Back Matter

Annex—Observance of Financial Supervision Standards and Codes—Summary Assessments

This Annex contains the summary assessments of standards and codes in the financial sector. The assessment has helped to identify the extent to which the supervisory and regulatory framework is adequate to address the potential risks and vulnerabilities in the financial system.

The following detailed assessments were undertaken:

  1. Basel Core Principles for Effective Banking Supervision—by Mr. Kruschel (BaFin, banking supervision expert), and Mr. Bell (banking supervision expert).

  2. The IAIS Insurance Core Principles—by Ms. Chang (insurance supervision expert).

Guernsey’s compliance with the international supervisory standards is generally high, and the vast majority of the issues raised in the 2003 assessment have been addressed.

A. Basel Core Principles for Effective Banking Supervision

80. The assessment of the implementation of the BCPs was undertaken as part of an IMF FSAP Update for Guernsey in 2010, and in particular was prepared during an IMF mission that visited Guernsey during March 2010. It updates an earlier BCP assessment performed in the context of the 2002/2003 IMF OFC assessment of Guernsey. The assessors were Peter Kruschel (BaFin) and Keith Bell (banking supervision consultant).

Main findings

81. The BCP assessment confirms the high standard of prudential regulation and supervision described in the 2003 assessment, and found that the issues identified at that time have largely been addressed. The GFSC now conducts a program of on-site supervision, supported by off-site analysis. The on-site program lays particular emphasis on inspection of licensees’ risk management procedures for AML/CFT and credit, although other “themes” are also addressed. On-site supervision visits are followed up with recommendations, where judged necessary, with close tracking of corrective action required. A framework of minimum prudential standards is provided by the Financial Services Commission (Bailiwick of Guernsey) Law 1987 (FSC(G) L, as amended, the Banking Supervision (Bailiwick of Guernsey) Law 1994, as amended, the Banking Supervision (Bailiwick of Guernsey) Regulations 1994, the Codes of Practice for Banks and applicable Guidelines and Guidance Notes issued by the GFSC.

82. The GFSC—as the integrated regulator—has as its main responsibility, the supervision of financial services provided on the island. The GFSC is also responsible for (a) reducing the level of risks to the public due to financial unsoundness or mismanagement in a financial institution; (b) protecting and enhancing the island’s reputation; (c) pursuing activities and policies that promote the best economic interests of Guernsey; and (d) recognizing the need to counter financial crime.

83. The GFSC enjoys considerable independence, and is subject to suitable accountability provisions. The FSC(G) L, was amended in 2009 to remove “development of the financial services industry” as a function of the GFSC and to clarify the circumstances in which the PC may give instruction to the GFSC (i.e., in general terms and not in specific cases, without any instruction being made public). The GFSC’s chairman is appointed for a one-year term, an anachronism that appears to date from its initial establishment, when the chairman was a political appointee.

84. The GFSC is broadly adequately resourced. It is funded by fees on the industry, which it adjusts periodically to keep them in line with marginal costs plus a markup for fixed costs. The GFSC currently has over 100 staff. Close monitoring of salaries in the supervised sectors has enabled the GFSC to retain good staff. Representatives from the private sector generally felt that the GFSC carries out its duties with rigor and expertise; it consults with the industry but is viewed as not beholden to it.

85. As the banking supervisor, the GFSC has an array of disciplinary powers to address safety and soundness issues; there is evidence that it uses them when needed. The GFSC can request information, issue directions, impose license conditions, appoint inspectors, revoke licenses, or even request that a court place a bank in administration. Fines cannot yet be imposed for administrative matters, such as late submissions of supervisory returns, but the necessary enabling powers are available in the law.

86. In the recent past the authorities have faced major difficulties in two banks as the result of problems elsewhere being quickly transmitted to Guernsey, ultimately leading to their failure. Subsequent reviews of the GFSC’s performance under stress have been favorable.

87. The GFSC cooperates with the home supervisors of institutions active on the island. Numerous MOUs with supervisors abroad have been signed to address both on-going supervision and information exchange. Information is in fact exchanged, and regular visits to and from the home supervisors are undertaken, including for the purpose of on-site supervision. However, as experience in the recent past has shown, the asymmetry in the relationship between the GFSC and certain home regulators severely limits the benefit that the GFSC can draw from cooperation with them.

88. Several broad areas for further action have been identified. Primarily, these require primary or secondary legislative changes and the latter’s consequent practical application. In these regards:

  • (i) CP 4 “Transfer of significant ownership” requires that the GFSC be given power to review and, if necessary, rescind transfers of significant shareholdings in licensed banks.

  • (ii) A similar power for the GFSC is required by CP 5 “Major acquisitions.”

  • (iii) For CP 9, the GFSC should have the explicit power to require that a bank increase its level of provisioning and, if necessary, its overall financial strength.

  • (iv) Given the related party lending which characterizes the business model favored by several major participants in the Guernsey banking industry, large exposure limits (CP 10) should be applied on a consolidated basis and all transactions with banks’ related parties should receive prior board approval and be on market terms (CP 11).

  • (v) Supervisory reporting (CP 21) to the GFSC would benefit from imposition of a requirement for senior level certification and capacity for the GFSC to impose administrative penalties for tardy reporting.

  • (vi) The GFSC should consider amending its governing statute to increase the term of office of its chairman from the current one year period to a term consistent with international practice (CP 1.2).

The Banking Supervision (Bailiwick of Guernsey) Regulations 2010, which came into operation on April 30, 2010 (i.e., following the conclusion of the mission’s on-site work) together with contemplated amendments to the GFSC’s Codes of Practice, have been designed to address the areas identified in (i) through (v) above.

Table 8.

Summary of Compliance with the Basel Core Principles—Detailed Assessments

article image

Recommended action plan

Table 9.

Recommended Action Plan to Improve Compliance with the Basel Core Principles

article image

Authorities’ response to the assessment

article image

B. Assessment of Observance of the Insurance Core Principles

89. This assessment benchmarks Guernsey’s regulatory regime against the ICPs issued by the IAIS in October 2003. It also took into account relevant IAIS standards and guidance in addition to the ICPs. The assessment was conducted from March 1-10, 2010 under the Fund’s FSAP.27 Guernsey’s insurance regulatory regime was previously assessed in 2002. The assessment covers all regulated entities licensed by the GFSC, including captive insurers and insurance intermediaries. The regime applicable to captive insurers is benchmarked against the IAIS Guidance Paper on the Regulation and Supervision of Captive Insurers.

Main findings

90. Guernsey’s status as the largest international insurance center in Europe hinges on its progressive infrastructure and operational flexibility. The insurance industry in Guernsey consists of two distinct sectors: domestic and international. The small domestic sector caters the insurance needs of Guernsey residents and has been consolidating. The international sector represents more than 90 percent of the market and is dominated by captive insurers, who represent 60 percent of the sector. Guernsey continues to attract U.K. reinsurers, with about 50 percent of international business originating from the UK. The captive market is sensitive to tax changes. Given the maturity of the captive market, continued growth is expected to come from reinsurance and other specialized insurance lines.

91. The insurance industry is more exposed to external risks than local conditions. The domestic and international sectors have different risk profiles. Domestic insurers are exposed to weather risks in Guernsey. The captive and international life insurers are susceptible to external market developments, e.g., global economic downturn, industry-specific events affecting the parents of captives, or changes in legislative and political climates in the insurers’ home markets. Although insurers generally adopt prudent investment strategies, their performances were affected by the global financial crisis.

92. Guernsey updates its regulatory regime continually and has implemented all the recommendations arising from the 2003 OFC assessment. The GFSC adopts a risk-based and proportionate approach in supervising its large population of insurers, which promotes efficient allocation of regulatory resources. The GFSC gives licenses to captive insurers individually and adopts consistent prudential regulation for both captive and commercial insurers. On-going supervision of captives is exercised through insurance managers. The GFSC has adequate powers and well-documented policies, procedures, and customized checklists to ensure consistency in supervisory decisions. The introduction of the OSCA by insurers has been well received by the industry. The regulatory frameworks for corporate governance, risk management, and AML/CFT are comprehensive and robust.

93. The GFSC responded proactively to the global financial crisis. The GFSC worked with the relevant insurance managers to resolve issues that arose from the crisis and assessed the financial condition of the parent companies of some captives. The relevant insurers affected by the crisis were closely monitored. The GFSC also required insurers who relied on loans to parent companies to meet solvency requirements to reapply for such loans to qualify as approved assets and GFSC imposed restrictions in some cases. As at March 3, 2010, insurers’ loans to parents totaled £5.8 billion of which £5.2 billion was approved for solvency purposes, representing 33 percent of net assets.28

94. The GFSC is mindful of the implications of global market and regulatory developments for Guernsey as an international financial centre.29 The GFSC is committed to following international standards in enhancing its risk-based solvency regime. The GFSC is currently assessing the impact on the Guernsey insurance sector in the event that Guernsey decides to implement a risk-based solvency regime. An independent review of the implications of Guernsey seeking recognition of Solvency II equivalence has been commissioned by the CED. The GFSC is fully involved in that review and is working with the CED on investigating the implications of Solvency II.

95. While the updated regulatory framework has a high level of observance with the ICPs, there is scope for enhancements. Given the dominance of the international sector, the GFSC has a keen interest in establishing effective cooperation arrangements with relevant home/host supervisors in respect of recognized insurers without a physical presence, and to protect foreign policyholders of international life insurers. The GFSC should also consider expanding its range of enforcement powers and how best to implement the public disclosure standards established by the IAIS. The mission advised the GFSC to continually assess the practical implementation of OSCA, including establishing criteria on the use of internal models.

Table 10.

Guernsey: Summary of Compliance with the Insurance Core Principles

article image
article image
article image

Recommended Action Plan and Authorities’ Response to the Assessment

Table 11.

Guernsey: Recommended Action Plan to Improve Observance of Insurance Core Principles

article image

Authorities’ response to the assessment

article image
1

Guernsey is one of the three British Crown Dependencies, the others being Jersey and the Isle of Man (IOM).

2

The Bailiwick of Guernsey (“Guernsey” for the purposes of this report) comprises the island of Guernsey itself and six other islands. However, financial services are concentrated in the island of Guernsey. FSAP Update reports for the IOM and Jersey were published in September 2009.

3

Defined by the IAIS as “an insurance or reinsurance entity created and owned, directly or indirectly, by one or more industrial, commercial or financial entities, the purpose of which is to provide insurance or reinsurance cover for risks of the entity or entities to which it belongs, or for entities connected to those entities and only a small part if any of its risk exposure is related to providing insurance or reinsurance to other parties.”

4

One alternative discussed at the time of the mission was a uniform 10 percent rate.

5

From, for example, Bahrain, Bermuda, Canada, Switzerland, and the United States.

6

A PCC is a single legal entity divided into an unlimited number of cells whose assets and liabilities are legally segregated from each other and from the general assets of the “core” cell.

7

An ICC is a legal structure where each of the cells is a separate company in its own right with limited liabilities. It is unlike the PCC structure, where the cells are not separate companies.

8

In many jurisdictions, mandatory insurance such as motor third party liability and workers compensation can be underwritten only by insurers licensed in that jurisdiction. To insure such risks with a related captive that is not located/licensed in that jurisdiction, a parent company will arrange with a licensed insurer to accept the risks with a back-to-back “reinsurance” to a related captive, termed “fronting.”

9

Solvency II, the “Basel II for insurers,” is the revised regulatory requirements for insurance firms that operate in the EU, coming into effect by end-2012. Solvency II is based on a risk-based measurement of capital requirements.

10

101 open-ended and 40 closed-ended investment funds are established as PCCs and another 9 open-ended and 4 closed-ended investment funds as ICCs.

11

While the risk of contagion is high for the Guernsey financial system, the reverse risk for the financial systems of the home countries is limited, resulting from the relative size of the Guernsey financial system, which is less than 2 percent of the UK bank system.

12

To do so, the GFSC should improve its database in order to monitor exposure to borrower units on a timely basis (both the volume and default probability of the large exposures).

13

Two banks with significant capital bases had already addressed the issue some years ago and have denominated their capital in US Dollars.

14

This finding is based on feedback from the industry and was raised by various firms in all financial sectors.

15

Capital divided by the minimum solvency margin.

16

It is worth mentioning that the average is distorted by a limited number of insurers with very high levels of solvency according to statutory rules.

17

Test A3 is probably the most conservative test among all of the tests, which has been taken into account when assessing the overall impact of the tests (and has lead to classifying asset price risk among the ‘relatively limited’ risks).

18

The exercise included deposits available within a month.

19

This analysis was not done during the time of the mission as the final rules were not yet decided on. The FSIs (Table 5) suggest that Guernsey banks do not face major challenges with respect to the Basel III liquidity ratios.

20

This compares with GBP 1.2 billion in deposits covered by the scheme—i.e., amounts under GBP 50,000.

21

Separate laws govern the regulation of each sector—banking, insurance, investments, and fiduciary services.

22

These figures are skewed by two large captive insurers. If the loans by these two captives are excluded, loans to parents amounting to £1.1 billion of which £392 million (or 2.2 percent of net assets) was approved for solvency purpose.

23

In particular, the EU Solvency II Directive may have an impact on some captive reinsurers, such as those who use EU fronting insurers. This is because reinsurance cessions to reinsurers subject to a solvency regime that is not Solvency II equivalent may not be fully admissible for the purpose of solvency requirements applied to the ceding insurers.

24

See Appendix I for a more detailed account of responses to the 2003 recommendations.

25

This discussion also addresses the question whether the system should be pre-funded. At present, the system is not funded, but has government guaranteed liquidity back-up.

26

A separate Fund mission was conducted in May 2010 to assess Guernsey’s compliance with the FATF AML/CFT standard. A detailed assessment report is nearing completion, following which an AML/CFT ROSC will be circulated to the Executive Board for information.

27

This assessment was performed by Ms. Su Hoong Chang, Insurance Supervision Advisor, engaged by the IMF.

28

These figures are skewed by two large captive insurers. If the loans by these two captives are excluded, loans to parents amounting to £1.1 billion of which £392 million (or 2.2 percent of net assets) was approved for solvency purpose.

29

In particular, the EU Solvency II Directive may have an impact on some captive reinsurers, such as those who use EU fronting insurers. This is because reinsurance cessions to reinsurers subject to a solvency regime that is not Solvency II equivalent may not be fully admissible for the purpose of solvency requirements applied to the ceding insurers.

30

Technical Performance and Risks for Nonlife Insurers and Reinsurers, Technical Risks and Performance for Life Insurers and Investment Risks and Performance for Insurers and Reinsurers.