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P a g e | 1 Inter n atio na l A s s oci a t ion of R isk a nd Co mpl i a n c e Pr o f e s s io na l s ( I A RCP) 12 0 0 G St re e t N W Su i t e 8 0 0 W a s h i ng t o n, D C 2 000 5 - 67 0 5 U SA T e l : 2 0 2 - 44 9 - 9750 www .ri s k - c ompl i ance-a ss o c i a tion . c om.

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  1. P age |1 InternationalAssociationofRiskandComplianceProfessionals(IARCP) 1200GStreet NWSuite800Washington,DC20005-6705USATel:202-449-9750www.risk-compliance-association.com Top10riskandcompliancemanagementrelatednewsstoriesandworldeventsthat(forbetterorforworse)shapedthe week'sagenda,andwhatisnext DearMember, WhatistheUSDLCR? WelcometotheBaseliiiimplementationinSingaporeandthenewnationaldiscretions. WhiletheLiquidityCoverageRatio(LCR)requirementsarecalculatedonaconsolidatedbasisandreportedinacommoncurrency,theBaselliquiditystandardalsoexpectsbanks andtheirsupervisorstocloselymonitorLCRbysignificantcurrency. Singaporeisaregionaltreasurycentreformanybanksandtheirliabilitiesherearediversifiedintermsofcurrencies. U.S.Dollar(“USD”)isthedominantforeigncurrencyformostfinancialinstitutionsinSingaporeandone-thirdofthesefinancialinstitutionsalsohave3ormoreothersignificantcurrencies. Assuch,thereisaneedtoimposeLCRbysignificantcurrencies,ontop oftheconsolidatedcurrencyLCRrequirement,to ensurethatfinancialinstitutionshavesufficientliquidassetsintheforeigncurrenciesandarenotoverly-reliantontheFXswapmarketstomeettheirforeigncurrencyliquidityneedsduringaliquiditystresssituation,ashighlightedbythereducedFXswapmarketliquidityduringthelastfinancialcrisis. TheMonetaryAuthorityinSingaporeproposestoimposeaUSDLCRrequirementonallfinancialinstitutionsin Singaporegiventhatitis thenextmostsignificantcurrencyinthebanking industrybesidesSGD. InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  2. P age |2 TheproposedLCRrequirementforUSDin Singaporewillbesetat80%,allowingfinancialinstitutionstorelyonexternalsourcessuchastheFXswapmarket tosomeextent. ReadmoreatNumber10below. Iloverisk management.Therearesouniqueriskstoquantify. Oneofmybestislongevityrisk… therisk tolivelongerthananticipated(byactuaries). Ok,we canmakeitmorescientific. Longevityrisk istheriskofpayingoutonpensionsandannuitieslongerthananticipated. IlovetheAmericandefinition–“forindividuals,longevityriskistherisk ofoutlivingones’assets,resulting in alowerstandardofliving,reducedcare,orareturn to employment.”(NationalAssociationofInsuranceCommissioners) Itisanimportantrisk.Theageingpopulationphenomenonbeingobservedinmanycountriesposesserioussocialpolicy challenges. ReadmoreatNumber3below. Also… “Thosebentonperpetratingandperpetuatingorganizedcrimeoftenusethelegitimateinstitutionsandfacilitiesestablishedandrecognizedunderlaw to disguisetheirtransactionsandgivethemasemblanceoflegitimacy. In manyinstancestheresultsofsuchtransactions,wheretheyaresuccessful,areemployedtofurtherothercriminalactivities. Thenatureoforganizedcrimeissuchthatitpermeatesnationalbordersandassumesaninternationalcharacter. Thismakesitdifficultforanycountryonitsowntoefficientlyandeffectivelyinvestigateandprosecuteactsofcriminalitywithouttheaidof InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  3. P age |3 othercountriesinwhichorthroughwhichthe actofcriminalconductextends. Thustheefficientandeffectivecombatingoforganizedcrimecallsforacollaborativeeffortandcooperationbetweencountriesandataninternationallevel. Suchco-operationmustberobustandmulti-facetedinordertosignificantlythwartcriminalsfromdesigningandexecutingtheircriminal intents. Thisco-operativeapproachrecognizesthemutualityof interestinmaintaininglawandorder insocietyaswellasensuringthelegitimateuseoffinancialandotherinstitutionstoprotectthesecurityandfinancialstabilityofourcommunities. Theworld’seconomiesareinmanywaysintertwinedandthedisruption ofoneoftenhasnegativeconsequencesforothers,albeit to varyingdegrees. Itthereforebecomesincumbentoneveryjurisdiction– largeandsmall– toputinplacedomesticmeasuresandmechanismsgearedtowardsfightingorganizedcrimeandabovealltocreateaneffectiveregimeofassistanceandco-operation to aidlawenforcementinstitutionsoragenciesofothercountriesinthisfight. Suchmeasuresandmechanisms,coupledwithaneffectiveimplementationprocess,actasabufferindenyingcriminalsasafehavenwithinwhichtoengagein criminalactivities. Organisedcrimeisfar-reachingandextendstothemarketregulationandtaxadministrationsectors;therearealsoindividualsandbusinessentitieswhichexploitforill-gainthelegitimatebusinessmechanismsdesignedtofacilitatecommerceandtrade. Themanipulationofthesecuritiesmarket,insiderdealing,abuseofcorporatevehicles,evadinglegitimatetaxesusuallybyemployingunlawfulmeans,anddisguisingthetruenatureofinvestmentbusiness tothedetrimentofinvestorsareallformsofillegalactivitywhich,if not InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  4. P age |4 checked,canbringaboutfinancialinstabilityanddisrupt otherwiseorderlyeconomies. Theseareasthereforewarranttheapplicationofthebenefitsassociatedwithestablishedregimesofinternationalco-operation,bothnationallyandinternationally. Anothersignificantareaofinternationalco-operationrelatestoextradition. Extraditionservesasaneffectivemediumofdenyingcriminalsasafesanctuary;theymayfleefromthejurisdictionwheretheyperpetratetheircrimes,buttheyarenotbeyondthereachoflawenforcementand prosecution. Whilegenerally theextraditionofcriminalsisfoundedonbilateralagreementsandarrangements,theincreasingtrendinmultilateraltreatiesisthatwherenationallawsdonotprovideforalegislativemechanismfortheextraditionof criminals,therelevanttreatymaybeusedasthebasisforeffectingextradition.” Whosaidthat?Canyouguess?No,youcannot! Locatedinthenorth-eastern CaribbeanSea,agroupofsome32islands,188rocksand20cays situated60mileseastofPuertoRicoandatthe topoftheLeewardIslandschain. TheBritishVirginIslands! InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  5. P age |5 ReadmoreatNumber9below. Welcome totheTop10list. BestRegards, GeorgeLekatisPresidentoftheIARCP GeneralManager,ComplianceLLC 1200GStreetNWSuite800,WashingtonDC20005,USATel:(202)449-9750 Email:lekatis@risk-compliance-association.comWeb:www.risk-compliance-association.com HQ:1220N.MarketStreetSuite804, WilmingtonDE19801,USATel:(302)342-8828 InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  6. P age |6 JointForum Mortgageinsurance:marketstructure,underwritingcycleandpolicyimplications Theeventsofthelastfewyears,particularlythoseintheglobalfinancialcrisisthatbeganin2007, indicatethatmortgageinsurance(MI)is subjecttosignificantstressintheworsttailevents. Thisreportexamines theinteractionofmortgageinsurerswithmortgageoriginatorsandunderwriters,andmakesasetofrecommendationsdirectedatpolicymakersandsupervisorswhichaimatreducingthelikelihoodofMIstressandfailureinsuchtailevents. FMALiechtenstein FactsandfiguresonthefinancialintermediariessupervisedbytheFMA2013edition Interestingparts Asanintegratedsupervisoryauthority,theFMALiechtensteinsupervisesbanksandinsurancesaswellas otherparticipantsintheLiechtensteinfinancialmarketsuchasassetmanagers,funds,professionaltrustees,andauditors. InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  7. P age |7 Longevityrisktransfermarkets:marketstructure,growthdriversandimpediments,andpotentialrisks-consultativereport,August2013 Theageingpopulationphenomenonbeingobservedinmanycountriesposesserioussocialpolicychallenges. Longevityrisk-theriskofpayingoutonpensionsandannuitieslongerthananticipated- issignificantwhenmeasuredfromafinancialperspective. Longevityrisk transfermarkets:marketstructure,growthdriversandimpediments,andpotentialrisksisaforward-lookingreportreleasedby theJointForumonlongevityrisktransfer(LRT)markets. EuropeanCommissionRecognises DFSA’sAuditOversightSystem TheEuropeanCommission(Commission)announceditsdecision,recently,togranttheDubaiFinancialServicesAuthority’s(DFSA’s)audit monitoringsystem‘equivalentstatus’withEuropeanUnion(EU)memberstates. Followinganassessmentofthesupervisoryregimeforauditorsin theDubaiInternationalFinancialcentre(DIFC),theCommissionconsideredtheDFSA’sauditoversightsystemequivalentwiththatofEUmemberstates. Onthebasisofthisdecision, individualEUauditregulatorsmayenter co-operativeagreementswiththeDFSAwiththeviewtorelyingon eachother’sworkonthesupervisionofauditorsandauditfirms. InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  8. P age |8 HedgeFundCorporateGovernanceInterestingparts InformationsharingforresolutionpurposesConsultativeDocument Theabilitytoexchangeinformationbetweenallrelevantauthoritiesthathavearolein resolution,subject to appropriatesafeguardstoprotecttheconfidentialityofnon-publicinformation,isfundamentaltocoordinatedandeffectiveplanning,preparationandimplementationofresolution. PointofSaledisclosureintheinsurance,bankingandsecuritiessectors-consultativereport August2013 PointofSaledisclosureintheinsurance,bankingandsecuritiessectorsidentifiesandassessesdifferencesandgapsinregulatoryapproachestopointofsale(POS)disclosureforinvestmentandsavingsproductsacrosstheinsurance,bankingandsecuritiessectors. InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  9. P age |9 TheimpactofpaymentssystemandprudentialreformsontheReserveBankofAustralia’sprovisionofliquidity AddressbyMrGuyDebelle,AssistantGovernor (FinancialMarkets)oftheReserveBankofAustralia,totheAustralianFinancialMarketsAssociation(AFMA)andReserveBankofAustralia(RBA)Briefing,Sydney. “Today,IwishtotalkaboutseveralimportantchangesthatwillbemadetotheframeworkunderwhichtheReserveBankoperatesindomesticfinancialmarkets. Thesechangeswillbeintroducedatdifferentpointsduringthenext18monthsandwillhavesignificantimplicationsforthesizeoftheReserveBank’sbalancesheetandthewayinwhichtheBankprovidesliquiditytofinancialinstitutions.” INTERNATIONALCOOPERATIONANDINFORMATIONEXCHANGE “Itisgloballyrecognizedthatcrossbordercooperationandcoordination ofeffortsarethemostviabletools intheinternationalresponseto organizedcrimeand, in particular,moneylaundering,terrorismand terroristfinancing,andmorerecently thefinancingofproliferationofweaponsofmassdestruction. Thosebentonperpetratingandperpetuatingorganizedcrimeoftenusethelegitimateinstitutionsandfacilitiesestablishedandrecognizedunder InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  10. P age |10 law to disguisetheirtransactionsandgivethemasemblanceoflegitimacy. In manyinstancestheresultsofsuchtransactions,wheretheyaresuccessful,areemployedtofurtherothercriminalactivities. Thenatureoforganizedcrimeissuchthatitpermeatesnationalbordersandassumesaninternationalcharacter.” ConsultationPaperonLocalImplementationofBaselIIILiquidity Rules–LiquidityCoverageRatio “On6January2013,theGroupofCentralBankGovernorsandHeadsofSupervision(“GHOS”)endorsedtheBaselIIILiquidityRule-LiquidityCoverageRatio(“LCR”)astheglobalminimumstandardforliquidityrisk. TheLCRframeworkaimstoimprovetheshort-termresilienceofabank'sliquidityriskprofile. Itdoes thisbyensuringthatabankhasanadequatestock of unencumberedhighqualityliquidassets(“HQLA”)thatcanbeconvertedintocashatlittleornolossofvaluetomeetitsliquidityneedsfora30 calendardayliquiditystressscenario. Underthetimelineforimplementation,theLCRrequirementstartsat60%on1January2015andincreases10%annually to reach100%by1 January2019.” InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  11. P age |11 JointForum Mortgageinsurance:marketstructure,underwritingcycleandpolicyimplications Executivesummary Theeventsofthelastfewyears,particularlythoseintheglobalfinancialcrisisthatbeganin2007,indicatethatmortgageinsurance(MI)issubjecttosignificantstressintheworsttailevents. Thisreportexamines theinteractionofmortgageinsurerswithmortgageoriginatorsandunderwriters,andmakesasetofrecommendationsdirectedatpolicymakersandsupervisorswhichaimatreducingthelikelihoodofMIstressandfailureinsuchtailevents. Asummaryoftheserecommendationsfollow: 1. Policymakersshouldconsiderrequiringthatmortgageoriginators andmortgageinsurersaligntheirinterests; 2. Supervisorsshouldensurethatmortgageinsurersandmortgage originatorsmaintainstrongunderwritingstandards; 3. Supervisorsshouldbealertto– andcorrectfor– deteriorationin underwritingstandardsstemmingfrombehaviouralincentivesinfluencingmortgageoriginatorsandmortgageinsurers; Supervisorsshouldrequiremortgageinsurers tobuildlong-termcapitalbuffersandreservesduringthetroughsoftheunderwritingcycletocoverclaimsduringitspeaks; Supervisorsshouldbeawareofandtakeaction to preventcross-sectoralarbitragewhichcouldarisefromdifferencesintheaccountingbetweeninsurers’technicalreservesandbanks’loanloss InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  12. P age |12 provisions,andfromdifferencesinthecapitalrequirementsforcreditriskbetweenbanks andinsurers; Supervisorsshouldbealerttopotentialcross-sectoralarbitrageresultingfromtheuseofalternativestotraditionalmortgageinsurance;and SupervisorsshouldapplytheFSBPrinciplesforSoundResidentialMortgageUnderwritingPractices(“FSBPrinciples”)tomortgageinsurersnotingthatpropersupervisoryimplementationnecessitatesbothinsuranceandbankingexpertise. Introductionandbackground Mortgageinsuranceisusedtoprotectmortgagelenders(ieoriginatorsand/orunderwriters)bytransferringmortgagerisk,andnotablytailrisk,fromlenderstoinsurers. Insurersbytheirnatureprovideservicesforeventsinthetailof distributions,whereas thebankingsectortendstoprovideservicesclosertothemean ofdistributions. Theeventsofthelastfewyears,particularlythoseintheglobalfinancialcrisisthatbeganin2007,indicatethatMIissubjecttosignificantstressintheworsttailevents. In theworstcases,failureofamortgageinsurermayoccurleadingtoresolutionoftheinsurer, wherebysomeofthemostextremetailriskmayreverttothelenderattheverytimethattheinsurancewouldbemostneeded, potentiallycreatingsystemicrisk. Atitsmostfundamentallevel,thisreportexaminestheinteractionofmortgageinsurerswithmortgageoriginatorsandunderwriters,andmakes asetofrecommendationsdirectedatpolicymakersandsupervisorswhichaimatreducingthelikelihoodofMIstressandfailureinsuchtailevents. InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  13. P age |13 • Theoriginalimpetusforthisworkcanbetracedback to theJointForum’s ReviewoftheDifferentiatedNatureandScopeofFinancialRegulation(“DNSR”– January2010). • Asisoftenthecase,makingrecommendationsaboutinteractionsisfraughtwithdifficulty:anycomplexsystemtends to reacttochangesinwaysthatarenotalwayspredictable. • Nonetheless,theJointForumhasconsideredtheeffectsofthecrisesoverthelastfewyearsandendeavouredtoidentifystepsthatshouldhelpmitigatesomeoftheproblemsandhelptoensureconsistentlystrongstandardswhereMIisused. • Marketstructureoverview • MIprovidesadditionalhousingfinanceflexibilityforlendersandconsumersbyexpandingthe“underwritingenvelope”usuallyalongtheloan-to-value(LTV) dimension(Blood,2001). • EventhoughMIisavailableinmanycountries,itiscurrentlyusedextensivelyin onlyafew:Australia,Canada,France,HongKong,Netherlands,andtheUnitedStates. • In anumberofcountries,MIiseithermandatoryforhighLTVloans,incentivisedbycapitalrequirementreliefontheunderlyingmortgages,orthegovernmentparticipatesin itsprovision: • In CanadaandHongKong,MIisrequiredonhighLTVloansmadebyregulateddeposit-takinginstitutions,whileintheUnitedStates,thegovernment-sponsoredhousingenterprises(GSEs)requireMIonloanstheypurchasethathaveLTVratiosabove80%. • In Australia,Canada,France,Mexico,Spain,andtheUnitedKingdom,MIis(in effect)incentivisedthroughaloweringof • risk-weightsforthecapitalrequirementsoflenders,althoughthishas • notnecessarilyledtosignificantMIuse. • ThegovernmentsofCanada,HongKong,Indonesia,Mexico,theNetherlands,andUnitedStatesparticipateintheprovisionofMI. InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  14. P age |14 In manycountries,thegovernmentorgovernmentagencyisinfactthedominantorsoleproviderofMI. In somecountriesthatdominanceisincertainsectorsandsocially targeted,suchastheUSFederalHousingAdministration(FHA)thatspecialisesinsubprimeloans. In othercountries,suchasCanada,thegovernmentprovidesaback-stopguaranteeagainstmortgageinsuranceobligations. TheJointForumsurveyedvariousjurisdictionstodiscoverthetypesofinsurancegenerallysoldwithmortgages:thereasonwasthatboththeterminology,andthepurpose,oftheprotectionsdifferedindifferent regions. Whenexaminingthecross-sectoralintersectionofproductsandrisks,theJointForumconsideredtheentireexpectedpaymentstreamfromtheborrowertothelender:thisofcourseconsistsofbothinterestand principal. Differentproductsprotecttheinterestincomestream(ortheinterestandamortisationofprincipal)andthedefaultrisk ontheprincipal(withinterestarrearssometimesaddedtotheprincipal). PleaserefertoAnnexBforgreaterdetailonthemarketstructureinvariousjurisdictions. Becausemortgagedefaultrisk isinherentlycorrelatedwiththehousingmarketandthebroadereconomicenvironment,theefficacyofMIcandeclineduringacrisispreciselywhenitismostneeded. Forexample,theUSMIindustrywasseverelyaffectedbytherecentglobalfinancialcrisis. Two ofthefivebigUSmortgageinsurers(PMIandRepublic)areunderordersofsupervision(proceedingsinaspectrumofpreventativeregulatoryactions),andtheotherthreearesub-investmentgrade,whereasallfivewereinvestmentgradeprior to thecrisis. InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  15. P age |15 Furthermore,becauseinsurersbearsubstantiallyallofthe loss-given-defaultonforeclosedloans,theirlossesaremoresensitivetomortgagedefaultthanfortheoriginallenders. ThisisespeciallythecasegiventhecommonpracticeofonlyinsuringloanswithhighLTVratios. TypicalpolicieslimitlossesbyinsuringonlylossesinexcessofcertainLTVratios. In somecountries,MIcoverageislimitedto lossesuptothefirst10%to30%ofoutstandingbalance. Coveragelimitsareuseful in incentivisingprudentlenderloanscreeningandmonitoringandcontrollingadverseselectionproblems. Theadverseselectionproblemrelatestothesuperiorinformationthatlendersmayhaveonborrowers’repayment capacity(D’SousaandSinha,2006). Thestructureofthepremiumpaymentsvariesbycountry. In somecountries,theMIpremiumispaidasasingleup-frontpayment(orcapitalisedoverthelife oftheloan),whilein othercountriesthepremiumispaiddirectlybytheborroweronamonthlybasissolongastheloanis activeandtheLTVremainsaboveaparticularlimitlike 80%. StrongprudentialsupervisionofMIisessential. In thisregard,mortgageinsurersareusuallyregulatedandsupervisedseparately,bylegalentity,bythelocalinsurancesupervisor. Alsotocontaintherisk,inmanycountriesmortgageinsurersarerequiredtobemonolines. Whileonecouldmake amonolineargumentforothertypesofinsurance,thepotentialforcatastrophicmortgagelossessetsMIapart(Jaffee,2006). InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  16. P age |16 Theissueofrecourseornon-recourseloans9withintheUnitedStatesreceivedmuchpresscoverageduringthefinancialcrisis. WhilethroughouttheUS,stateswithnon-recourseandanti-deficiencylawsareintheminority,ithappenedthatsomeofthegreatestdifficultiesinthehousingmarketswereinstatessuchasCaliforniaandFloridathatdohavenon-recourselaws. Suchlawstendtoincreasetheriskinherentinloanstothelenders,andbyextension tothemortgageinsurerswhoinsurethehighestLTVlayers. SummaryofFebruary2012MIroundtable Asanadjunct to theJointForumPlenarymeetinginMiamiinFebruary2012,theJointForumsponsoredaroundtablediscussiononMIwithrepresentationfromindustry,regulationandacademia. Themesandlessonsfromthediscussionincluded: • In jurisdictionswhereitisused,MImayconstituteapositivepart • ofasafemortgagesystem. • Wherewronglyorpoorlyused,however,itmaymaskrisks. • MIissubjectovertheyearstooccasionalcatastrophicloss. • Insuchcircumstances,thereisasignificantpossibilitythatinsuredlossesmayexceedtheinsurer’sresourcesleadingto insolvency. • Maintenanceofamonolinesystemprotectsthe overallfinancialstabilityoftheinsurancesector:problemsin MIarering-fencedagainstothergeneralinsurancerisk. • Nonetheless,whethermonolineornot,ifmortgageinsurersfail,thecreditrisk willrevertto,andcrystallisein,thebankingsector. • Itislikelythatwide-scalefailurewillonlyoccurifweakand pervasivemortgageoriginationstandardshavepreviouslypassedcontagionfromthebankingsectortotheinsurancesector. InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  17. P age |17 Otherwisefailuresarelikelytobeoccasionalandidiosyncratic. • Alignmentofinterestsbetweenthegovernmentandprivatesectors • isimportant. • Someoftheproblemsarising inthefinancialcrisisweredue tomisalignmentsofinterests,andpublicsectorincentivescanheightenriskconcentrations. • Politicalwillisneededtocreateappropriatemacro-prudentialandcounter-cyclicalmeasures,whichduringboomtimesmayseemtobetheoppositeofotherwisedesirablesocialgoalssuchasincreasingpublicownershipofhousing. • Suchmeasuresmayincludeloan tovaluerestrictions,restrictionsonownership,debt to incomelimitsandrestrictionsonsourceofdown payments. • Thesemeasuresmaybeintroducedin responsetotheidentificationofagrowingrisk ratherthanbeingpartofthestandardoperatingenvironment. • MandatoryMIisusedinsomejurisdictions.Itisonepossibilitythatavoidsadverseselectionalthoughitmustberecognisedasanextremeanswer tothisissue. • MIislessnecessaryandlessbeneficialinjurisdictionswheremortgageoriginationischaracterisedbylow loan-to-valueratios(andthereforehighdownpayments). • TheDifferingRolesofGovernmentsinMIMarkets • MIprovidesadditionalfinancingflexibilityforlendersandconsumers. • Asmentionedattheroundtable,MIislessnecessaryandthereforelessbeneficialinjurisdictionswheremortgageoriginationischaracterisedbylow loan-to-valueratios(andthereforehighdownpayments). InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  18. P age |18 GovernmentpolicymakersshouldconsiderwhetherMIcanbeused prudentlyinconjunctionwithLTVrequirementstomeethousinggoalsandneedsintheirrespectivemarkets. InsomecountriestheuseofMIisachievedbydirectparticipationandinothersthroughindirectincentives. Forexample,theCanadianMImarketisdominatedbyasinglepublicinsurer(CanadaMortgageandHousingCorporation-CMHC)andasmallnumberofprivatefirms. Tomakeitpossibleforprivatemortgageinsurers tocompeteeffectivelywithCMHC,theCanadiangovernmentguaranteestheobligationsof privatemortgageinsurers to lendersthroughlegislationthatprotectslendersintheeventofdefaultbytheinsurer. Thegovernment’sbackingofprivate insurers’businessissubjecttoadeductibleequalto 10%oftheoriginalprincipalamountofthemortgageloan. Loansinsuredbygovernment-backedmortgageinsurersmust adheretospecificunderwritingparametersestablishedby thegovernment. Throughthisinstitutionalarrangement,thegovernmentinfluencessoundmortgageunderwritingpracticesfortheindustry. AsimilarproposalisoneoptionunderareporttoUSCongress“ReformingAmerica’sHousingFinanceMarket”. In somecountries,capitalreliefisapplied to mortgagescoveredbygovernmentguaranteeschemesaimedatprovidingincentivesforlenderstoservemorevulnerablecategories. Althoughtheseschemes,whichareinplacein afewjurisdictionsespeciallyinEurope(egFrance,Netherlands),provideprotection tolendersagainstborrowers’default,theyaredifferentfrom“mortgageinsurance” inthecommonusageoftheterm. InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  19. P age |19 Regulatoryframeworkthatappliestomortgageinsurers TheJointForuminvestigatedthetypesofinsurersthatprovideMI,andwhethertheyaremonolines. Amonolinerequirementprotectstheremainderoftheinsurancesectorfromanadverseeventinmortgageinsurance. Ontheotherhand,amonolinemortgageinsurerandthemortgageoriginatorshaveincreasedrisk duetothelackofdiversification. Viewsdifferregardingwhichoutcomeispreferable. TheJointForumalsolookedatwhethermortgageinsurersareregulated underthenormalinsuranceprudentialrulesinthejurisdiction,orwhetherspecialisedrulesareapplied. WhileMIunderwriters canberegulatedundernormalinsuranceprudentialrules,forthemostpartadditionalspecialisedrulesare requiredtorecognisetherisksposedbyMI. Mortgageunderwritingstandardsandtheunderwritingcycle TheJointForumconsiderscertaintypesofloanstobeconsiderablymoreriskythanothers,andthesemayconcentrateriskbothinthebankingandtheinsurancesectors. Forexample,negativeamortisationloansor100%LTVloansarelikelytobehighrisk,althoughthesemayinthefuturebeaddressedbytheFSBPrinciples(recommendation6.3)withrespectto absoluteminimum standards. JurisdictionsshouldconsiderwhethersuchloansshouldqualifyforMI,orshouldonlyqualifywithspecialconditionsorinspecifictargetedcircumstances. Nonetheless,theJointForumrecognisedthattheremaybecircumstanceswheresuchloansarejudgedtobeappropriateforMIcoverage. InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  20. P age |20 Examplesincludeveryhighclosingcostloansandloanstoenablelabourmobilitywherehomeownershavenegativeequity. Therearebothmacro-andmicro-prudentialaspectsthatmightbeexaminedwithrespecttowhatisgenericallyregardedasMI. Fromamicro-prudentialstandpoint,thebehaviouralissuestouchedonearlierarerelevant:thereisadangerthattheexistenceofMImayleadboththelenderandtheinsurerto relaxstandardsbecause“the otherpartyislookingatit”–preciselycountertothebenefitsofasecondpairofeyes. Fromamoremacro-prudentialstandpoint,therearedangersthatover-concentrationofdefaultrisk inmortgageinsurersmayexacerbatesystemicornear-systemicproblemsintheunderlyingmarket. Thesebehaviouralissuesarelikelytobekeyin identifyinganddealingwithproblemsarising in theMIarena:bythetimethefinancialstatementsofamortgageinsurerbegintoindicateseriousproblems,thereislikelytoalreadybeasignificantpipelineoflosses. Ifontheotherhandthebehaviouralissuesthatleadtosuchlossescanbeidentified,itislikelythatanysuchproblemscouldbemitigatedfarearlierintheprocess. Itisworthwhileconsideringfourextremecases,andthenconsideringhowmigrationsarelikelytooccurbetweenthesituations. Thefoursituationsarewhere theoriginator/lenderhasstrongorweakunderwriting,andthemortgageinsurerhasstrongorweakinsuranceunderwritingstandards. This canbeshowninamatrixasfollows,togetherwithahighlevelsummaryoftheexpectationsundereachofthefourcircumstances. Fromasupervisorypointofview,ideallybothoriginationandmortgageunderwritingstandardsshouldbestrong. InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  21. P age |21 Nonetheless,supervisorsneed tobeawarethatitisalsolikelytobeasomewhatunstableequilibriumwithbothoriginators/lendersandmortgageunderwriters tempted to lowertheirstandardstoincrease businessvolumetherebytakingadvantageofanapparentlystablemarketwhich,thoughprofitable,doesnotgeneratehighreturns. Thisequilibriummightalsobefurtherweakenedwherechangingmacro-economicforces addtothesebehaviouraltrends– unlessthese forcesaremitigatedbyprudentialrequirements(seeBox1abovedealingwithGovernments’role intheMImarket). Overtime,migration toneighbouringmatrixelements can occur. Iftheoriginators/lenderslowertheirstandardswhilethemortgageinsurersmaintaintheirhighunderwritingstandards,MIwillbescarce. Thisscarcity,however,islikelyitselfto createpressure. Thatpressuremayinfluencemortgageinsurers to lowertheirstandardsonanetbasis,eitherbyaweakeningofpre-existingmortgageunderwritingstandards,ortheentranceintothemarketofnewMIunderwritersconvincedthattheyspotanopportunity. BrokerswillthentendtodiscovertheMIunderwriterswiththecomparativelyweakerstandards,leadingtobusinessbeingplacedwiththosecompanies. Alternatively,thepressuremaycreatearegulatoryarbitrageresulting inalternativestoMIbeingutilisedsuchaspiggy-back loans,financialguarantees,securitisationorcreditdefaultswaps(CDS). Eithercasemaycauseafurthermigration– whetherdirectlyor indirectly – totheworstscenario,wherebothoriginator/lenderandmortgageinsurerunderwritingstandardsareweak. In therecentfinancialcrisis,itcouldbearguedthattheMIunderwritersdidnotlowertheirunderwritingstandardswhiletheoriginators/lenders,nonetheless,utilisedalternativesandtheresultinghousingbubble causedsignificantlossesforMIunderwriters. InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  22. P age |22 Ontheotherhand,MIunderwritersmaylowertheirunderwritingstandardswhiletheoriginators/lendersmaintainhighstandards. Thisisunlikelytocauseimmediateproblems,astheoriginators/lenders’standardswouldeffectivelyprotectthemortgageinsurersfromthemselves. However,undersuchcircumstances,theoriginators/lendersmaybegintotakeadvantageofthenaïveinsurancecapitalwhileweakeningtheirpreviouslyhighstandards. Assuch,we canseeplausiblereasonswhyovertimetheremaybeamigrationfromthestrong/strongscenario to theweak/weak. Itisclearthateithertheweak/weakscenariooramigrationtheretowasrepresentative,forexample,ofthe overallmarketsintheUnitedStatesintherun-up to thefinancialcrisisbeginning in 2008. Aweak/weakscenarioisofcoursetheworstcasescenariobothfromaregulatorystandpointandforthestabilityoftheeconomyasawhole,withthepossibilityofsystemiceffects. Aweak/weakscenarioislikelytomigrate to astrong/strongscenarioascorrectionsareapplied. Henceoverallwecanconstructaplausiblesetofstoriesthatwouldcreateacyclicalityoverlayingthematrixasfollows: InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  23. P age |23 Itisnotclearthatexperimentationbymortgageinsurersandoriginatorsthatmovesoutsideofthe toplefthandmatrixelement(“strong/strong”)toeitherstrong/weakorweak/strongshouldalwaysbepreventedbypolicymakersandsupervisors. Ratherfurthermigrationintoweak/weakshouldbeconstrained. Theaimshouldbetoshortenthecyclebycreating incentivesthatwouldmoveinsurersandoriginatorsbacktostrong/strongfromstrong/weakorweak/strongsuchthattheweak/weakquadrantisnotentered(orifitisonlyforveryshortperiods): InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  24. P age |24 Recommendationsforpolicymakersandsupervisors Policymakersshouldconsiderrequiringthatmortgageoriginatorsandmortgageinsurersaligntheirinterests. Outcomesshouldimproveifasmanyofthepartiesaspossibleshare thefinancialconsequencesofatransaction. Policymakersshouldconsidervariousmeansofaligning interests. Forexample,aneffectivemeansofaligningfinancialinterestsin theinsurancesectorispartialriskretention. Also,theFSBPrinciples’recommendation3.2thatdownpaymentsaresubstantiallydrawnfromtheborrower’sownresourceshelpsaligntheinterestsofthelenderandtheborrower. Jurisdictionalbankingandinsurancesupervisorsshouldalsoconsiderjointlycollaboratingtoinvestigatewhethertheremaybeanysharingmechanismsthatwouldbeviableandusefulintheirjurisdiction. Whenlossesareshared,itisimportantthatclaimscostsarecontrolledby thepartywiththegreatestexposure. In mostcases,thiswillbethemortgageinsurer. Supervisorsshouldensurethatmortgageinsurersandmortgageoriginatorsmaintainstrongunderwritingstandards Therewillalwaysbepressuresonmortgageoriginatorsormortgageinsurerstolowertheirunderwritingstandards. Lowerstandardsbyasingleplayer ineithersectorwillincreasethepressureon otherpartieswithinthatsectortolowertheirstandards. Lowerstandardsinonesectorwillin turnincreasethepressureontheothersectortoloweritsstandardsultimatelyresultinginapotentialcrisis. InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  25. P age |25 Supervisorsmust thereforeremainvigilanttoensurethatstrongunderwritingpracticesaremaintainedbyallpartiesandthattheunderwritingcycledoesnotentertheweak/weakquadrantdescribedabove. Supervisoryexaminationsshouldverifysuchpractices. Wheresupervisorsdonothavethelegalauthority todoso,supervisorypowersshouldberequested. Relevantpolicymakersshouldalsoensurethatsupervisorshavetheappropriatelegalauthority tobeabletomakesuchverifications. 3.Supervisorsshouldbealert to –andcorrect for– deteriorationinunderwritingstandardsstemmingfrombehaviouralincentivesinfluencingmortgageoriginatorsandmortgageinsurers. Behaviouralincentivessuchas tensionsbetweenthesalesforceandtheadministrativefunctionsarearecurringconcernthatshouldbemonitored:volume,whichmayincentivisefrontofficepersonnel especiallyduringgoodtimes,maycomeattheexpenseofgoodcontrolsinthebackoffice. Suchincentives canaffect bothoriginatorsandmortgageinsurers. Supervisorsandmortgageinsurersshouldbealerttosuchbehaviourasitcan influencetheoverallqualityofrisksoffered,andthereforeultimatelyunderwritingstandardsandtheunderwritingcycleacrossbothsectors. Assoundresidentialmortgageunderwritingpracticesarefundamentallylinkedwithresponsibleconductofbusiness,supervisorsshouldconsiderwhetherbehaviouralincentivesareappropriatelyalignedwiththefairtreatmentofconsumers. Forexample,originatorsmayhavesignificantmarketpowerand,insomejurisdictions,beable to demandcommissionorothersalesincentivesinreturnforrecommendingorselectingaspecificmortgageinsurer. Abundleddistributionandlendingmodelcontainssignificantdistortions andpotentialconflictsofinterest. InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  26. P age |26 Supervisorsmayneed toaddresstheincentivesthatmaybecreatedbysuchremunerationpracticesby,forexample,requiringchoicesofmortgageinsurertobeprovided to thehomeowners,orotheractions. 4.Supervisorsshouldrequiremortgageinsurerstobuildlong-termcapitalbuffersandreservesduring thetroughsoftheunderwritingcycletocover claimsduringits peaks. LongtermcapitalbuffersareneededindealingwiththetaileventlossesofMI. MItendstohavearelativelyconsistentlevelofriskformanyyears,andthenissubjectto(typicallyshort)extremetaileventscreatingmuchworselossexperience. Thiscyclicalitythenrepeatsoveralongcycle. In theUnitedStatesforexample,approximately75yearshadelapsed betweentwoseverefinancialcrises;however,lessseverecyclesof10to20yearsarecommoninmanycountries. Highercapitalstandardsinnormaltimeswillprovideadditionalresourcestomitigatetheeffectoftheseriousdownturnswhentheyoccur. In addition,supervisorscouldregularlyrequiremortgageinsurers to runspecificstresstestsorothercapitaladequacytestsagainsttheirportfolios.Suchstresstestsarehelpfulin assessingan insurer’ssolvencypositionasaresultofcertainstresses. Theyalsohelpsupervisorscomparetheabilitiesof insurersindividually,aswellascollectively,towithstandaspecificstressscenario. In theUnitedStates,supervisorsrequiredthatso-calledcontingencyreservesbesetupatmortgageinsurersthatwouldpreventotherwisedistributableprofitsbeingdeclaredasdividendsfor10years. InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  27. P age |27 Halfofeachpremiumdollarearnedgoesintothecontingencyreserveandremainunavailablefora10-yearperiodunlesslossesin acalendaryearexceed35%ofearnedpremiums,dependinguponthestate. Thesecontingencyreservesplaythesameroleasacapitalbufferandallow insurerstobuildreservesduringthenormalpartoftheriskcycletocoverclaimsduringpeakyears. Differentapproachesareneededin otherjurisdictionswheretheMIproductdiffers,andintheUnitedStatestheseprovisionsmayrequirerecalibrationbasedonrecentexperience. In lightofconcernsarisingfromthefinancialcrisis,USstateinsurancesupervisorshaveadoptedacharge“todetermineandmakearecommendation…onwhatchangesarenecessary,ifany,tothesolvencyregulationofmortgageinsurers,includingchangestotheMortgageGuarantyInsurersModelAct”. Itisexpectedthatthisworkwillconsiderabroadrangeoffinancialsolvency-relatedissues,includingbutnotlimited to leverageandcapitalstatutorystandards,accountingandlossreservingmethods,andreinsurancerequirementsforsuchinsurers Totheextentthatalternativestomortgageinsurancearise,supervisorsshouldconsiderwhetherthereisaneedforequivalentcapitalbuffersforthosealternatives. 5.Supervisorsshouldbeawareofandtake actiontopreventcross-sectoralarbitragewhichcouldarisefromdifferencesintheaccountingbetweeninsurers’technicalreservesandbanks’loanlossprovisions,andfromdifferencesinthecapitalrequirementsforcreditriskbetweenbanksandinsurers. WhileIFRSandUSGAAPrequirementsforinsurancecontractsandfinancialinstrumentswerenotyetfinalisedatthetimeofthisreport’spublication,itwouldappearthattheremaybedifferencesbetweenthetimingandleveloflossesdependingonwhetheraloan lossprovisionisrecognisedorthesamepotentiallossisevaluatedundertheinsurancecontractsstandard. InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  28. P age |28 • Thismayparticularlybethe caseforexpectedlossesonaportfoliowherenospecificdefaultshavebeenidentified:IASB’sfinancialinstrumentimpairmentisprojectedtousealossprovisionbasedonexpectedlifetimelossesonloansexpected tobecomeimpairedinthenext12months,whereasinsuredloanswouldbereservedatafulllifetimelosslevel(equivalenttothesecondlevelofimpairmentundertheIASB’scurrenttentativedecisionsregardingfinancialinstrumentimpairment). • Supervisorsneed tobeawareofthisissue,andmonitoritastheaccountingstandardsettersmovetowardsconcludingtheInsuranceContractsand FinancialInstrumentstandards. • Dependingontheconclusions,supervisorsshouldtake action topreventanyrelatedcross-sectoralarbitragearisingfromtheseaccountingdifferences. • Further,differentmeasurementsofcreditrisk inthe capitalrequirementsforbanks andmortgageinsurersmaybeanothersourceofcross-sectoral arbitragewhichshouldbemitigatedbysupervisors. • 6.Supervisorsshouldbealert topotentialcrosssectoralarbitrageresultingfromtheuseofalternativestotraditionalmortgageinsurance • AlternativestoMImayexistforthemortgageoriginator.Examplesinclude: • capitalmarketsproducts(egstructuredfinanceandcreditderivatives); • lenderself-insurance;and • structuredloanarrangements,inwhichloansofseniorandjuniorpriorityareoriginatedsimultaneously,withthejuniorloanprovidingthecreditenhancementontheseniorloan. InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  29. P age |29 • Totheextentthatsuchalternativesexistorareused,supervisorsshould bealertto,andpreparedtoadjustfor,any cross sectoralarbitragethatmayarise. • Supervisorsshouldseek to mitigatecrosssectoralarbitrage. • Forexample,oneway to mitigateregulatoryarbitragebetweentypesofguaranteeandbusinesssectorsistoensurethatcapitalrequirementsthatapplytothelender/originatorandtheguaranteeprovider,whenconsideredinconjunction,are: • equivalent, • indexedtothe actualrisk levelobservedbythem,and • notdependentonthetypeofguaranteeusedbytheoriginatororonthebusinesssector. • 7.SupervisorsshouldapplytheFSBPrinciplesforSoundResidentialMortgageUnderwritingPracticestomortgageinsurersnotingthatpropersupervisoryimplementationnecessitatesbothinsuranceandbankingexpertise. • IftheFSBPrinciplesarefullyapplied,supervisorsexpectthatanumberofthemostsystemicor potentiallysystemicproblemsthatmayoccurinMIarelikelytobemitigatedsignificantly. • Moreover,anumberoftheFSBPrinciplesshouldbeappliedbymortgageinsurersthemselves. • Forexample,FSBPrinciples5.1and5.2requirelendersto carry outappropriateduediligenceonboththeborrowerandthemortgageinsurers. • Mortgageinsurers,likewise,shouldensurethatlendersareundertakingeffectiveverificationofincomeand otherfinancialinformation,maintainingreasonabledebtservicecoverageandappropriategrossand netLTVratios,whilemakingreasonableinquiriesthemselvesregardingtheseissues. InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  30. P age |30 Applicationoftheseprincipleswouldnotpreventproblemseverarisingatamortgageinsurer,butanysuchproblemswouldbemorelikelytoberesolvablewithintheusualsupervisoryframeworkwithoutsignificantmarketdisruption. UnitedStates TheNAICMortgageGuarantyInsuranceModelAct630-1(“Model”)was createdforthepurposeofprovidingfortheeffectiveregulationandsupervisionofmortgageguarantyinsurers. TheModeldefinesmortgageguarantyinsuranceasinsuranceagainstfinanciallossbyreasonofnonpaymentofprincipal, interest,orothersumsagreed tobepaidonanynotesecuredbyamortgage,deedoftrust,orotherinstrumentconstitutingalienorchargeonrealestate. Mortgageguarantyinsurancemayalsocoveragainstfinanciallossbyreasonofnonpaymentofrentunderthetermsofawrittenlease. AsofApril2012,eightstateshaveadoptedthemostrecentversionoftheModelinasubstantiallysimilarmanner. Anadditionaltwelvestateshaveadoptedan olderversionoftheModel,legislation,orregulationderivedfromothersourcessuchasbulletinsandadministrativerulings. CurrentstateoftheMortgageGuarantyIndustry Asaresultofthedownturninthehousingmarket,themortgageguarantyindustrycontinuesonadepressednote. Althoughsignsofimprovementinthehousing industrymaysignalincreasedpremiumsproduction,strictermortgageunderwritingstandardsmayhaveacontraryeffectonmortgageguarantypremiumproduction. In addition,recordunemploymentandpooroveralleconomicconditionsaddfurtherpressures to thedepressedrealestatemarketandmortgage guaranty activity. InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  31. P age |31 Asofyear-end2011therewereatotal39activemono-linewritersofmortgageguarantyproductswithin11insurancegroups. Ofthese11insurancegroups,sixgroupsaccountfor94.5%ofgrossmortgageguarantypremiums. Currently,S&P’shighestratingofamortgageguaranty insureris“AA-” foronlyonecompany. Grosspremiumswrittenformono-linemortgageguarantorshavefluctuatedoverthepastfive-yearsfromlowofUSD5.3billionin2011toahighofUSD7.4billionin2008. Grosspaidlossespeakedin2010atUDS12.9billion(77.4%ofwhichwasreportedwithinthesixlargestguarantors)comparedtoUSD2.8billionfor2007. Contingencyreserveswerenearlyexhaustedoverthepastfiveyears,totallingUSD615thousandatyear-end2011comparedtoUSD13.4billionin2007. RegulationbasedontheModelCapitalRequirements Amortgageguarantyinsurancecompanyshallnottransactthebusinessofmortgageguarantyinsuranceunless,ifastockinsurancecompany,ithaspaid-incapitalofatleastUSD1,000,000andpaid-insurplusofatleastUSD1,000,000,orifamutualinsurancecompany,aminimuminitialsurplusofUSD2,000,000. Astock companyora mutualcompanyshallatalltimesthereaftermaintainaminimumpolicyholders’surplusofatleastUSD1,500,000. GeographicConcentration Mortgageguarantyinsurersarenotallowedto insureloans,byasinglerisk,thatare inexcessof10%ofthecompany’saggregatepolicyholders’ surplusandcontingencyreserves. InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  32. P age |32 Also,mortgageguarantyinsurersareprohibitedfromhavingmorethan20%oftotalinsuranceinforceinanyoneStandard MetropolitanStatisticalArea,asdefinedbytheUnitedStatesDepartmentofCommerce. Bothoftheseprovisionstakeeffectonlyafteramortgageinsurer haspossessedacertificateofauthorityinastateforatimeperiodofthreeyears. CoverageLimitation Coverageprovidedbymortgageguarantyinsurers,netofreinsurancecededtoareinsurerinwhichthecompanyhasnointerest,islimited to25%oftheentireindebtedness totheinsured. In theeventofdefault,themortgageguarantyinsurerhastheoptionof payingtheentireindebtedness totheinsured,thereforeacquiringtitle totherealestate. PolicyFormandPremiumRates Allpolicy formsandendorsementsshallbefiledwithandbesubjecttotheapprovalofthecommissioner. In addition,eachmortgageinsurershallfilewiththedepartmenttheratetobechargedandthepremiumtobepaidbythepolicyholder. OutstandingTotalLiability Mortgageguarantyinsurersareprohibitedfromhavinganoutstandingtotalmortgageguarantyin-forceliability, netofreinsurance,inexcessoftwenty-fivetimesofaggregatepolicyholders’surplusandcontingencyreserves. In theeventthatamortgageguarantyinsurerexceedsthisthreshold,thecompanymustceasewritingnewmortgageguarantybusinessuntilthesituationiscorrected. InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  33. P age |33 Totaloutstandingliabilityiscalculatedonaconsolidatedbasis. UnearnedPremiumandLossReserves Mortgageguarantyinsurersshallcomputeandmaintainunearnedpremiumreservesalongwithadequatecasebasisandotherlossreservesthataccuratelyreflectlossfrequencyandlossseverity. Casebasisandotherlossreservesshallincludecomponentsforclaimsreportedandforclaimsincurredbutnotreported, includingestimatedlosseson: Insuredloansthathaveresultedinthetransferofpropertythatremainsunsold; Insuredloansintheprocessofforeclosure; 3. Insuredloansindefaultforfourmonthsorforanylesserperiodthat isdefinedasdefaultforsuchpurposesinthepolicyprovisions;and 4. Insuredleasesindefaultforfourmonthsorforanylesserperiod thatisdefinedasdefaultforsuchpurposesinpolicyprovisions. ContingencyReserves Eachmortgageguarantyinsurershallestablishacontingencyreserveoutofnetpremiumremaining(grosspremiumslesspremiumsreturned topolicyholdersnetofreinsurance)afterestablishmentoftheunearnedpremiumreserve. Themortgageguarantyinsurershallcontribute to thecontingencyreserveanamountequalto50%oftheremainingunearnedpremiums. Contributionstothecontingencyreservemadeduringeachcalendaryearshallbemaintainedforaperiodof120months. InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  34. P age |34 Anexceptionallowsforreleasestobemadeby thecompany,fromcontingencyreserves,inanyyearinwhichthe actualincurredlossesexceed35%ofthecorrespondingearnedpremiums. However,releasesarenotallowedwithoutpriorapprovalbythecommissionerofinsuranceofthe insurancecompany’sstateofdomicile. ExtractfromtheNAICCenterForInsurancePolicy Researchpaper“FinancingHomeOwnership:OriginsandEvolutionofMortgageSecuritisation-PublicPolicy,FinancialInnovationsandCrises“dated12August2012. Mortgage Insurers Thefinancialcrisisfoundprivatemortgageinsurersexposedonthefrontlinesastheyweredirectlyunderwritingtherisk ofborrowersdefaultingontheirmortgageloans. Particularly,sincemortgageinsurersprovidedcoverageonhigh loan-to-valuemortgageswithverythinequityslices,theywerevulnerabletopotentiallossesintheeventofrisingdelinquenciesanddefaults. Whilemortgageinsurersavoidedmanyofthenow worst-performingloansduringthecreditboom,theystilladdedsignificantexposuretomortgagerisk,includingmaterialsubprimeexposure. Mortgage insurers’shifttoward“affordability”productsandsubprimeloansincreasedtheirexposuretotheriseinmortgagedefaultsduringthecrisis. Insuranceforadjustablerateproductsjumpedfrom13percentat year-end2001 to about25percentatyear-end2006,whilesubprimeloansmadeup about12percentoftheindustryaggregaterisk-in-force. Theprivatemortgageinsuranceindustryrecordeditsbestyearintermsofnewinsurancevolumein2007,withtotal newinsurancewrittenexceeding$300billionforthefirsttime. InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  35. P age |35 Ashorttwo yearslater,newinsurancewrittenhaddeclined to$81billionas themarketformortgageinsuranceshrunk,followingthecollapseofthehousingmarketandthesubprimecrisis. Ashomepricesplummeted,thewaveofmortgagedefaultsandhomeforeclosuresweakenedmortgageinsurers’capitalpositionandresultedinsubstantiallosses. Havingto setasidesubstantialcapitalto coverfutureclaimsseverelyconstrainedmortgage insurers’abilitytowritenewbusiness. Theverychallengingmarketconditionsthatthemortgageinsuranceindustryexperiencedsincetheeruptionofthecrisisarereflectedinthesharpriseoftheindustry’slossandcombinedratios(Figure6). The industry’slossratio(lossesovernetpremiumsearned)jumpedfrom41percentin2006toarecordhigh218percentin 200815(Figure6). Althoughmarketandeconomictrendsappeartohavegenerallystabilisedinthelastcoupleofyears,thistrendhasnotyethelpedmortgageinsurerstomateriallyimprovetheirfinancialsituation. InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  36. P age |36 AsTable3shows,lossespaidarestillveryhighcompared to2007,eventhoughtherewassomeminorimprovementrecordedin2011. Poor industryresultscouldbepartlyattributedtothelossesoftwo insurers,PMIMortgageInsuranceCo.(PMI)andRepublicMortgageInsuranceCo. (RMIC),whichwereplacedunderstatesupervisiondue tomountinglossesandtheresultant capitalshortfalls. Mortgageguarantors’reportedlossesin2011werestillathighlevels,stressingtheiralreadyweakenedcapitalpositions. Accordingto Standard&Poor’s,thelossesgeneratedfromthe insurers’2005-2007booksofbusinessstilloutweighanyprofitsthathaveresultedfromnewer,highercreditqualitybusiness. Theunderwritingexperienceformortgageinsurersoverthepastfiveyears(2007-2011)isshownbelow in Table4. Premiumsin 2007and2008climbedtohistoricalhighs,buoyedbytherapidlyexpandinghousingmarket. Withthecollapseofthehousingmarket,underwritingslumpedbyalmost 30percentbetweenthepeakyear(2008)and2011(Table4). InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  37. P age |37 Thecushionprovidedbycontingencyreservesthatmortgageinsurersarerequiredtomaintainagainstcatastrophiclossesduringaneconomiccrisishasthinnedconsiderably overthelastfiveyears. Thesereservesarebuiltduringgoodtimesanddrawnonlyintheeventlossesexceedcertainstatutorythresholdsorotherwisedirectedbystateregulators. Althoughthestructureofcapitalrequirementsformortgageinsurerswasmorestringent,itstillprovedinadequategiventhewholesalemeltdown. Whatoncewasaverycomfortablecushionseemstobeneardepletedthroughthefinancialcrisisandneedstobebuiltbackup. Theaggregatecontingencyreservesofthemortgageinsuranceindustryshrunkmorethan95percentintheperiodbetween2007and2011(Table5). AsofMarch2012,bothStandard&Poor’sandMoody’shaveratedmortgageinsurersBBB(Baa)andbelowwhiletheyhavemaintaineda InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  38. P age |38 negativeoutlookfortheindustryfortherestof2012andpossiblywellinto2013(Table6). Creditratingagenciesbelievethatnewbusinesswritingswill notbesufficient to offsetexpectedlossesinto2013. Althoughthe2005–2007vintageloansinmortgageinsurers’bookshaveshownsomesignsofdelinquencyburnout,defaultrateshaveremainedatelevatedlevels,causingsignificantlosses(Figure7). Whileinthemediumtermtherun-offofthelegacyriskwillhelp improvethequalityofmortgageinsurers’portfolios,ratingagenciesexpectdefaultratestoremainatthesehighlevels evenbeyond2013. InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  39. P age |39 Atthesametime,astheeconomyandthehousingmarketrecover,theperformanceofatleastthebetter-capitalisedinsurersshouldshowgradualimprovement. Themortgage insuranceindustry’sfutureprospectshinge,ingreatpart,onthechangesinthemortgagefinancesystem,andespeciallyonthefuturestatusandroleoftheGSEs.Forthetimebeing,givenmortgageinsurers’weakenedposition,themarketstilllargelyreliesontheFederalHousingAdministrationfor insurance. Thepossiblewinding-downofGSEs’operationscouldpotentiallyshiftcreditrisk totheprivatesector,whichmightenhancemortgage insurers’roleinthehousingfinancemarketbyincreasingtherelianceonmortgageinsurance. Ontheotherhand,theissuanceofthecreditrisk retentionproposalin2011,allowingtheexemptionofqualifiedresidentialmortgages(highcreditquality)fromriskretentionrequirementsiftheyincludea20percentdownpayment(allowingmortgageoriginators to avoidretaining InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  40. P age |40 aportionoftheriskbeingsecuritised),couldadverselyimpactthemortgageinsurers’currentbusinessmodel. InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  41. P age |41 FMALiechtenstein FactsandfiguresonthefinancialintermediariessupervisedbytheFMA2013edition Interestingparts Asanintegratedsupervisoryauthority,theFMALiechtensteinsupervisesbanksandinsurancesaswellas otherparticipantsintheLiechtensteinfinancialmarketsuchasassetmanagers,funds,professionaltrustees,andauditors. In thispublication,wehavepresentedthemostimportantfactsandfiguresonthefinancialcentrein acompactform. Attractiveresultswereachievedintheindividualsectorsofthefinancialcentre in2012. Earningsinthebankingsectorimprovedagain. TheLiechtensteinfinancialsystemhasproven to beveryreliablein ademandingenvironment. Itmaintaineditshighdegreeofstabilityevenduringtheglobalfinancialcrisisandofferedsecurity to clients. Thebankshavesurpassinglyhigh capitalresourcescomparedto otherbanksinternationally,andwithprivatebanking,theypursueaconservativebusinessmodel. Factorssuchaspoliticalstability,soundpublicfinances,andtheSwissfrancalsopromotethestabilityandattractivenessofthefinancialcentre. Greatchallengesremain,however. InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  42. P age |42 Thefinancialcentreisundergoingaphaseofreorientation,requiringthedevelopmentofnewareasofbusiness. Theearningsandgrowthoutlookisrestrainedintheprevalentmarketenvironment. Thefar-reachingregulatoryreforminthefinancialcentreisalsorequiringmoreworkoffinancialintermediaries. Finally,theEuropeaneconomyhasbeendevelopingunfavourably,andseriouspublicdebtcrisesinseveralcountrieswithstabilityrisksforthefinancialsystemmustbe overcome. ThisenvironmentalsodemandsmuchoftheFMA. Withtheincreasingdensityofregulation,theFMA'sresponsibilitiesarealsoincreasing. Byguaranteeingstability,protectingclients,combatingabuse,andimplementing internationalregulatorystandards,theFMAperformsfundamentalfunctionsforthefinan-cialcentre. In thisway,itstrengthensthereputationofandtrustinthefinancialcentre,promotesinterna-tionalrecognition,andaccordinglycontributestosecuringtheinternationalmarketaccessthatisessentialforLiechtenstein. MarioGassnerCEO InternationalEconomyandFinancialMarkets Fiveyearsaftertheburstingofthecreditbubbleandtheassociatedoutbreakoftheglobalfinancialcrisis,theworldeconomyischaracterized byamassivesurplusofdebt andstagnatingeconomicgrowth. Thecentralbankshavecontinuedtheirexpansivepoliciesandinsome casessupplementedthembyunconventionalmonetarypolicymeasures. InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  43. P age |43 Thefinancialmarketsarebeingdeterminedbytheconti-nuinglyextraordinarilylow interestlevelandtheEuropeandebtcrisis,whichspreadfurtherin2012. Worldeconomicgrowthsloweddownoverthecourseof2012. Thisresultedin anunfavourabledevelopmentoftheEuropeaneconomy,whichslippedintoadeeprecession. In lightofthehighinterna-tionallinkageoftheworldeconomyandabroadlyweakeningdemandforexports,economicgrowthinChinaandinotherimportantemergingmarketsalsosloweddown,whiletheUSeconomyhasgrownonlymodestly. Thegroupofcountriesaffectedbythedebtcrisishasexpanded. In June2012,Cyprussubmittedanapplicationforfinancialassistance. Spainwaspromisedassistancetorestructureitsbankingsector inJuly2012. In summer2012,thecrisisreachedatemporaryclimaxwhenthetensiononthebondmarketsofthetwo largeeconomiesItalyandSpainhardened. Finally,theburdenofdealingwiththecrisishasshiftedfurthertothecentralbanks. Withtheincreasingmixingofmonetaryandfinancialpolicy,therisksandsideeffectsofthepermanentcrisismanagementsincetheoutbreakofthefinancialcrisishaveincreased. TheEuropeanCentralBank(ECB)wasable topreventafurtherescalationofthedebtcrisis: In September2012,itannouncedthepurchaseofshort-termgovernmentbondsissuedbycertaincountries,withtheintenttolowermarketinterestrates. InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  44. P age |44 Thepreconditionforbuyingthegovernmentbondsisthatthecountryin questionmust obtainfundingaspartofaEuropeanrescueprogramme anduseit toconsolidateitsbudget. In October,theEuropeangovernmentsalsoagreedonatimetabletointroduceauniformEuropeansupervisorymechanism,whichassignstheECBfar-reachingcompetencesandresponsibilitiestosecurefinancialstability. Sincethebeginningof2013,thecrisisonthefinancialmarketshasmeanwhileworsenedagainsome-what. ThepoliticaluncertaintyaftertheelectionsinItalyandtheworseningofthecrisisinCyprushave,afteranextendedphaseofquietermarkets,madeclearthattheregionisstillfarfromatruesolutiontothecrisis. However,the overallrestrainedreactionofthefinancialmarketshasalsoshownthatthemeasuresforcalmingthemarketsandcombatingthecrisisadoptedbytheECBandthegovernmentshavecertainlyhadastabilizingeffect. WhiletheriskpremiumsforItaliangovernmentbondsroseslightlyintheinterim,theywereslightlylowerattheendofAprilagainthaninJanuary,andfarbelowthelevelofsummeroflastyear. Riskscontinue to arisefromthelinkagesbetweenbanks andtheirhome countries,whichcanaggravateproblemsin bothdirections. In thecountriesdirectlyaffectedbythedebtcrisis,bankshaveincreasedinvestmentsinthegovernmentbondsoftheirowncountries. Thankstothis,thefinancialsituationoftheaffectedstateshaseased,thoughtherisk potentialforthefinancialinstitutionsdue tocreditandmarketriskshasgrown. Ontheotherside,thelinkagesincreasethedangerthatacrisisofamajorfinancialinstitutioncouldspreadtothestate,andthatthebailoutwould bemorethanthestatecouldafford. InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  45. P age |45 ApartfromtheEuropeandebtcrisis,thelow interestrateenvironmentalsorepresentsariskforthelong-termmaintenanceofLiechtenstein'sfinancialstability. Thelow interestrateenvironmentgivesinvestorsincentivestoinvestinriskiermarketsegmentsintheirsearchforhigheryieldsandin thatwayunavoidably tobuildupriskpositions,whichmighthaveanadverseimpactespeciallyoninstitutionalinvestorssuchaspensionschemesandinsurances. Themassiveequitypricegainsin2012insomeareasandtheachievementofnewrecordsinarealeconomicenvironmentofstagnationorevenrecession(Eurozone)canbeseenasasignofthepotentiallymisguidedincentives. Thelow interestrateenvironmenthasalsofavouredtheincreaseinrealestateprices.Forthisreason,theFMAhasstrengthenedriskcontrollingintherealestateandmortgagemarket. LiechtensteinFinancialCentre TheLiechtensteinfinancialsystemhasfunctionedreliablyoverthepastfiveyearsin anextremelydemandingmarketenvironment. Theearningssituationimprovedagainin2012,afterearningsfellto ahistoriclow inthepreviousyear. Assetsundermanagementinthefundsectorgrewin2012,benefitingfromtheincreaseinsecuritiesprices. ThechallengesfortheLiechtensteinfinancialcentrearegreat,however:Thecostratioofthebanksisunfavourable. Theshort-andmedium-termearningsandgrowthoutlookinthefinancialsectorcontinuestoberestrained. Persistentlydifficultmarketconditionsandanincreasein regulatoryandadministrativeefforts mustbeexpected. InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  46. P age |46 • Fortheinsuranceindustry,thelow interestratelevelrepresentsachallenge,althoughLiechtensteininsurancesmainlymarketfund-linkedlifeinsurancepro-ductscharacterizedbythefactthattheinvestmentriskremainswiththepolicyholder. • TheLiechtensteinbankingsystemhasfurtherimproveditsrisk capacitysincetheoutbreakoftheglobalfinancialcrisis. • Core capitalresourceshaveincreased,andequityratiosexceedtheinternationalstandards. • Also,thebankshavegoodliquiditybuffers,sothattheresilienceoftheLiechtensteinfinancialsectorcancontinue tobedeemedhigh. • Banks:Attheendof2012,Liechtensteinbanksincludingforeigngroupcompaniesmanagedclientassetsin theamountofCHF184billion. • Thisrepresentsanincreaseof11.1%comparedwiththepreviousyear. • Thenetinflowofnewassetsin2012wasCHF 13.2billion,comparedwithCHF 7.0billioninthepreviousyear. • Insuranceundertakings:Premiumincomein2012fellby12%toCHF 4.2billion,ofwhichCHF3.3billionwasgeneratedbylife insurances,CHF0.84billionbynon-lifeinsurances,andCHF0.05billionbyreinsurances. • ThebalancesheettotaloftheinsuranceundertakingswasaboutCHF • 32.3billion(previousyear:CHF30.5billion). – Investmentundertakings(funds):Thetotalnetassetsroseby5%in 2012 to CHF 37.2billion. – Assetmanagementcompanies:Theassetsmanagedbythe companiesroseby8%toCHF 23.5billion. Ofthatamount,CHF 17.1billionareinvestedatLiechtensteinbanks. InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  47. P age |47 Regulatorydevelopments ImplementationofCRDIVandCRRrules Withtheupcomingbankingregulation– themostsubstantialsofar– whichwillincorporatetheinternationalstandardsalsoknownasBaselIIIintoEUlaw,theEUbankingsectoristobemademoreresilient. Forthispurpose,newruleson capitalresources,anewgovernanceframework,andauniformregulatoryframeworkarebeingcreated. Thesecomprehensiveandtechnicallydemandingruleswillbeinstitutedintheformofadirective(CRDIV)tobetransposedintonationallawandadirectlyapplicableregulation(CRR). Theenormousscope coversfarmorethan1,000pagesofnewrules, additionallysupplementedbymorethan70standardsoftheEuropeanBankingAuthority,mostofwhicharebinding. Implementationofcrisismanagementrules Withthecrisismanagementrules,auniformframeworkinEuropeforcrisismanagementandreso-lution(restructuringandorderlydissolution)inrespectofbanks andinvestmentfirmsis to thecrea-ted.Implementation–someofwhichiscomplex– willbeintheformofadirective. In mid-2012,theEuropeanCommissionpublishedaproposalforadirectiveoftheEuropeanParliamentandtheCouncilestablishingaframeworkfortherecoveryandresolutionofcreditinstitutionsandinvestmentfirms. Prevention,earlyintervention,andalsotheresolutionofbanks andinvestmentfirmsarebeingharmonizedbylawforthefirsttime. ThisprojectwithsubstantialmarketimpactenjoystoppriorityonthepartoftheEuropeanCommission,sothatadecisionisexpectedalreadyin2013. InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  48. P age |48 Implementationofmarketabuserules Withthemarketabuserules,theexistingframeworkforensuringmarketintegrityandinvestorprotection,establishedbytheMarketAbuseDirective2003/6/EC,isbeingadjustedtothecurrentmarketrealityandstrengthened. Animportantcomponentisanexpansionofthescope–suchasinclusionofspotmarkets–andthecompetencesofthecompetentauthoritiesaswellasEuropeanharmonizationandtighteningofpenalties. ImplementationoftheMortgageDirective Theglobalfinancialmarketcrisishasexposedweaknessesintheregulationoflending. Forthisreason,anewEUdirectiveisintendedtoimprovetheprotectionofborrowers. Thenewrulesgovernissuessuchassolicitation,pre-contractualinformation,advising,creditassessments,andearlyrepayment. ForeignAccountTaxComplianceAct(FATCA) ThisUSlegislationprovidesthatforeignfinancialintermediariesmustidentifytheirUSclientsanddeliverinformationconcerningthemtotheUStax authorities. Non-cooperativefinancialintermediariesarethreatenedwitha30%withholdingtaxonincomefromUSfinancialinstrumentsandonincomefromthesalethereof. Atthebeginningof2013,theUSTreasuryandtheInternalRevenueService(IRS)publishedtheFinalRegulations,definingvariouskeypointssuchastheregistrationportaloftheIRS,informationreporting,andfirst-timedeductionsoncertainpaymentsstarting1January2014. InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  49. P age |49 PartialtranspositionofDirective2009/14/EC(depositguarantee,2ndphase) In the2ndphaseofimplementationoftheDepositGuaranteeDirective,thetimeperiodsfordeter-miningclaimsandmakingpayoutsunderthedepositguaranteeschemeare tobereducedandthecoverage amountsslightlyincreased. Theimplementationdraftisavailableandisplannedfortrans-positionintoLiechtensteinlawatthebeginningof2014 ImplementationoftheAIFMDirective On19December2012,LiechtensteinadoptedtheLawonAlternativeInvestmentFundManagers(AIFMAct). TheAIFMActandtheassociatedordinance(AIFMOrdinance)enteredintoforceon22July2013. Liechtensteinhas accordinglytransposedtheAIFMDirective2011/61/EUintonationallawbeforethedeadlineapplicabletoEUmemberstates. ForEuropeanmarketaccess,EEA/EFTAstatesmustincorporatetheAIFMDirectiveintotheEEAAgreement. TheEUpassport,whichisnecessaryforcross-bordermanagementandmarketingofalternativefundsthroughoutEurope,willbecomepartoftheauthorizationonlyoncetheincorporationiscompleted. Shortsales On14March2012,theEuropean legislativepoweradoptedtheRegulationonshortsellingandcertainaspectsofcreditdefaultswaps. UncoveredshortsalesofsharesandsovereigndebtoftheEUstatesandtheEUarenow prohibited. InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

  50. P age |50 Additionally,creditdefaultswapsonsuchgovernmentbondsthatdonotserveahedgingpurposearealsoprohibited. Theregulationenteredintoforceon25March2012,anditsessentialpartshavebeendirectlyapplicablesince1November2012. Theprocessofincor-porationintotheEEAAgreementisunderway. EuropeanMarketInfrastructureRegulation(EMIR) On4July2012,theEuropeanlegislativepoweradoptedtheRegulationonOTCderivatives,centralcounterpartiesandtraderepositories(EMIR). EMIRprovidesthatstartingin2013,standardizedOTCderivativecontractsmaynolongerbeconcludedbilaterally,butmustnecessarilybeclearedthroughcentralcounterpartiesandreported to traderepositories. Instruction ontheheadoffice Bywayofaninstruction,theFMAhasdefinedtherequirementsfortheheadofficeofaninsuranceundertakingorpensionfundinLiechtenstein. Theinstructionservestofurtherspecifythesuper-visoryrequirementsandsetoutaminimumstandard. AmendmentstotheInsuranceSupervisionOrdinance(ISO) AspartofthecompletedrevisionoftheISO,amendmentsweremadetotheprovisionsgoverninggroupandconglomeratesupervision. Theminimumguaranteefundinlife,non-life,andreinsurancewasalsoincreased. TranspositionoftheSolvencyIIDirective2009/138/EC SolvencyIIestablishesanewEuropeansupervisorysystemprovidingappropriatequalitativeandquantitativetoolstothesupervisory InternationalAssociationofRiskandComplianceProfessionals(IARCP)www.risk-compliance-association.com

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