Module 5: Risk frameworks (mandatory) Flashcards
5 Stakeholders with roles involving supervision and control of companies
- professional bodies
- professional regulators
- industry bodies
- industry regulators
- governments
Functional regulation
Regulation with different supervisory bodies regulating different activities.
(eg separate regulators for banks, insurance companies, charities, etc.)
United regulation
Regulation with a single supervisory body regulating all activities.
3 Pillars of the Basel Accord
- minimum capital requirements for
- credit,
- market and
- operational risk - supervisory review of
- internal systems,
- processes and
- risk limits - adequate disclosure facilitating market discipline via pricing of capital
What do the 3 Basel accords comprise?
- Basel I - minimum capital requirements for credit (and later market) risk
- Basel II - superseded Basel I
- Basel III - established in response to the global financial crisis - focuses on liquidity, counterparty and systemic risk - works alongside Basel II.
Solvency II
Solvency II is the mandatory risk framework for insurance companies operating in EU member states.
It is modelled on Basel II, and comprises 3 pillars:
- quantitative requirements
- qualitative requirements
- disclosure
Solvency II:
2 Quantitative requirements
- A solvency capital requirement (SCR)
- A minimum capital requirement (MCR)
Solvency II:
Qualitative requirement
Under Pillar 2, insurance companies must carry out an Own Risk and Solvency Assessment (ORSA), which assesses the adequacy of risk management and likely future solvency.
Sarbanes-Oxley
The Sarbanes-Oxley Act of 2002 (SOX) is primary legislation in the US designed to protect shareholders.
It comprises reforms in relation to:
- disclosure
- the role of the external auditor
- corporate governance
COSO
The Committee of Sponsoring Organisations of the Treadway Commission.
COSO ERM Integrated Framework
Their published framework is advisory (rather than mandatory), but many companies use the framework to demonstrate that they have adequate internal controls for SOX purposes.
A key component of the framework is the “COSO cube” which considers the:
- ERM components / processes,
- in each business area covered by the framework,
- and at each business level of application.
5 Processes that can form part of a system of prudential supervision
Prudential supervision involves:
- Oversight
- Licensing
- A requirement to maintain minimum standards (eg operational)
- Procedures for monitoring compliance with standards and licences
- Processes to take action against those who fail to comply
Why might different parts of a business be subject to different regulatory regimes and capital adequacy requirements?
This can arise for a number of reasons, including:
- for international business, having operations that are regulated by DIFFERENT TERRITORIES
- having subsidiaries that operate in DIFFERENT INDUSTRY SECTORS, eg financial and manufacturing
- having subsidiaries that operate in DIFFERENT AREAS WITHIN THE SAME SECTOR, eg banking and insurance
- having subsidiaries or portfolios within the same sector that are subject to DIFFERENT REGULATORY REQUIREMENTS, eg traditional insurer and captive insurer
- having subsidiaries which are new ventures or acquisitions and are at DIFFERENT LIFECYCLE STAGES
4 Categories of supervisors (other than governments) and name a specific example of each
In addition to governments, supervision and control may be exercised by:
- Professional bodies
- — e.g. IFoA - Professional regulators
- — e.g. Chartered Financial Analyst Institute or the Financial Reporting Council - Industry bodies
- — such as the British Bankers’ Association (BBA), British Sandwich Association and the Association of British Insurers (ABI) - Industry regulators
- — such as the PRA, FCA and LSE
Outline the specific role of:
Professional bodies
Professional bodies ensure:
- members are ADEQUATELY TRAINED, usually through a process of examination
- members MAINTAIN THEIR COMPETENCE, through continuing professional development (CPD)
Some professional bodies also have the power to discipline members who fail to maintain appropriate standards.
Outline the specific role of:
Professional regulators
Where a profession has statutory responsibilities, for example, in the accounting and auditing professions, it is more likely to be subject to external regulation.
Professional regulators MAINTAIN PUBLIC CONFIDENCE in the profession by:
- setting standards
- monitoring adherence to the standards
- disciplining in cases of non-adherence
Outline the specific role of:
Industry Bodies
The main purpose of industry bodies is to PROMOTE THE INTEREST OF THEIR MEMBERS, through lobbying and other activities, such as shared research projects.
Outline the specific role of:
Industry Regulators / Supervisors
Regulators act on behalf of government to PROTECT THE PUBLIC by controlling the activities of firms and individuals operating in a particular industry.
The main aim of regulation (or supervision) is to prevent problems from occurring, rather than punishing those who are responsible for problems.
6 Advantages (claimed) of a unified system
- it is easier to regulate financial CONGLOMERATES
- it ensures a CONSISTENT APPROACH across various financial services activities
- limits any incentive for REGULATORY ARBITRAGE (firms picking and choosing the most favourable regulatory environment)
- ECONOMIES OF SCALE
- better SHARING OF IDEAS between regulatory staff
- improved ACCOUNTABILITY (less chance of buck-passing between regulators)
List the aspects considered by a supervisor when developing their understanding of an insurer
In addition to the nature of the business, regulators typically seek to understand an organisation’s:
- governance arrangements
- business plans
- financial (condition) reports
- risk management strategies and processes
Outline the reasons an insurer should engage proactively with their supervisors
A practical argument would be that the insurer-regulator relationship should be a key component of an insurer’s ERM framework.
Proactive engagement helps to reduce the level of risk a supervisor places on a particular insurer and therefore reduces the supervisory burden on that insurer.
Regulators see a wide range of risk management practices in operation and are well placed to advice on what is best practice. Proactive engagement provides greater opportunity to benefit from such advice.
Risk-Based Regulation
Although regulators monitor all institutions, they focus their attention on those institutions that, in their opinion, represent the greatest risk.
FCA
The Financial Conduct Authority (FCA) regulates the financial services industry in the UK.
Their aim is to
- protect consumers,
- ensure the industry remains stable and
- promote healthy competition between financial services providers.
PRA
The Prudential Regulation Authority (PRA) is a part of the Bank of England and is responsible for the prudential regulation and supervision of
- banks,
- building societies,
- credit unions,
- insurers and
- major investment firms.
It sets standards and supervises financial institutions at the level of the individual firm.