in accordance with the Basel Capital Standards as reported to its principal regulator.

189

“Entity that has a principal regulator” is defined in new rule § 240.15c3-1(a)(13)(i) and includes, among other entities, an insured depository institution as defined in § 3(c)(2), Federal Deposit Insurance Act, 12 U.S.C. § 1813(c)(2) (2000); an insurance company licensed by a state insurance regulator; a foreign bank, as defined in § 1(b)(7), International Banking Act of 1978, 12 U.S.C. § 3101(7)(2000) that has its headquarters in a jurisdiction for which any foreign bank has been approved by the Board of Governors of the Federal Reserve System to conduct business pursuant to the standards set forth in 12 C.F.R. § 211.24(c) (2004), provided such foreign bank represents to the SEC that it is subject to the same supervisory regime as the foreign bank previously approved by the Board of Governors of the Federal Reserve System. See CSE Release, 69 Fed. Reg. at 34,431.

190

See CSE Release, 69 Fed. Reg. at 34,430–34,439; CSE Proposed Release, 68 Fed. Reg. at 62,872; rule 15c3-1, 17 C.F.R. § 240.15c3-1 (2004) and new rule § 240.15c3-1(a)(7), in conjunction with Appendix E to 17 C.F.R. § 240.15c3-1 (§ 240.15c3-1e).

191

Section 17, Exchange Act, 15 U.S.C. § 78q (2000).

192

SEC Release No. 34-49831, 82 SEC Docket 3578, 69 Fed. Reg. 34,472 (June 21, 2004) (Supervised Investment Bank Holding Companies) [hereinafter SIBHC Release]. See proposed rule SEC Release No. 34-48694, 81 SEC Docket 1262, 68 Fed. Reg. 62,910 (Nov. 6, 2003) [hereinafter SIBHC Proposed Release].

193

See new rules § 240.17i-2 (notice of intention to be supervised by the SEC as SIBHC) and § 240.17i-3 (withdrawal from supervision by the SEC as an SIBHC).

194

SIBHC Release, 69 Fed. Reg. at 34,473; SIBH Proposed Release, 68 Fed. Reg. at 62,911.

195

Section 17(i)(5)(A), Exchange Act, 15 U.S.C. § 78q(i)(5)(A) (2000).

196

Section 17(i)(5)(F), Exchange Act, 15 U.S.C. § 78q(i)(5)(7) (2000). See new rule § 240.17i-1(a).

197

15 U.S.C. § 78q(i)(1)(A) (2000).

198

Section 17(i)(1)(A)(i)–(iii), Exchange Act, 15 U.S.C. § 78q(i)(1)(A)(i)–(iii) (2000). See § 8(a), International Banking Act of 1978, 12 U.S.C. § 3106(a) (2000) (foreign banks); § 25A, Federal Reserve Act, 12 U.S.C. § 611 et seq. (2000) (Edge Act corporations).

199

New rule § 240.17i-2(a).

200

New rule § 240.17i-4, referring to 17 C.F.R. § 240.15c3–4 (2004). See SIBHC Release, 69 Fed. Reg. at 34,477.

201

15 U.S.C. § 78q(i)(3)(A) (2000).

202

These requirements of record creation and maintenance and access to records are set forth in new rule § 240.17i-5. New rule § 240.17i-6 contains reporting requirements.

203

New rule § 240.17i-7. See SIBHC Release, 69 Fed. Reg. at 34,480–85.

204

SIBHC Release, 69 Fed. Reg. at 34,481.

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Current Developments in Monetary and Financial Law, Vol. 4

Author:

International Monetary Fund

ISBN:: 9781589065079

Publication Date:: 06 Nov 2008

Publisher:: International Monetary Fund

DOI:: https://doi.org/10.5089/9781589065079.072

Pages:: 864

The Purpose of Supplementary Supervision
Relationship to Existing Solo and Consolidated Supervision
Determination of Financial Conglomerates and the Addressees of Supplementary Supervision
Supplementary Supervision
Equivalent Supplemental Supervision for Parent Undertakings Outside the European Union
Equivalent Consolidated Supervision and Supplementary Supervision of Groups Headed by U.S. Entities
Notes

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^{Figure 1.}

Financial Conglomerates

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(b) Horizontal Financial Conglomerate

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Financial Conglomerates Subject to Equivalent, Analogous, or Appropriate Supplementary Supervision

(d) Group Headed by a Non-EU-Regulated Entity

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(e) Group Headed by Mixed Financial Holding Company with Non-EU Head Office

Foresee

^{Table 1.}

Financial Sector Entities

	Banking Sector	Investment Sector	Insurance Sector	Mixed Financial Holding Company
Regulated Entities	Credit institution Asset management company	Investment firm Asset management company	Life insurance undertaking Non-life insurance undertaking Asset management company
Nonregulated Entities	Financial institution (other than an investment firm) Ancillary banking service undertaking	Financial institution (other than an investment firm)	Reinsurance undertaking Insurance holding company	Mixed financial holding company

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Countries

Series

About

Resources

Abstract

The Purpose of Supplementary Supervision

Relationship to Existing Solo and Consolidated Supervision

Determination of Financial Conglomerates and the Addressees of Supplementary Supervision

Sectoral and Cross-Sectoral Supervision

Financial Conglomerates

Definition of Group

Definition of Financial Conglomerate

Discretionary Expansion of Financial Conglomerate

Determination of Financial Conglomerate

Undertakings in a Financial Conglomerate That Are the Addressees of Supplementary Supervision

Supplementary Supervision

Capital Adequacy

Methods for Calculating the Solvency Position

Capital Policies and Supervision

Intra-Group Transactions and Risk Concentration

Intra-Group Transactions

Risk Concentration

Common Provisions

Management Qualifications

Measures to Facilitate Supplementary Supervision

Equivalent Supplemental Supervision for Parent Undertakings Outside the European Union

Equivalent Consolidated Supervision and Supplementary Supervision of Groups Headed by U.S. Entities

Financial Holding Companies

Capital Adequacy

Intra-Group Transactions

Risk Concentration

Consolidated Supervised Entities

Supervised Investment Bank Holding Companies

Notes

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Foresee