52. Intragroup exposures take the form of an often complex web of direct and indirect claims which entities within financial conglomerates typically hold on each other. The most transparent form of intra-group exposure is a credit or a line of credit which either the parent grants to a subsidiary or one subsidiary makes available to another subsidiary. Intragroup exposures, however, can originate in a variety of other ways: for example, through (a) intragroup cross shareholdings; (b) trading operations whereby one group company deals with or on behalf of another group company; (c) central management of shortterm liquidity within the conglomerate; (d) guarantees and commitments provided to or received from other companies in the group; and (e) the provision of such services as pension arrangements.
53. Intragroup exposures can have implications for both liquidity and the overall solvency of a conglomerate, connected to contagion risks. For example, if a life insurance company is placing its premiums on deposit with its own parent bank, this is not necessarily obvious to the supervisors. Such risks make it important for all regulators with responsibility for some part of a financial conglomerate to monitor carefully the intragroup exposures (both on and offbalancesheet) of the entities they regulate; it may also be desirable for them to be aware of the level of intragroup exposures within the financial conglomerate more generally. The Tripartite Group believes it to be important for regulators to be made aware in specific terms of the purpose of any intragroup exposures, whether they are long or shortterm in nature, whether they are self liquidating, and whether they are likely to be repeated or rolled over. Regulators in turn must seek to ensure that capital is increased or activities are limited if the risk which other companies pose to the regulated entity appear to be unacceptable.
54. The Tripartite Group considered the following questions:
- what types of intragroup exposures are relevant in the supervision of financial conglomerates? - how can such exposures be detected and monitored by supervisors?
- how readily do the supervisory approaches listed earlier in this paper address these problems? Are qualitative as well as quantitative methods needed?
- what limits, if any, should be applied and if so, how?
55. There was widespread agreement that all types of intragroup exposure are in principle relevant to the supervision of financial conglomerates. Intragroup exposures are considered to be particularly important for the following reasons:
- They determine the scope of the potential impact of contagion on individual entities and hence on the effectiveness of solo supervision; - They affect not only the solvency, but also the liquidity and the profitability of a group;
- They can be used as a means of supervisory arbitrage or of evading capital requirements altogether.
56. What sets intragroup exposures apart from exposures to third parties in the context of a financial conglomerate is that they will not necessarily be apparent to supervisors examining a consolidated balance sheet of the group as a whole (because the intragroup exposures will be netted out). Asset and liability exposures are likely to be equally relevant in this respect since they are both capable of causing contagion. Another important difference between intragroup exposures and exposures to third parties is that the former may be created on terms or under circumstances which parties operating at arms' length would not countenance.
57. It was felt that the least obtrusive way of detecting and monitoring most intragroup exposures would be to set aside parts of routine reporting forms and routine regulatory meetings (between the regulator and the regulated entity) for an analysis of intragroup transactions. Data on the following were considered to be particularly important:
- gross commitments; - amount, nature and residual maturity of the commitments;
- the profits and losses associated with intragroup transactions;
- confirmation that business is being conducted at market terms / conditions.
58. Where nonequity resources are upstreamed from a regulated subsidiary to the parent, it has been suggested that reporting requirements need to be complemented by capital standards which deal adequately with the resource transfer. The straightforward deduction from a subsidiary's capital of any amounts upstreamed to the parent was suggested as one way of ensuring the subsidiary's stability. Some members of the Tripartite Group viewed this as a particularly harsh penalty, but it really does no more than eliminate intragroup exposures; certain techniques for assessing capital adequacy in financial conglomerates would do this automatically (e.g. accountingbased consolidation and the building block prudential approach see chapter IV). Other demanding measures which supervisors might take in appropriate circumstances would be to give limited value to intragroup assets if there is any doubt about the financial status of the other group company or potential realisation problems. Alternatively, limits could be imposed on the amounts of additional intragroup exposure that a company could take on; or it could be prohibited from any further intragroup exposure.
59. Although the various techniques for assessing capital adequacy in financial conglomerates (see next chapter) take account of the equity investments and other intragroup exposures inside a group in assessing overall solvency and identifying instances of double gearing, they are essentially quantitative techniques. They do not include any analysis of intragroup nonequity commitments and of the likelihood that these could give rise to contagion. Additional qualitative techniques are considered necessary in order to assess the particular risks associated with such intragroup exposures (e.g. the recoverability of amounts due from group companies which may be in other jurisdictions).
60. The Tripartite Group takes the view that consideration of the potential problems of intragroup exposures is best tackled as an element of solo supervision, not least because the parent regulator's perspective is likely to be quite different from that of a subsidiary's regulator. From the point of view of the parent regulator, loans, guarantees and holdings of securities issued by the subsidiary add to the risk represented by the participation. This additional risk exposure is particularly relevant in the case of minority participations, where the parent's responsibility for the subsidiary and for classical exposures, such as guarantees and loans, takes on relatively more importance. From the subsidiary regulator's perspective, however, it is the risk of a resource transfer to the parent company which is of most concern. In an extreme case, the net transfer of resources from the parent to a subsidiary may be reversed if the subsidiary upstreams capital in the form of loans to the parent or the purchase of securities issued by the parent. Trading exposures could, of course, have the same effect. Parent and subsidiary regulators alike should be concerned with the purchase by a subsidiary of shares in its parent institution, and with the existence of extensive crossholdings by sister companies within a group.
61. Insurance regulators face an additional problem in the form of intragroup transactions with reinsurance companies because the reinsurance transaction reduces the risk to the insurance company by transferring it to another part of the group. However, if the reinsurance company is not included in the group-wide risk assessment as is the case in some jurisdictions where reinsurance is not regulated the group's risk will be underestimated.
62. The Tripartite Group agreed that intragroup exposures are a potential source of contagion between regulated (and unregulated) entities within a financial conglomerate. Solo supervisors (at both subsidiary and parent level) need to monitor carefully the extent of such exposures, including exposures to similar but unregulated businesses (e.g. in some countries, factoring, leasing and reinsurance). Within a framework of prudent principles the exercise of regulatory judgement on a casebycase basis is called for.
63. First and foremost, regulators need information about all types of intragroup exposure. Solo regulators should then ensure that the pattern of activity and aggregate exposure between the regulated entity for which they are responsible and other group companies is not such that failure of another group company (or the mere existence of such intragroup transactions) will undermine the regulated entity. Solo supervisors need to liaise closely with other group supervisors when uncertainties arise; they need powers to limit or prohibit intragroup exposures when necessary; and they should be particularly concerned about situations where funds are being invested by a subsidiary in securities issued by a parent, or are being deposited directly with a parent.