Risk-Based Supervision Toolkit: Enhancing Pension Fund Oversight

1. IOPS TOOLKIT RISK-BASED SUPERIVSION INTRODUCTION TO RISK-BASED SUPERVISION Taliya Cikoja – IOPS Secretariat www.iopsweb.org

2. What is Risk-based Supervision? • A structured approach focusing on identifying potential risks faced by pension funds and assessing the financial and operational factors in place to manage and mitigate those risks • Objectives of RBS • Direct limited supervisory resources towards institutions that poses the greatest threat • Supervisory resources and attention will follow identified risks in a forward looking fashion – identifying where problems are likely to occur • Advantages of RBS • Maximises the use of scare supervisory resources • Significant problems will be identified in forward looking and timely fashion and will be remedied effectively • Encourages pension funds to minimise their risk exposures to receive less attention by the supervisory authority • Adaptable to different market situations, pension systems and supervisory philosophies

3. Applying risk-based supervision • Can be applied in many different ways • Quantitative measures of risk vs. qualitative judgement of risk management • Risk-scores for each entity vs. analysis of risks systemic to pension system • Identify weak areas within a supervised entity vs. which institutions amongst thousands may pose the greatest threat • Elements common to all RBS systems • Determine objectives of supervisory authority + greatest risks to these • Assess hazard or adverse events + likelihood of these occurring • Assign scores and / or ranks to firms or activities based on assessments • Link supervisory, inspection and enforcement resources to the risk scores assigned to individual firms or system-wide issues

4. Combine ‘rules’ and ‘risk’ based approach

5. Risk-based supervision for pensions

6. Risk-based Supervision DB vs DC The structure of pension funds presents differing risk perspectives RBS for DB RBS for DC • Capital support from sponsor – soundness of plan sponsor • Solvency and funding key issues • Assessment of asset / liability mismatch • Capital support not an issue - individual members bear risk • Focus on risk-management systems • Member disclosure, investment returns and pension fund costs

7. Why adopt Risk-based supervision? • To improve supervisory effectiveness and efficiency • To address internal organisational concerns • To adapt to changes in the overseen industry • To gain legitimacy following supervisory failure • To meet requirements imposed by legislation • To adapt to the changing nature of financial risks themselves, as these become more complex and - with the growth of DC pension systems - are increasingly transferred to individuals • To provide pension funds with value-added feedback resulting in more effective management of significant risks.

8. Risk-based Supervision Process

9. Challenges to introducing RBS • Combining simplicity with complexity • Knowledge and data • Ensuring that assessments of firms are forward looking • Going beyond the individual firm in assessing risk • Structure and operation of internal risk governance processes • Changing the culture to embed the risk based approach across the whole organization • Managing blame • Making resources follow risks

10. Lessons Learnt • Adaptation of Models - consult widely and adapt carefully/ build flexibility for upgrades, pilot test • Application of Models – know weaknesses / consider ‘tail risk’/ use in conjunction with supervisory judgment • Data Collection – use existing where possible / power to collect additional / plan scope and scale / collect electronically • Reorganisation of the Supervisory Authority – allow plenty of time to adapt • Staff – on-going train for all on philosophy as well as process • Industry– explain new approach and what is expected of them • Powers – make sure supervisory authority has necessary and flexible powers • Risk-based solvency – apply flexibly in volatile conditions / counter-cyclical • Systemic risk– build in macroeconomic and systemic risks into analysis • Think in terms of achievability– target resources for maximum impact • It is worth doing!

11. IOPS Toolkit for Risk-based Supervision