97. For the purposes of its discussions, the Tripartite Group defined "mixed conglomerates" as those groups which are predominantly commercially or industrially oriented, but contain at least one regulated financial entity (which is more than merely a "captive" entity doing business only on behalf of the group) in some part of their corporate structure. Typically, mixed conglomerates would be headed by a commercial or industrial company (or by an unregulated non-financial holding company) with the regulated entities embedded downstream in the group structure.

98. While legislation in some countries limits the extent to which non­financial ("commercial") and financial activities may be combined, other countries have found that such mixing provides additional support for financial activities, which is beneficial to the market and to the economy as a whole. Indeed, in some countries such links between financial and non­financial entities in the same group have existed widely and continue to exist. Where regulators have not adopted the approach of separation of financial and non­financial activities, they need to deal with potential contagion risk as best they can. The traditional approach of securities regulators, for example, is to apply qualification standards to managers and shareholders of the regulated entities and stringent capital requirements to the regulated entity; at the same time, a qualitative assessment of the risks assumed elsewhere in the group is undertaken.

99. At the heart of the problem facing regulators in respect of mixed conglomerates is the difficulty in assessing overall capital adequacy. Unlike financial conglomerates, where information on non­regulated entities can be meaningfully included in a capital assessment of the group as a whole (see next chapter), this is just not possible where commercial or industrial companies are involved. Supervisory rules and practices cannot be extended to them in the same way as they might be to non­regulated financial entities.

100. The Tripartite Group is of the view that the best way regulators can ensure that standard regulatory practices and rules are adhered to by the regulated financial entities which form part of a mixed conglomerate is to implement some form of ring­fencing procedure. The most straightforward way of doing this - short of prohibiting mixed conglomerates entirely ­ would seem to be to insist on a legal and organisational separation of the financial parts of a mixed conglomerate from the rest of the group. This could be achieved by the establishment of an intermediate holding company which would enable regulators to supervise the financial entities of a mixed conglomerate in much the same way as financial conglomerates. Similarly, it might be that much easier to ascertain those managers who need to satisfy their supervisors with regard to their fitness and propriety. In many cases, it might be advantageous for all financial entities to be grouped together in a financial sub­group, thus facilitating the imposition of any restrictive measures the supervisor deemed to be necessary in order to satisfy supervisory concerns.

101. Compared with financial conglomerates, mixed conglomerates raise some rather different issues for regulators and can demand a fundamentally different approach. For example, assuming that ownership of the regulated entity by the commercial or industrial company is not precluded by legislation, then the supervisor needs to consider the reputational risk of the regulated entity being owned by the company in question ­ i.e. the extent to which the regulated entity is exposed to contagion risk as a result of being part of that commercial or industrial group. Such contagion risk could be psychological to the extent that the business of the regulated entity could be affected by any adverse publicity and the like related to the commercial or industrial enterprise. However, of more concern to regulators perhaps would be the risk of contagion arising as a result of financial transactions between the regulated entities and the non­regulated non-financial parts of the group. A mixed conglomerate is different from a financial conglomerate in this respect in that opportunities exist for intra­group funding of the group's own commercial and industrial activity. For this reason, it is especially important that regulators establish that management and decision­taking processes within the financial entities are independent from the non­financial activities (i.e. that business is conducted on terms prevailing in the market in general at the time). Clearly, there is scope for discretion in this area, but supervisors need to be satisfied that, as a general rule, intra­group business is not being conducted on terms which are significantly below those prevailing generally. Only in certain circumstances would such favourable treatment be justified.

102. Even where intra­group business is being conducted at "arms' length", it may also be appropriate for the regulator to assess whether the mere existence of transactions between the regulated company and the other parts of the group is likely to have adverse effects on the regulated entity. For this purpose, some information about the non­financial entities would undoubtedly be required, but it would be important for regulators not to venture into areas which are beyond their sphere of responsibility and thus risking a situation of moral hazard. Only information which is relevant to the financial health or safety and soundness of the supervised entities should be collected.

103. Moreover, a supervisor who is asked to authorise an entity which is part of a mixed conglomerate is confronted by some difficult issues with regard to the assessment of fitness and propriety. It is possible for the people who are effectively managing a regulated entity to be situated in a holding company or a fully­fledged commercial or industrial company at the top of the group structure. Where this is the case, the people concerned may not be accustomed to having companies operating in a regulatory environment; they may be uncomfortable about dealing with regulators; and they might even be tempted to ignore usual supervisory practices. Where an individual's background is outside the financial sector, it certainly makes it more difficult for supervisors to assess whether the person in question is fit and proper to manage the regulated entity. An organisational separation of financial activities from non-financial activities in a mixed conglomerate, with the former presided over by someone with a proven track record in the financial field, would be a welcome development for supervisors of the financial entities.