Circular NBB_2016_08 on the Treatment of Affiliated Undertakings, Including Participations

NBB_2016_08 – 25 April 2016 Circular – Page 1/9 boulevard de Berlaimont 14 – BE-1000 Brussels tel. +32 2 221 38 12 – fax + 32 2 221 31 04 company number: 0203.201.340 RPM Brussels www.bnb.be

Circular
Brussels, 25 April 2016
Reference: NBB_2016_08 your contact:
Patricia Kaiser tel. +32 2 221 34 31 – fax +32 2 221 31 04 patricia.kaiser@nbb.be

Circular regarding the treatment of affiliated undertakings, including participations

Scope
Belgian insurance or reinsurance undertakings.
Insurance or reinsurance undertakings that are part of a Belgian group within the meaning of Article 339, 2° of the Law of 13 March 2016 on the status and supervision of insurance or reinsurance undertakings.
Belgian undertakings that are part of a Belgian financial conglomerate within the meaning of Article 340, 1° of the aforementioned Law of 13 March 2016.
Branches of undertakings from third countries carrying on insurance [or reinsurance] activities in Belgium.
This circular applies to mutual insurance undertakings defined in Article 15, 79° of the aforementioned Law of 13 March 2016. For these undertakings, "the Bank" should be replaced by "the Office for the Supervision of Mutual Societies and National Unions of Mutual Societies" as defined in Article 15, 84° of the same Law. This circular does not apply to insurance undertakings referred to in Articles 275, 276 or 294 of the aforementioned Law of 13 March 2016.

Summary/Objectives
This circular aims to provide clarification on the identification and treatment of affiliated undertakings and participations.

Legal References
The Law: The Law of 13 March 2016 on the status and supervision of insurance or reinsurance undertakings.
Regulation 2015/35: Delegated Regulation (EU) 2015/35 of the Commission of 10 October 2014 supplementing Directive 2009/138/EC of the European Parliament and of the Council on the taking-up and pursuit of the business of Insurance and Reinsurance (Solvency II).

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Structure
I. Objectives
II. Definitions
III. Supplementary Information
IV. Entry into Force
V. Guidelines on the Treatment of Affiliated Undertakings, Including Participations

Madam,
Sir,

I. Objectives
This circular concerns Articles 68, 168 and 171 of Regulation 2015/35, without prejudice to the provisions of Article 84 of that same Regulation.
For the purposes of this circular, the participating undertaking is the undertaking that calculates its solvency. The term "affiliated undertaking" refers to any affiliated undertaking of that participating undertaking. The term "participation" refers to a type of affiliated undertaking. Annex A of this circular provides an overview of the different terms used in the Law regarding the relationship between two or more undertakings. This circular covers, on the one hand, the treatment of all affiliated undertakings in the calculation of the required solvency capital (hereinafter "SCR") and, on the other hand, the calculation of own funds in the case of participations in financial or credit institutions. The meaning given to the term "financial or credit institution" is explained in Annex A of this circular. The guidelines follow a holistic approach. They first describe the identification of the different types of affiliated undertakings, including participations. They then cover the treatment of the different types of affiliated undertakings, including participations in financial or credit institutions and strategic participations. They conclude with clarifications on the treatment of affiliated undertakings in the standard formula or internal model used to calculate the SCR. When the guidelines refer to the valuation or value of an affiliated undertaking, reference should be made to Article 13 of Regulation 2015/35. The guidelines concern the treatment of affiliated undertakings, including participations, at the individual level. In most cases, the identification of an affiliated undertaking is the same from the perspective of the participating undertaking as an individual entity as from the perspective of the group. However, in some cases, there are differences: depending on the activities of the affiliated undertaking, the participating undertaking and the affiliated undertaking may not be subject to group supervision provided for in Articles 343 to 345 of the Law. Furthermore, in some cases, several entities of the same group may hold voting rights or capital in an undertaking which, combined, represent 20% or more of the voting rights or capital of the undertaking. In this case, this undertaking is identified as an affiliated undertaking at the group level. However, if the participation of each individual entity of the group is less than 20%, the undertaking is not identified as an affiliated undertaking of those entities at the individual level. In some cases, provisions established by individual entities for affiliated undertakings are used to calculate the contribution of these undertakings to the group's SCR. These circumstances are presented in Regulation 2015/35 and specified in the circular on group solvency which aims to define and harmonize the requirements for the calculation of group solvability.

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Annex B of this circular provides, in the form of a decision tree, a method for treating all types of affiliated undertakings. Additional analyses and calculations are necessary for indirect participations in financial and credit institutions, as indicated in Guideline 4 and Guideline 7. In some cases, the treatment of participations is identical to that which would result from the application of the standard formula in the absence of any participation.

II. Definitions
In the absence of a definition in this circular or its annexes, the terms have the meaning defined in the legislative and regulatory acts referred to therein.

III. Supplementary Information
This circular is part of the harmonized implementation of the principles of Directive 2009/138/EC of the European Parliament and of the Council of 25 November 2009 on the taking-up and pursuit of the business of Insurance and Reinsurance (Solvency II), as determined by the guidelines of the European Insurance and Occupational Pensions Authority. Undertakings may consult these guidelines for information purposes at the following address: https://eiopa.europa.eu/publications/eiopa-guidelines.

IV. Entry into Force
This circular applies from 23 March 2016.

V. Guidelines on the Treatment of Affiliated Undertakings, Including Participations.
Section 1 – Identification of Participations
Guideline 1 – Identification
Participating undertakings should identify their affiliated undertakings and participations based on an assessment from their perspective as an individual entity.
To identify an affiliated undertaking based on its share in capital, directly or through a control link, participating undertakings should calculate:
(a) the voting rights they hold, as a percentage of the voting rights of the undertaking; (b) the shares they hold in the share capital issued by the undertaking, all classes combined, as a percentage of the issued share capital of the undertaking concerned, without regard to voting rights. If the participation (a) or (b) is equal to or greater than 20%, the participating undertaking should treat its holding in the undertaking concerned as a participation. If the participation is held in an insurance or reinsurance undertaking subject to the Solvency II Directive, the assessment made in point (a) generally relates to the issued ordinary share capital referred to in Article 69, point a), sub-i), of Regulation 2015/35 and the assessment made in point (b) relates to the issued ordinary share capital and paid-up preference shares referred to in Article 69, point a), sub-v), of Regulation 2015/35. Participating undertakings should ensure that they can identify the impact of any change in the share capital of affiliated undertakings on the assessment described in the preceding paragraph, and this each time the participating undertaking calculates its SCR in accordance with Article 152 of the Law.

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To identify an affiliated undertaking in accordance with Article 338, 4° of the Law on the grounds that the participating undertaking may exercise dominant or significant influence over another undertaking, the Bank will take into account:
(a) the shareholdings of the participating undertaking in the undertaking and any potential increase due to the holding of options, warrants or similar instruments; (b) the social rights of the participating undertaking in a mutual society or in a mutual-type undertaking and any potential increase in these rights; (c) the presence of the participating undertaking in the administrative, management or supervisory body of the undertaking; (d) the involvement of the participating undertaking in the undertaking's policy-making processes, including decisions concerning dividends or other distributions; (e) significant transactions between the participating undertaking and the undertaking; (f) changes in the management of the participating undertaking and the undertaking; (g) the provision of essential technical information to the undertaking; (h) the unified management of the participating undertaking and the undertaking. The Bank will examine any initial assessment by the participating undertaking in accordance with points (a) to (h) of this paragraph.

Guideline 2 – Identification of participations in financial or credit institutions Participating undertakings should treat an affiliated undertaking as a financial or credit institution if that institution is covered by Article 15, 49°, b) of the Law, or Article 15, 48° of the Law, or Article 15, 47° of the Law. These descriptions cover any institution performing the functions or activities described in accordance with these articles, regardless of whether the institution may not be subject to supervision organized by Directives 2013/36/EU or 2004/39/EU. Participating undertakings should ensure that any participation in a financial or credit institution in which voting rights or capital are held indirectly is treated in the same way as a participation in a financial or credit institution in which voting rights or capital are held directly.

Guideline 3 – Identification of a strategic participation Participating undertakings should identify strategic participations in accordance with Article 171 of Regulation 2015/35, as follows:
(a) participating undertakings using the standard formula to calculate their SCR should identify strategic participations regardless of whether their participation is in an insurance or reinsurance undertaking, in a financial or credit institution, or in another affiliated undertaking;

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(b) participating undertakings using an internal model to calculate their SCR should identify strategic participations in financial or credit institutions only to determine whether Article 68, paragraph 3, of Regulation 2015/35 should be applied.
To prove that they comply with the requirements of Article 171 of Regulation 2015/35, participating undertakings should not divide a participation into several parts and treat some parts as strategic participations and others as non-strategic participations. If a participation is identified as strategic:
(a) if it is a participation in a financial or credit institution, all holdings in its own funds are strategic; (b) if it is any other affiliated undertaking, all shareholdings in the participation are strategic.
To demonstrate that the value of the shareholding is likely to be much less volatile, in accordance with Article 171, point a), of Regulation 2015/35, participating undertakings should ensure:
(a) that consistent and appropriate valuations are applied over time to the participation and to other shares chosen for comparison; (b) that they take into account the impact of their influence on the value of the participation.
To demonstrate that the nature of the holding is strategic, in accordance with Article 171, point b), sub-i) to iii), of Regulation 2015/35, participating undertakings should:
(a) indicate the period during which the holding strategy for the participation is expected to be applied; (b) take into account the impact of market conditions on key policies; (c) identify any significant factor affecting the participating undertaking's ability to maintain its strategy or imposing constraints on that ability, and how it might be remedied. To demonstrate the existence of a lasting link, in accordance with Article 171, point b), sub-iv), of Regulation 2015/35, participating undertakings should take into account the following criteria:
(a) whether there is a stable relationship between the two undertakings over time; (b) whether this stable relationship arises from a close economic link, the sharing of risks and benefits between the undertakings, or the exposure of one undertaking to the risks of the other; (c) the nature of the relationship between the two undertakings, for example, shareholding, common products or distribution channels, cross-sales, the creation of joint ventures or other long-term operational or financial links. Pursuant to Article 171, point b), sub-v), of Regulation 2015/35, a participating undertaking that is part of a group should consider that the key policies guiding or limiting the actions of the group are those defined by the parent undertaking or, if different, by the undertaking defining the key policies for the group as a whole. Participating undertakings should document their examination of the matters stipulated in Article 171 of Regulation 2015/35 and the paragraphs above, including notably any other relevant factor and supporting documentation.

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Holdings in insurance or reinsurance undertakings equal to or greater than 90%, where the legal administrative bodies or management committees are composed of a majority of the same persons, are presumed to be strategic participations until proven otherwise.

Section 2 – Treatment of participations held in credit institutions or financial institutions under Article 68 of Regulation 2015/35 - deduction of the participation
For reminder, Article 68 of Regulation 2015/35 regarding the treatment of participations in the determination of basic own funds provides that:
"1. For the purpose of determining the basic own funds of insurance and reinsurance undertakings, the basic own funds, as referred to in Article 88 of Directive 2009/138/EC, shall be reduced by the total value of participations held in credit institutions or financial institutions, as referred to in Article 92, paragraph 2, of that Directive, which exceeds 10% of the value of the items referred to in Article 69, point a), i), ii)), iv) and vi).
2. For the purpose of determining the basic own funds of insurance and reinsurance undertakings, the basic own funds, as referred to in Article 88 of Directive 2009/138/EC, shall be reduced by the fraction of the value of all participations held in credit institutions or financial institutions, as referred to in Article 92, paragraph 2, of that Directive, which exceeds 10% of the value of the items referred to in Article 69, point a), i), ii)), iv) and vi).
3. Notwithstanding paragraphs 1 and 2, insurance and reinsurance undertakings shall not deduct strategic participations, as referred to in Article 171, which are taken into account in the calculation of group solvency on the basis of method no 1 set out in Annex I of Directive 2002/87/EC.
4. The deductions provided for in paragraph 2 shall be applied pro rata to all participations referred to in that paragraph.
5. The deductions provided for in paragraphs 1 and 2 shall be made as follows at the own funds level where the participation has increased the own funds of the affiliated undertaking:
(a) tier 1 common equity holdings of credit institutions and financial institutions shall be deducted from the items referred to in Article 69, points a) i), a) ii), a) iv) and a) vi); (b) tier 1 additional own funds instruments of credit institutions and financial institutions shall be deducted from the items referred to in Article 69, point a), iii) and v), and point b); (c) tier 2 own funds instruments of credit institutions and financial institutions shall be deducted from the basic own funds items referred to in Article 72."

Guideline 4 – Scope of calculation for the purposes of Article 68 of Regulation 2015/35 To calculate the value of participations in financial or credit institutions for the purposes of Article 68 of Regulation 2015/35, participating undertakings should include shareholdings and any other own funds items, whether their holding is direct or indirect. Participating undertakings should apply the following approaches:
(a) regarding direct participations, the value of participations in financial or credit institutions, as calculated by the participating undertaking in accordance with the valuation principles of the Solvency II Directive, should be used for the purposes of Article 68 of Regulation 2015/35, as indicated in Guideline 5; (b) participations in financial or credit institutions held indirectly through another participation in a financial or credit institution should not be taken into account under Article 68 of Regulation 2015/35, as their value is normally included in the value of the participation in a financial or credit institution held directly, in accordance with point (a); (c) a deduction for a participation in a financial or credit institution held indirectly is only applicable if the affiliated undertakings between the participating undertaking and the participation in the financial or credit institution are not participations in a financial or credit institution; (d) regarding other indirect participations in a financial or credit institution, the value of the relevant participation, calculated by the affiliated undertaking in accordance with Article 13 of Regulation 2015/35, should be used for the purposes of Article 68 of Regulation 2015/35; (e) the values used for the purposes of Article 68 of Regulation 2015/35 should represent the proportional share of the participating undertaking, held directly or indirectly, in the participation in the financial or credit institution.

Guideline 5 – Calculations for the purposes of Article 68 of Regulation 2015/35 To calculate the 10% of items included in Article 69, point a), sub-i), ii), iv) and vi), of Regulation 2015/35 for the purposes of Article 68 of Regulation 2015/35, participating undertakings should use the amount of basic own funds items before any deduction made under Article 68 of Regulation 2015/35 regarding participations in financial or credit institutions. If the value of all participations in financial or credit institutions, with the exception of the participations cited in Article 68, paragraph 1, of Regulation 2015/35, does not exceed 10% of the items included in Article 69, point a), sub-i), ii), iv) and vi), of Regulation 2015/35 for the purposes of Article 68, paragraph 2, of Regulation 2015/35, no deduction occurs and Guideline 8 or 9 applies. Participating undertakings should only apply Article 68, paragraph 3, of Regulation 2015/35 if:
(a) they have demonstrated, in accordance with Guideline 3, that the participation meets the criteria for a strategic participation; (b) the participating undertaking and the participation are included in the calculations according to method no 1 in accordance with Directive 2002/87/EC for the financial conglomerate to which they belong, or according to method no 1 in accordance with Article 2 § 1st of Annex V of the Law.

Guideline 6 – Deductions relating to participations in financial or credit institutions If the deductions provided for in Article 68, paragraphs 1 and 2, of Regulation 2015/35 cannot be made at the corresponding level, as defined in Article 68, paragraph 5, of Regulation 2015/35, undertakings should adopt the following approaches:
(a) if the items to be deducted are not classified in the levels defined in Article 68, paragraph 5, of Regulation 2015/35, all deductions should be made on the amount of items included in Article 69, point a), sub-i), ii), iv) and vi), of Regulation 2015/35; (b) if the amount of the deduction exceeds the amount from which it is supposed to be deducted in accordance with Article 68, paragraph 5, of Regulation 2015/35, the excess should be deducted as follows:
(i) tier 1 additional own funds instruments exceeding the items included in Article 69, point a), sub-iii) and v), and point b), of Regulation 2015/35

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should be deducted from the items included in Article 69, point a), sub-iii) and v), and point b), of Regulation 2015/35; (ii) tier 2 own funds instruments exceeding the basic own funds items referred to in Article 72 of Regulation 2015/35 should be deducted from the basic own funds items referred to in Article 72 of Regulation 2015/35.

Guideline 7 – Treatment of indirect participations in financial or credit institutions Participating undertakings should calculate the value of indirect participations in financial or credit institutions in accordance with Guideline 4.
If the participating undertaking holds a participation in a financial or credit institution directly, and that financial or credit institution holds a participation in another financial or credit institution, the participating undertaking should not take into account the indirect participation in the second financial or credit institution for the purposes of Article 68 of Regulation 2015/35, as its value is included in the value of the direct participation. If the participating undertaking holds a participation in a financial or credit institution indirectly, through an affiliated undertaking that is not a financial or credit institution, the participating undertaking should take into account the indirect participation for the purposes of Article 68 of Regulation 2015/35. The value of this indirect participation should be calculated by the affiliated undertaking in accordance with Article 13 of Regulation 2015/35.

Guideline 8 – Treatment of participations in financial or credit institutions not subject to deduction Participating undertakings should treat participations in financial or credit institutions that are not subject to deduction under Article 68 of Regulation 2015/35 in accordance with the standard formula or internal model used to calculate the SCR. If the participating undertaking uses the standard formula, it should apply the standard formula to these participations, taking into account the specific characteristics of financial or credit institutions. If the participating undertaking uses an internal model, it should apply its internal model to these participations, taking into account the specific characteristics of financial or credit institutions.

Guideline 9 – Treatment of strategic participations in financial or credit institutions Participating undertakings should treat strategic participations in financial or credit institutions in accordance with Article 68, paragraph 3, of Regulation 2015/35. If the participating undertaking uses the standard formula, it should include the value of strategic participations in financial or credit institutions in the calculation of the SCR, taking into account the specific characteristics of financial or credit institutions. If the participating undertaking uses an internal model, it should include the value of strategic participations in financial or credit institutions in the calculation of the SCR, taking into account the specific characteristics of financial or credit institutions.

Guideline 10 – Treatment of participations in insurance or reinsurance undertakings Participating undertakings should treat participations in insurance or reinsurance undertakings in accordance with the standard formula or internal model used to calculate the SCR. If the participating undertaking uses the standard formula, it should apply the standard formula to these participations, taking into account the specific characteristics of insurance or reinsurance undertakings. If the participating undertaking uses an internal model, it should apply its internal model to these participations, taking into account the specific characteristics of insurance or reinsurance undertakings.

Guideline 11 – Treatment of strategic participations in insurance or reinsurance undertakings Participating undertakings should treat strategic participations in insurance or reinsurance undertakings in accordance with Article 171 of Regulation 2015/35. If the participating undertaking uses the standard formula, it should include the value of strategic participations in insurance or reinsurance undertakings in the calculation of the SCR, taking into account the specific characteristics of insurance or reinsurance undertakings. If the participating undertaking uses an internal model, it should include the value of strategic participations in insurance or reinsurance undertakings in the calculation of the SCR, taking into account the specific characteristics of insurance or reinsurance undertakings.

Guideline 12 – Treatment of participations in other affiliated undertakings Participating undertakings should treat participations in other affiliated undertakings in accordance with the standard formula or internal model used to calculate the SCR.
If the participating undertaking uses the standard formula, it should apply the standard formula to these participations, taking into account the specific characteristics of other affiliated undertakings.
If the participating undertaking uses an internal model, it should apply its internal model to these participations, taking into account the specific characteristics of other affiliated undertakings.

Guideline 13 – Treatment of strategic participations in other affiliated undertakings Participating undertakings should treat strategic participations in other affiliated undertakings in accordance with Article 171 of Regulation 2015/35.
If the participating undertaking uses the standard formula, it should include the value of strategic participations in other affiliated undertakings in the calculation of the SCR, taking into account the specific characteristics of other affiliated undertakings. If the participating undertaking uses an internal model, it should include the value of strategic participations in other affiliated undertakings in the calculation of the SCR, taking into account the specific characteristics of other affiliated undertakings.

Guideline 14 – Documentation
Participating undertakings should document their identification and treatment of affiliated undertakings and participations, including strategic participations.
This documentation should include, where relevant, the calculations performed, the assumptions made, and the justifications for the treatment applied.

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Annex A – Overview of terms used in the Law regarding the relationship between two or more undertakings
Affiliated undertaking: An undertaking in which a participating undertaking holds a participation, or over which it exercises dominant or significant influence.
Participation: A direct or indirect holding of capital or voting rights in an undertaking, or the ability to exercise dominant or significant influence over another undertaking.
Strategic participation: A participation that meets the criteria set out in Article 171 of Regulation 2015/35.
Financial or credit institution: An undertaking as defined in Article 15, 47°, 48° or 49°, b) of the Law.

Annex B – Decision tree for the treatment of affiliated undertakings
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are deducted from the items included in Article 69, point (a), points (i), (ii), (iv) and (vi), of Regulation 2015/35;

(ii) holdings in category 2 instruments exceeding the common equity tier 1 capital included in Article 72 of Regulation 2015/35 are deducted first from the items included in Article 69, point (a), points (iii) and (v), and point (b), of Regulation 2015/35 and secondly from the items included in Article 69, point (a), points (i), (ii), (iv) and (vi), of Regulation 2015/35, until the deduction is fully effected.

Orientation 7 – Adjustments due to deductions of holdings in financial or credit institutions held indirectly

If it is necessary to deduct the full or partial value of a holding in a financial or credit institution held indirectly, in accordance with Article 68 of Regulation 2015/35, participating undertakings should, solely for the purpose of calculating the SCR:

(a) reduce, by the amount of the relevant deduction, the value of the linked undertaking held directly, which forms part of the assets of the participating undertaking, through which the holding in the financial or credit institution is held indirectly;

(b) for the adjustment described in point (a), follow the approach defined in Article 68, paragraph 5, of Regulation 2015/35 and in Orientation 6.

Section 3 Treatment of holdings other than (non-strategic) holdings held in credit institutions or financial institutions - SCR Calculation

Orientation 8 – Application of the standard formula to linked undertakings

This orientation applies to all participating undertakings using the standard formula to calculate the SCR in respect of risks arising from linked undertakings held directly by the participating undertaking.

If a participating undertaking includes in its assets equity instruments of a linked undertaking and if their value is not deducted, in full or in part, from the own funds of the participating undertaking pursuant to Article 68 of Regulation 2015/35, the capital requirements for the risks arising from the remaining value of these holdings should be calculated according to the standard formula.

The participating undertaking should apply the standard formula as follows:

(a) holdings in ordinary or preferred shares of the linked undertaking should be treated as equities by applying the 'equities risk' sub-module as appropriate as well as all relevant sub-modules of the market risk module without prejudice to Article 84(4) of Regulation 2015/35;

(b) holdings in subordinated liabilities issued by the linked undertaking should be treated as financial instruments taking into account contractual terms and market stress, as appropriate, including by applying the 'interest rate risk', 'margin risk', 'foreign exchange risk', 'concentration risk' and other risk sub-modules;

(c) any of the aforementioned holdings presenting both equity and bond-like characteristics should be treated in accordance with Orientation 5 of the orientations on the treatment of market and counterparty risk exposures in the standard formula.

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Orientation 9 – Application of internal models to linked undertakings

This orientation applies to all participating undertakings using a full or partial internal model to calculate the SCR in respect of risks arising from linked undertakings.

If a participating undertaking includes in its assets equity instruments of a linked undertaking and if their value is not deducted, in full or in part, from the own funds of the participating undertaking pursuant to Article 68 of Regulation 2015/35, the risks arising from the remaining value of these holdings should be included in the internal model.

The participating undertaking should cover in its internal model all material quantifiable risks arising from its linked undertakings, taking into account its exposures to linked undertakings including any holdings in equity or subordinated liabilities. The model should reflect an appropriate assessment of these risks.

If a participating undertaking calculates the SCR at the individual entity level for a holding or a linked undertaking in a way that takes into account risks affecting the value of the underlying assets and liabilities of that linked undertaking, it should ensure that this calculation is appropriate at the individual entity level and should not replace this calculation with a consolidated calculation as if the participating undertaking and its linked undertaking formed a group within the meaning of the Solvency II Directive.

A copy of this circular is sent to the commissioner(s), approved auditor(s) of your undertaking.

We ask you to accept, Madam, Sir, the expression of our distinguished sentiments.

Jan Smets
Governor

Annexes: 2