The complexities of the current regulatory environment undoubtedly pose significant challenges for the broad spectrum of financial services companies, as regulators continue to expect management to demonstrate robust oversight, compliance and risk management standards. These challenges are generated at multiple, and sometimes competing, levels of regulatory authority, including state and local, federal and international, and, in some cases, by regulatory entities that have been newly formed or given expanded authority. Their demands are particularly pressing for the largest, most globally active firms, though smaller institutions are also struggling to optimize business models and infrastructure to better address the growing regulatory scrutiny and new expectations.
In the first part of this two-part series,
we covered the first five key regulatory issues we anticipate will have an impact on insurance companies this year. Here are the final five:
6. Transforming the Effectiveness and Sustainability of Compliance
Compliance continues to be a top concern for financial institutions and insurance companies as the pace and complexity of regulatory change, coupled with increased regulatory scrutiny and enforcement activity, have pushed concerns about reputation risk to new levels. These firms need to be able to respond to changes in their internal and external environments with flexibility and speed to limit the impact from potentially costly business shifts or compliance failures. To do so, however, can demand enhancements to the current compliance risk management program that build adaptability into the inter-relationships of the people, processes and technologies supporting compliance activities; augment monitoring and testing to self-identify compliance matters and expand root cause analysis; and integrate compliance accountability into all facets of the business. Compliance accountability starts with a strong compliance culture that is supported by the “tone from the top” and reaches across all three lines of defense, recognizing that each line plays an important role within the overall risk management governance framework. Transforming compliance in this way allows it to align on an enterprise-wide basis with the firm’s risk appetite; strategic and financial objectives; and business, operating, functional and human capital models.
7. Managing Challenges in Surveillance, Reporting, Data and Control
Driven largely by regulatory requirements and industry pressures
for increased speed and access, trade and transaction reporting has become increasingly complex. Capturing and analyzing vast amounts of data in real time remains a massive challenge for financial services firms, as regulators continue to initiate civil and criminal investigations and levy heavy fines on broker-dealers, investment banks and insurance companies based on failures to completely and accurately report required information. In addition, ensuring compliance with federal and state laws prohibiting money laundering, financial crimes, insider trading, front running and other market manipulations and misconduct remains critically important. In the coming year, it will be essential for financial institutions and insurance companies to reassess the strength and comprehensiveness of their compliance risk management programs to better manage and mitigate both known and emerging regulatory and legal risks and respond to prospective market structure reforms.
See Also: Should We Take This Risk?
8. Reforming Regulatory Reporting
The financial services industry, including the insurance sector, continues to face challenges around producing core regulatory reports and other requested financial information, as demands from both regulators and investors have increased exponentially in the wake of the financial crisis. For insurance companies, the IAIS faces a significant challenge as there is no common basis of accounting applied across jurisdictions, either for regulatory or financial reporting purposes. The need for consistent regulatory reporting has been highlighted by the efforts of the IAIS to develop an insurance capital standard for IAIGs as well as basic capital requirements (BCR) and a higher loss absorbency (HLA) for global systemically important insurers. The IAIS is moving toward a market-consistent basis of valuation for both assets and liabilities to underpin this effort. Complementing the work previously performed by the Financial Stability Oversight Council, which solicited comment on certain aspects of the asset management industry that included requests for additional financial information that would be helpful to regulators and market participants, the SEC published rules to modernize and improve the information reported and disclosed by registered investment companies and investment advisers (Investment Company Reporting Modernization, proposal published in June 2015).
Among other areas of reform, the SEC’s rule is intended to provide enhanced information that will be used to monitor risks in the asset management industry as a whole and increase the transparency of individual fund portfolios, investment practices and investment advisers, particularly for derivatives, securities lending and counterparty exposures. Fund administrators and managers will likely need to carefully contemplate and implement new governance, operational and reporting capabilities that will be necessary to support enhanced reporting and disclosure requirements.
9. Examining Capital
Recovery and Resolution Planning and the EPS for large U.S. bank holding companies, foreign banking organizations and insurance and nonbank financial companies have brought capital planning and liquidity risk management to the forefront, as regulators have sought to restore both public and investor confidence in the aftermath of the financial crisis. Financial institutions, including nonbank SIFIs, are required to demonstrate their ability to develop internal stress testing scenarios that properly reflect and aggregate the full range of their business activities and exposures, as well as the effectiveness of their governance and internal control processes. A growing number of state regulators have adopted the Own Risk and Solvency Assessments (ORSA) requirement to support insurers’ risk management and capital adequacy.
The international development of an insurance capital standard for IAIGs continues along with BCR and HLA requirements. In the U.S., the NAIC and state regulators are working closely with the Federal Insurance Office, the Federal Reserve and industry participants to develop a group capital assessment. Insurers, however, are challenged to fit capital requirements originally designed for banks into the insurance business model along with group capital into local entity capital requirements. The potential variability and current uncertainty resulting from these and other pending requirements may limit funding flexibility and make capital planning difficult, as financial institutions will need to consider the ties between capital and liquidity in areas such as enterprise-wide governance, risk identification processes, related stress testing scenarios and interrelated contingency planning efforts.
10. Managing the Complexities of Cross-Border Regulatory Change
The largest financial institutions and insurance companies must now understand and manage regulatory mandates across more jurisdictions and services than ever before. Regulatory obligations and cross-border pressure points continue to challenge global financial firms to move past their current reactionary mode of response to tackling high-impact regulatory change. For insurers and their regulators (both international and domestic), the integration of ComFrame (Common Framework) into local entity requirements as they are adopted by individual jurisdictions will be such a challenge. Anticipating the recognition of “equivalence” or a covered agreement for certain U.S. regulations under Solvency II for U.S. insurers operating in Europe is another. However, to address these challenges, financial institutions and insurance companies will need to consider implementing a regulatory change management framework that is capable of centralizing and synthesizing current and future regulatory demands and incorporates both internally developed and externally provided governance, risk management, and compliance regulatory change tools. This framework will enable financial entities to improve coordination across their operations and gain insights that can improve overall performance, ensure risk management and compliance controls are integrated into strategic objectives, avoid redundancy and rework and better address regulatory expectations in a practical and efficient way.
This piece was co-written by Amy Matsuo, Tracey Whille, David White and Deborah Bailey.