A cura di Alessio Buontempo
Financial conglomerates are generally defined as groups of companies, significantly active in the insurance and banking or investment services sectors, which include at least one insurance company and one operating in the banking or investment services sector, and which have at the head a regulated entity or carry out activities primarily in the financial sector[i]. But the European regulation provides for a specific definition from which it is possible to understand if a group of companies forms a conglomerate, in fact the Directive 2002/87/EC – recently amended by the Directive 2013/36/EU – article 2 titled “definitions” in point 14 states that “financial conglomerate shall mean a group which meets, subject to Article 3, the following conditions”: a regulated entity is at the head of the group or at least one of the subsidiaries in the group is a regulated entity within the meaning of Article 1[ii]; (b) where there is a regulated entity within the meaning of Article 1 at the head of the group, it is either a parent undertaking of an entity in the financial sector, an entity which holds a participation in an entity in the financial sector, or an entity linked with an entity in the financial sector; (c) where there is no regulated entity within the meaning of Article 1 at the head of the group, the group’s activities mainly occur in the financial sector; (d) at least one of the entities in the group is within the insurance sector and at least one is within the banking or investment services sector; (e) the consolidated and/or aggregated activities of the entities in the group within the insurance sector and the consolidated and/or aggregated activities of the entities within the banking and investment services sector are both significant within the meaning of Article 3(2) or (3).
Internationally it is not a new concept, but it has received more attention from the European legislator in the last two decades due to the expansion of this phenomenon[iii], because the limits of the three traditional segments of the financial sector (banking, insurance and financial in the strict sense) have begun to blur, consequently breaking the traditional regulatory frameworks that provide for individual disciplines for each sector[iv], requiring rules created taking into account the particularities of the of a financial conglomerate. Thus, large institutions might use this scheme to obtain competitive advantages on the financial markets, but at the same time without providing consolidated supervision it is impossible to see the full picture of the financial stability of the financial conglomerate, to identify and properly evaluate the possible risks and offer their optimal regulation.
It is on this point that the attention of lawmakers in various countries has been focused, and they have developed more detailed regulations on the supervision of such institutions. While, even today, it is stated in the american literature that conglomerates are “too big to be supervised”[v], actually the European Union has the most developed legal framework for financial conglomerates, the definition of a financial conglomerate, prior to the amendment of Directive 2002/87/EC in 2012, differed by having an exhaustive list of possible financial conglomerate participants. But the changes introduced in the last decade reflect the increased role of the insurance sector and the emergence of new players in the financial market who become participants in financial conglomerates.
2. Supervision: why is it so important?
As mentioned earlier, the main difficulty in supervising a financial conglomerate is that it is managed as a whole. Traditional supervision focuses on the individual sectors making up the conglomerate without necessarily looking at the big picture.
The proper management of financial conglomerates requires the development of adequate internal procedures and accurate information systems for managing and controlling risk. Are now important, the Directive 2011/89/EU amending Directives 98/78/EC, 2002/87/EC, 2006/48/EC and 2009/138/EC with regard to the supplementary supervision of financial entities in a financial conglomerate, and Directive 2013/36/EU on the access to the activity of credit institutions and the prudential supervision of credit institutions and investment firms, amending Directive 2002/87/EC and repealing Directives 2006/48/EC and 2006/49/EC.
In the First Directive, what justifies the provision and introduction of supplementary supervision over and above normal supervision on an individual or group basis is the fact that financial conglomerates are exposed to risks (group risks) that include: contagion risk, where risk spreads from one end of the group to the other; risk concentration, where the same type of risk materializes with temporarily in different parts of the group; the complexity of managing many different legal entities; potential conflicts of interest; and the challenge of allocating supervisory capital to all regulated entities that are part of the financial conglomerate, thus avoiding multiple deployment of capital[vi], based on these premises, stronger supervisory powers are assigned than under previous directives.
The aim of the European regulation is to obtain an uniform regulation in each member State and require that national supervisory authorities of the three financial sectors acquire more information and cooperate with each other, this is also tased in point 6 of the second directive “The smooth operation of the internal market requires not only legal rules but also close and regular cooperation and significantly enhanced convergence of regulatory and supervisory practices between the competent authorities of the Member States”.
It must be considered, however, that the adoption of the first directive on “supplementary supervision” in 2002 was the outcome of a debate that had already been going on for a decade at international level, because the doctrine of supplementary supervision dates back to the 1990s when the activities carried out by financial intermediaries and banks were beginning to be less distinct, and large groups of companies offering different types of financial services were emerging, leading to changes in the financial sector[vii].
So that a joint forum of insurance, bank and securities regulators was set up to analyze several aspects relating conglomerates supervision focussing ultimately on groups whose interests were exclusively or predominantly in at least two financial sectors – banking, securities and insurance – albeit that ‘mixed conglomerates’ – commercially or industrially orientated groups containing at least one regulated financial entity – were also subject to analysis[viii]. The forum endorsed the rationale for sectoral supervision and identified a need for greater coordination between supervisions on a cross-sectoral and corse-jurisdictional basis.
Consequently, the European Commission prepared an appropriate legislative framework that became law with the 2002 directive, also called FICOD (the financial conglomerates directive), which was partly amended in 2011 to adapt it to the problems caused by the financial crisis. Thus, supplementary supervision pursuant to FICOD is intended to overcome potential supervisory blind spots that may otherwise exist in the event reliance were placed solely on sectoral supervisory frameworks; but the market is currently evolving as a result of technological progress, and this does not exclude the possibility that new legislation will be needed in the next few years or even sooner.
3. Financial conglomerates as financial market players: capital adequacy requirements
Corporate groups that form a financial conglomerate normally have large capital and thus greater strength on the financial markets. The literature has repeatedly questioned what role such groups actually play, whether it is a virtuous role or one that destroys economic value[ix]. Risk-taking and its consequences depend on regulation, which may incentivize or disincentivize risk-taking by financial conglomerates, particularly rules on capital, when capital requirements are set optimally, capital arbitrage within holding company conglomerates can raise welfare by increasing market discipline[x]. Thus, the aim is to understand the impact of regulation on the economic activity carried out by these groups.
In this context, rules providing stronger prudential supervisory regimes are a key mechanism in order to ensure the proper conduct of business. Also according to what can be inferred from the Directive 2013/36/EU, supervision on a consolidated basis of companies is aimed at protecting the interests of depositors and investors of institutions and ensuring the stability of the financial system, thus the main interest of protecting not generally the financial system but first and foremost those who come into contact with individual market players. Therefore, supervision on a consolidated basis, to be effective, should apply to all banking groups, including those groups whose parent companies are not credit institutions or investment firms. There is a need for member states, based on the provisions of European directives, to provide the competent authorities with the necessary legal instruments for the exercise of such supervision. In fact the financial crisis demonstrated links between the banking sector and so-called ‘shadow banking’. Some shadow banking usefully keeps risks separate from the banking sector and hence avoids potential negative effects on taxpayers and systemic impact. Nevertheless, a fuller understanding of shadow banking operations and their links to financial sector entities, and tighter regulation to provide transparency, a reduction of systemic risk and the elimination of any improper practices are necessary for the stability of the financial system.
These actions would be ineffective if Member States do not ensure that credit institutions and investment firms have internal capital that is adequate in terms of quantity, quality and allocation in view of the risks to which they are or may be exposed. Accordingly, Member States should ensure that credit institutions and investment firms have strategies and processes in place that enable them to assess and maintain the adequacy of their internal capital. The rules on the capital adequacy of financial conglomerates are contained in Article 6 of Directive 2002/87/EC, which were amended and specified by EU Delegated Regulation No. 342/2014. Relevant is Article 6(2) of the aforementioned directive, which states that “The Member States shall require regulated entities in a financial conglomerate to ensure that own funds are available at the level of the financial conglomerate which are always at least equal to the capital adequacy requirements as calculated in accordance with Annex I”[xi], then requires member States to “require regulated entities to have in place adequate capital adequacy policies at the level of the financial conglomerate”.
It is clear that the directive and its amendments only provide rules on the calculation of capital adequacy of financial conglomerates, and then refer to other specific rules contained in other directives and regulations for specific capital requirements, which are normally set for individual types of entities; for example Directive 2019/2034/EU on the prudential supervision of investment firms in Article 9 on initial capital requires that the initial capital of an investment firm shall be EUR 750.000.
It would be difficult to include in a single legislative text all the capital requirements for each type of company, thus necessitating a continuous reference to other texts. But in spite of the stratification of rules, the European legislator has found the provisions on financial conglomerates to have had a positive impact and yielded excellent results.
[i] It is a general definition also used by the Bank of Italy website.
[ii] Article 1 states “This Directive lays down rules for supplementary supervision of regulated entities which have obtained an authorisation pursuant to Article 6 of Directive 73/239/EEC, Article 6 of Directive 79/267/EEC, Article 3(1) of Directive 93/22/EEC or Article 4 of Directive 2000/12/EC, and which are part of a financial conglomerate. It also amends the relevant sectoral rules which apply to entities regulated by the Directives referred to above”.
[iii] Rysin, Galenko, Duchynska, Kara, Voitenko, Shalapak , “Financial Convergence as a Mechanism for Modifying Sectors of the Global Financial Services Market”, Universal Journal of Accounting and Finance, 2021, p. 23, “the processes of financial convergence and the formation of new institutional forms of financial associations (financial conglomerates) in the world economy already have a significant impact on the real and financial sectors, public finance and other spheres of the economy”.
[iv] See, Kuznetsova, Pisarenko, Lobanova, “Financial conglomerate identification by financial markets regulators: case of developed and emerging market economies”,10th International Scientific Conference “Business and Management 2018”, “the modern global trend in development financial services industry is characterized by the growing convergence and blurring of the dividing lines be- tween financial sectors. The largest banks and non-bank institutional investors such as: insurance undertakings, investment corporations and pension funds has begun to form financial conglomerates. They work globally and gain an enormous market power compared to a state power”.
[v] In this way see, Menand, “Too Big to Supervise: The Rise of Financial Conglomerates and the Decline of Discretionary Oversight in Banking,” Cornell Law Review, 2018, p. 1527.
[vi] Thus the point 1 of the Directive.
[vii] Thom “The Prudential Supervision of Financial Conglomerates in the European Union”, North American Actuarial Journal, 2002, p.120, “around the world, the formation of financial conglomerates is gaining importance. In the United States, the provisional agreement between Congress and President Clinton’s administration to break down the barriers between banking, insurance, and securities firms by repealing the Glass- Steagall Act is no less than revolutionary. Meanwhile, in the European Union (EU), where the establishment of financial groups working in all three sectors has long been permitted, the Financial Services Action Plan (COM 1999), as endorsed by European Heads of State at the Koln Council, identifies the further development of prudential rules for financial conglomerates as a top priority for EU financial services legislation in the coming years”.
[viii] See, Noble, “The Next Generation of Financial Conglomerates: BigTech and Beyond”, Butterworths Journal of International Banking and Financial Law, 2020, p. 2.
[ix] See, Schmid, Walter, “Do financial conglomerates create or destroy economic value?”, Journal of financial Intermediation, 2009.
[x] Freixas, Lóránth, Morrison, “Regulating financial conglomerates”, Journal of Finance Itermediation, 2007.
[xi] Which provides in paragraph 1 that “Whichever method is used, when the entity is a subsidiary undertaking and has a solvency deficit, or, in the case of a non-regulated financial sector entity, a notional solvency deficit, the total solvency deficit of the subsidiary has to be taken into account. Where in this case, in the opinion of the coordinator, the responsibility of the parent undertaking owning a share of the capital is limited strictly and unambiguously to that share of the capital, the coordinator may give permission for the solvency deficit of the subsidiary undertaking to be taken into account on a proportional basis.
Where there are no capital ties between entities in a financial conglomerate, the coordinator, after consultation with the other relevant competent authorities, shall determine which proportional share will have to be taken into account, bearing in mind the liability to which the existing relationship gives rise”.