October 15, 2003

Anne Cools
Review of Capital Requirements
DG Internal Market
Unit F2 Banking and Financial Conglomerates
European Commission
B-1049 Brussels
Belgium

Dear Ms. Cools:

The Investment Company Institute appreciates the opportunity to comment on the Commission's Third Consultation Paper on Capital Requirements for Credit Institutions and Investment Firms. The Institute is the national association of the US investment company industry.¹ Many of our members manage European mutual funds and pension funds through their European-based affiliates.

The Third Consultation Paper provides the basis upon which the Commission expects to issue draft proposals for a directive on new capital requirements for credit institutions and investment firms in the European Union. The proposals in the Third Consultation Paper are based on the third consultation paper issued by the Basel Committee and would be implemented in the EU under the Lamfalussy procedure. In other words, the Commission envisions that a revised EU Capital Adequacy Directive would be drafted to focus on essential principles and policies and the annexes would contain the technical implementing rules, which could be changed at a later time without amending the Directive.

As we have expressed in response to the Commission's prior consultations, we have two particular concerns with respect to the revision of the capital adequacy framework for asset managers: (1) bank-styled capital requirements are not appropriate for the asset management industry and (2) use of insurance should be permitted to offset minimum capital requirements. We were pleased that the Commission has begun to address the first issue in the Third Consultation Paper. We, however, were disappointed that the Commission reversed its position of permitting the use of insurance under all three methods of calculating capital.

Bank-Styled Capital Requirements Are Not Appropriate for the Asset Management Industry
We continue to believe that it would be unwise to introduce into the Capital Adequacy Directive bank-style capital requirements for asset management firms. As we mentioned in our previous letters to the Commission, the businesses of banking and asset management are fundamentally different and any capital requirement imposed on institutions that engage in these diverse activities must take into consideration the separate risks involved in these businesses. Although the Commission continues to take the general view that the new capital adequacy framework should apply to all types of institutions to ensure a level playing field within Europe, the Third Consultation Paper acknowledges that in the case of asset management firms, their limited activities and risk profile indicate the need for a modified approach. As a result, the Commission proposes that asset management firms that do not trade for their own account or underwrite securities (firms with limited license) would be permitted to continue to calculate their capital requirements under the current rules (i.e., firms must have a minimum capital of at least 13 weeks of expenditures).

We support the Commission's proposed approach to permit asset management companies to continue to calculate their minimum capital requirements under the current rules. We believe that this approach has the added benefit of making the capital requirements for asset managers authorized under the Investment Services Directive consistent with those imposed on asset managers authorized under the UCITS Directive. In the Third Consultation Paper, however, the Commission provides the Member States with discretion regarding whether asset management firms with limited license would be permitted to continue to calculate their capital requirements under the current rules. We respectfully urge that the Commission require the competent authorities of the member states to permit firms with limited license to comply only with the current expenditure-based requirement.

If, however, firms cannot rely only on the expenditure-based approach (either because they are not firms with limited licenses or Member States are permitted to prohibit firms from complying with only the expenditure-based approach), the Commission should permit these firms to not have to comply with both the expenditure-based approach and one of the three Basel-based approaches.² In other words, if a firm is required to calculate operational risk using one of the three methods, it should not also be required to comply with the expenditure-based approach. The Commission has taken a similar approach for firms authorized to use the Advanced Measurement Approach (Title II, Chapter 3, Article 113).³

The Commission Should Permit the Use of Insurance for All Methods of Calculating Minimum Capital
We were disappointed that the Commission decided not to permit the use of insurance to offset capital requirements if firms use the two simpler (Basic Indicator and Standardised) approaches to calculating minimum capital. As a result, consistent with the Basel proposals, only firms using the Advanced Measurement Approaches would be able to recognize insurance in calculating capital, and maximum capital alleviation would be limited to 20 percent.

In not permitting insurance to offset capital charges calculated under the two simpler methods, the Commission is of the view that the potential recognition of insurance under the simpler approaches should await further development in insurance products, progress in the mapping and measurement process of insured operational risk events, and the availability of a straightforward formula. The Commission expects to revisit these issues over time.

We appreciate that developing a specific proposal or formula for permitting insurance to alleviate capital charges is a complex undertaking. We, however, are of the view that it is critical for insurance to be part of all of the methodologies for calculating minimum capital, including the current expenditure-based approach.⁴ As discussed in our submission to the Commission in April 2003 on the experience of the US asset management industry in using insurance to cover certain risks, insurance provides adequate protection and, in some respects, other advantages over a capital adequacy framework.⁵

Moreover, we believe that the technical implementation of the use of insurance could be left to comitology procedures, which could draw on the expertise of the European Securities Committee (ESC) and the Committee of European Securities Regulators (CESR) as well as private sector experts.

Commission Should Retain the Alternative for Consolidated Capital
The Institute also urges the Commission to reconsider the specific conditions under which Member States may grant waivers to investment firm groups from the requirements to consolidate capital.

As we mentioned in our letter to the Commission in January 2003, some of the specific conditions under which the alternative for consolidated capital would be permissible are unduly restrictive. In particular, we are concerned about the condition that would require all the investment firms within a group to be authorized and supervised by the same Member State to be eligible for the waiver. This proposed condition would prevent Member States from granting waivers to groups whose holding company structure does not pose particular risks. Moreover, this particular condition, which would limit the alternative approach to only national investment firm groups, is fundamentally inconsistent with the goal of facilitating a truly pan-European market for financial services. We strongly urge the Commission to revise this condition and permit groups with affiliates authorized in more than one Member State to be eligible for this alternative.

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If we can provide any other information or if you would like to discuss further any issues, please call me at (202) 326-5826 or Jennifer Choi at (202) 326-5810.

Sincerely,

Mary S. Podesta
Senior Counsel

¹ The Institute's membership includes 8,655 open-end investment companies ("mutual funds"), 588 closed-end investment companies, 106 exchange-traded funds, and 6 sponsors of unit investment trusts. Its mutual fund members have assets of about $6.857 trillion, accounting for approximately 95 percent of total industry assets, and 90.2 million individual shareholders.

² For both the Basic Indicator and Standard approaches, we continue to believe that the Commission should apply a lower calibration for asset management than, for example, for banking and trading because of the lower risks involved in asset management.

³ Similarly, we recommend that the Commission not require a firm whose parent must calculate consolidated capital based on one of the three approaches also to have to comply with the expenditure-based approach.

⁴ Asset managers that would be allowed to calculate capital under the current expenditure-based rules also should be permitted to use insurance to offset capital charges.

⁵ A copy of the paper, produced by ICI Mutual (a captive insurance company of the US Investment company industry), is enclosed.