## _cr04311

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---

### Adoption of cross-sectoral functional supervision
- Netherlands moving from sectoral to cross-sectoral functional supervision; process began in 1999 and is expected to be completed during the course of 2005.
- Under sectoral approach: distinct types of financial institutions supervised by different agencies.
- Under cross-sectoral functional approach: two supervisory agencies focus on specific supervisory objectives:
  - prudential objective of promoting the soundness of financial institutions (DNB-PVK);
  - conduct of business objective of enhancing orderly and fair market practices (AFM).
- Rationale for change:
  - Financial system dominated by a few very large financial conglomerates operating across traditional sectoral lines, centralizing key risk management functions, and offering increasingly complex products that do not fit neatly into sectoral classifications.
  - Trend toward greater complexity and conglomeration makes sectoral supervision increasingly difficult to conduct effectively or efficiently.
- Conceptual insight quoted by the authorities:
  - “The objectives of supervision are more stable than are the institutional characteristics of financial markets, so they provide a better focal point for the organizational structure of supervision.”

### The Netherlands framework — Steps Toward a New Framework
- Timeline and institutional changes:
  - Prior to 1999: Cross-sectoral supervision limited to macro-prudential supervision by De Nederlandsche Bank (DNB) and conduct-of-business supervision relating to securities market activities by the Securities Supervisor (STE).
  - 1999: Council of Financial Supervisors (RFT) established to coordinate micro-prudential and conduct-of-business supervision among sectoral agencies (DNB, PVK, STE).
  - Late 2001: Plans for cross-sectoral supervisory framework submitted to Parliament; proposed consolidation of macro- and micro-prudential supervision into a single entity and a separate entity for conduct-of-business supervision.
  - March 2002: STE converted into the Authority for Financial Markets (AFM) for cross-sectoral conduct-of-business supervision; STE’s previous micro-prudential responsibilities for securities markets taken over by DNB.
  - September 2002: ‘Covenant’ between DNB, PVK, and AFM established cooperation arrangements to manage overlap and regulatory burden.
  - December 2002 / March 2003 / May 2004: DNB and PVK proposed full integration in December 2002; Parliament accepted in March 2003; practical merger took place in May 2004 (legal merger scheduled later).
  - Legislative overhaul of governing framework being completely overhauled, with Parliamentary passage expected in 2005.
- Covenant key provisions:
  - designation of a lead (“authorizing”) agency with overall responsibility for supervision (including licensing) of each financial institution and coordination of supervisory activities (DNB-PVK lead for institutions mainly in banking, insurance, and pensions; AFM leads for securities firms);
  - deference by lead supervisor to the judgment of other supervisors in their areas of responsibility;
  - agreement on which aspects of a firm’s management are under prudential supervision versus conduct-of-business supervision;
  - rules for consultation and information sharing;
  - provision for annual review and adjustments.
- Alignment with international practice:
  - Framework will facilitate effective supervision of LCFIs on a consolidated basis in line with Basel Committee principles and EU policy, and ensures cross-sector cooperation consistent with EU policy.

### The Netherlands framework — Design and rationale
- Key institutional features:
  - consolidation of all macro- and micro-prudential supervision into a single body within the central bank (DNB-PVK);
  - consolidation of all conduct-of-business supervision within a separate body, the Authority for Financial Markets (AFM);
  - establishment of agreements or ‘covenants’ between main supervisors to ensure coordination and cooperation; the RFT provides a platform for coordination, especially on integrity supervision issues.
- Reasons for consolidating macro- and micro-prudential supervision in one agency:
  - Dominance of a handful of large, complex financial institutions blurs distinction between micro- and macro-prudential issues.
  - Potential advantages:
    - greater incorporation of macroeconomic and systemic stability considerations into micro-prudential analysis;
    - macroeconomic analysis benefits from micro-level structure and characteristics;
    - improved crisis response through rapid assembly of prudential information and faster decision-making.
  - Potential disadvantages and mitigations:
    - possible conflict of objectives (e.g., pressure on central bank to provide lender-of-last-resort facilities). Mitigating factor: DNB authorized to lend only against acceptable collateral; moral hazard concern limited to potential slight relaxation of collateral terms.
    - risk that integration could reduce attention to macro-prudential issues. Mitigation: establishment of a separate, focused Financial Stability Department within DNB-PVK to coordinate macro-prudential work and enhance accountability.
- On taxpayer risk and bailouts:
  - Very large banks dominating the system imply that failure of any could have major economic impact; perception that main banks may be “too large to fail” exists irrespective of consolidation.
  - Consolidation of prudential supervision could reduce taxpayer risk if it improves supervision quality and thereby reduces probability of bank failures and bailouts.
- Data and analytical requirements:
  - Effective macro-prudential analysis across the financial sector requires better data (e.g., frequency and timeliness from insurance and pension sectors; some banking data such as sectoral analyses) and greater integration of risk analysis frameworks across institution types.
  - Need to balance improved data collection with reducing unnecessary administrative burdens on supervised institutions; Dutch government has a specific program targeting administrative burden reduction. EU-level initiatives, including streamlined data collection under the EU Directive on supervision of financial conglomerates, may aid balance.
- Separation of prudential and conduct-of-business supervision:
  - Netherlands separates prudential supervision (DNB-PVK) from conduct-of-business supervision (AFM), a design also used in Australia but differing from Britain where the FSA combined both.
  - Rationale:
    - Micro-prudential objective: ensure soundness of financial institutions.
    - Conduct-of-business objective: promote orderly and fair market practices, focusing on relationships between institutions and clients.
    - Significant conflicts between these objectives could arise, supporting separation; potential synergies may be limited.
  - Trade-offs:
    - Advantages of separation: institutional focus, transparency, accountability.
    - Disadvantages: foregone synergies, reduced flexibility in reallocating resources or staff between areas.
    - Net advantage of division depends on distinctness of objectives, fungibility of skills, and quality of co-operation arrangements.
    - Strong transparency and accountability might mitigate disadvantages in combined arrangements; interaction with macro-/micro-prudential allocation decisions complicates the judgment.

### Separation of prudential and conduct-of-business supervision (further detail)
- Dutch authorities judged: "the gains from potential synergies from combining prudential and conduct-of-business supervision do not outweigh the disadvantages of doing so."
- Practical enforcement-style differences:
  - Prudential supervision: "a premium is put on discretion and confidentiality, both to promote cooperation of financial institutions and to avoid shaking public confidence in them."
  - Conduct-of-business supervision: important "to be seen to be doing so," which "generally requires an approach to supervision that is more visible to the public."
- Reconciling these differences within one institution "may be difficult (unless the functions are effectively separated within the institution), and could undermine the credibility of both types of supervisors."
- Combining conduct-of-business with prudential supervision in the same institution would likely "distract resources and management attention from prudential supervision" given the "relatively high public profile of conduct-of-business issues."

### Making the model work — overall assessment
- Assessment conclusions:
  - The "Dutch variant of the cross-sectoral framework is well thought out, well suited to the circumstances of the Dutch market, and appears likely to enhance the flexibility and efficiency of supervision."
  - The design is "tailored to the specific situation of the Netherlands" but "should be relevant for other countries considering the adoption of cross-sectoral supervision, especially where financial systems are dominated by LCFIs."
  - Strengthening incentives for effective prudential supervision is particularly relevant where LCFIs are "highly systemically important," since "dropping the ball" in prudential supervision could be more damaging.

### Implementation and transition arrangements
- Nature of changes:
  - Changes entail "substantial changes in bureaucratic duties and organization for each of the supervisory agencies."
  - Authorities have "been very careful to introduce the changes in a gradual manner; they have avoided a ‘big bang’."
- Integration of DNB and PVK:
  - Integration "has progressed very deliberately" including:
    - beginning integration "at a high level, through cross-appointments at management level.";
    - providing "close cooperation and coordination of activities" through the Covenant.
  - Integrated supervision began in May 2004, but "the intention is not to move to a fully-integrated cross-sectoral approach in all areas right away."
  - Initial joint departments: DNB-PVK establishing joint departments, notably "the new Financial Stability Department and the Supervision Policy Department."
  - Anticipated benefits: early establishment of the Financial Stability Department expected to "help sharpen the monitoring and analysis of macro-prudential indicators at the operational level" and feed into aggregated analysis and public reporting.
- Operational supervision rollout:
  - "Aside from the largest groups, PVK will continue to provide prudential supervision of pensions and insurers, while DNB will continue to focus on banks and securities firms."
  - Use of integrated teams to cover the LCFIs from the outset may "facilitate integration of supervision at the operational level" by bringing together personnel with shared knowledge and experience.
  - Integration on a team-by-team basis offers "the potential for experimentation and to tailor the pace of integration to the needs and capacity of the particular teams."

### Institutional transformation and stakeholder responses
- STE to AFM transformation:
  - Transformation of STE into AFM is "probably the most substantial institutional make-over."
  - AFM required a major effort to develop its supervisory framework while it "has seen a rapid increase in staffing."
  - Expectation of "growing pains" for AFM, financial institutions supervised by AFM, and other supervisory agencies relinquishing conduct-of-business responsibilities.
  - Industry complaints about AFM's activities "are not very surprising"; importance lies in the nature of problems and how they are addressed.
  - Recommendation: clarify for financial institutions the reasons for differences in approaches taken by different supervisors and reassure that AFM operates in accordance with international standards and is subject to proper safeguards.
  - Some complaints concern AFM's less-confidential style; report notes "this is a transitional problem" and that "financial institutions will get more accustomed to AFM’s different approach, and AFM may also modify its style over time."

### Overlap, mandates, coordination, and review
- Overlap challenges:
  - Overlapping supervision by AFM and DNB-PVK has raised concerns; may reflect transitional issues and an inherent challenge where "there will be more than one supervisor for most financial institutions."
- Avoiding inefficiencies from overlap:
  - Ensure supervisors have very clear mandates, and make these clear to those being supervised.
  - Supervision legislation revision is expected to provide clarification at a higher level.
  - Clarify respective powers of the two supervisory authorities to grant, withhold or revoke licenses.
  - Within lead regulator concept, "either regulator can take licensing decisions where necessary to uphold the regulatory standards for which they are responsible."
- Recommended coordination mechanisms:
  - Establish "a process for regular consultation and review" to minimize problems.
  - RFT "clearly has an important role to play in ensuring close coordination between the supervisory agencies on a routine basis."
  - Implement a less frequent, but more comprehensive review process.
  - Use review of the Covenant between AFM, DNB and PVK as a model to take stock of developments, solicit views of supervised firms and other interested parties, and modify supervisors’ activities.
  - Formalize the review process and make the substance of the agreement readily available to the public.

*Prepared by Scott Roger.*

### 1.      This note discusses the new framework for financial sector surveillance and

### 1.      This note discusses the new framework for financial sector surveillance and supervision being adopted in the Netherlands.

### Adoption of cross-sectoral functional supervision
- The Netherlands is transforming from a sectoral approach to a cross-sectoral functional approach; the process began in 1999 and is expected to be completed during the course of 2005.
- Under the sectoral approach, distinct types of financial institutions were supervised by different agencies; under the cross-sectoral functional approach two supervisory agencies focus on specific supervisory objectives:
  - prudential objective of promoting the soundness of financial institutions (DNB-PVK);
  - conduct of business objective of enhancing orderly and fair market practices (AFM).
- Rationale for change:
  - The financial system is dominated by a few very large financial conglomerates operating across traditional sectoral lines, centralizing key risk management functions, and offering increasingly complex products that do not fit neatly into sectoral classifications.
  - Trend toward greater complexity and conglomeration makes sectoral supervision increasingly difficult to conduct effectively or efficiently.
- Conceptual insight highlighted by the authorities:
  - “The objectives of supervision are more stable than are the institutional characteristics of financial markets, so they provide a better focal point for the organizational structure of supervision.”

### The Netherlands framework — Steps Toward a New Framework
- Prior to 1999:
  - Cross-sectoral supervision was limited to macro-prudential supervision carried out by De Nederlandsche Bank (DNB) and conduct-of-business supervision relating to securities market activities carried out by the Securities Supervisor (STE).
- 1999:
  - The Council of Financial Supervisors (RFT) was established to coordinate micro-prudential and conduct-of-business supervision among sectoral agencies (DNB, PVK, STE).
- Late 2001:
  - Plans for adoption of a cross-sectoral supervisory framework were submitted to Parliament by the Finance Minister; plan envisaged consolidation of macro- and micro-prudential supervision into a single entity and establishment of a separate entity for conduct-of-business supervision.
- March 2002:
  - STE converted into the Authority for Financial Markets (AFM), taking responsibility for conduct-of-business supervision on a cross-sectoral basis; STE’s previous micro-prudential responsibilities for securities markets were taken over by DNB.
- September 2002:
  - A ‘Covenant’ between DNB, PVK, and AFM established cooperation arrangements to manage overlap and regulatory burden. Covenant provisions included:
    - designation of a lead (“authorizing”) agency with overall responsibility for supervision (including licensing) of each financial institution and coordination of supervisory activities (DNB-PVK lead for institutions mainly in banking, insurance, and pensions; AFM leads for securities firms);
    - deference by lead supervisor to the judgment of other supervisors in their areas of responsibility;
    - agreement on which aspects of a firm’s management are under prudential supervision versus conduct-of-business supervision;
    - rules for consultation and information sharing;
    - provision for annual review and adjustments.
- December 2002 / March 2003 / May 2004:
  - DNB and PVK proposed full integration in December 2002; Parliament accepted in March 2003; practical merger took place in May 2004 (legal merger scheduled later).
- Legislative overhaul:
  - Governing legislative framework being completely overhauled, with Parliamentary passage expected in 2005.
- Alignment with international practice:
  - Framework will facilitate effective supervision of LCFIs on a consolidated basis in line with Basel Committee principles and EU policy, and ensures cross-sector cooperation consistent with EU policy.

### The Netherlands framework — Design and rationale
- Key institutional features:
  - consolidation of all macro- and micro-prudential supervision into a single body within the central bank (DNB-PVK);
  - consolidation of all conduct-of-business supervision within a separate body, the Authority for Financial Markets (AFM);
  - establishment of agreements or ‘covenants’ between main supervisors to ensure coordination and cooperation; the RFT provides a platform for coordination, especially on integrity supervision issues.
- Reasons for consolidating macro- and micro-prudential supervision in one agency:
  - Financial system dominated by a handful of large, complex financial institutions blurs distinction between micro- and macro-prudential issues.
  - Potential advantages:
    - greater incorporation of macroeconomic and systemic stability considerations into micro-prudential analysis;
    - macroeconomic analysis benefits from micro-level structure and characteristics;
    - improved crisis response through rapid assembly of prudential information and faster decision-making.
  - Potential disadvantages and mitigations:
    - possible conflict of objectives (e.g., pressure on central bank to provide lender-of-last-resort facilities). Mitigating factor: DNB authorized to lend only against acceptable collateral; moral hazard concern limited to potential slight relaxation of collateral terms.
    - risk that integration could reduce attention to macro-prudential issues. Mitigation: establishment of a separate, focused Financial Stability Department within DNB-PVK to coordinate macro-prudential work and enhance accountability.
- On taxpayer risk and bailouts:
  - With very large banks dominating the system, failure of any could have major economic impact; perception that main banks may be “too large to fail” exists irrespective of consolidation.
  - Consolidation of prudential supervision could reduce taxpayer risk if it improves supervision quality and thereby reduces probability of bank failures and bailouts.
- Data and analytical requirements:
  - Effective macro-prudential analysis across the financial sector will require better data (e.g., frequency and timeliness from insurance and pension sectors; some banking data such as sectoral analyses) and greater integration of risk analysis frameworks across institution types.
  - Need to balance improved data collection with reducing unnecessary administrative burdens on supervised institutions; Dutch government has a specific program targeting administrative burden reduction. EU-level initiatives, including streamlined data collection under the EU Directive on supervision of financial conglomerates, may aid balance.
- Separation of prudential and conduct-of-business supervision:
  - Netherlands separates prudential supervision (DNB-PVK) from conduct-of-business supervision (AFM), a design also used in Australia but differing from Britain where the FSA combined both.
  - Rationale:
    - Micro-prudential objective: ensure soundness of financial institutions.
    - Conduct-of-business objective: promote orderly and fair market practices, focusing on relationships between institutions and clients.
    - Significant conflicts between these objectives could arise, supporting separation; potential synergies may be limited.
  - Trade-offs:
    - Advantages of separation: institutional focus, transparency, accountability.
    - Disadvantages: foregone synergies, reduced flexibility in reallocating resources or staff between areas.
    - Net advantage of division depends on distinctness of objectives, fungibility of skills, and quality of co-operation arrangements.
    - Strong transparency and accountability might mitigate disadvantages in combined arrangements; interaction with macro-/micro-prudential allocation decisions complicates the judgment.

_This note was prepared by Scott Roger._

### 22.      Given their own circumstances, the Dutch authorities have considered such

### _cr04311 - 22.      Given their own circumstances, the Dutch authorities have considered such

### Separation of prudential and conduct-of-business supervision
- The Dutch authorities judged that "the gains from potential synergies from combining prudential and conduct-of-business supervision do not outweigh the disadvantages of doing so."
- A pragmatic reason for separation is differences in supervisory approaches, particularly in the area of enforcement:
  - For prudential supervision, "a premium is put on discretion and confidentiality, both to promote cooperation of financial institutions and to avoid shaking public confidence in them."
  - For conduct-of-business supervision, it is important "to be seen to be doing so," which "generally requires an approach to supervision that is more visible to the public."
- Reconciling these differences within one institution "may be difficult (unless the functions are effectively separated within the institution), and could undermine the credibility of both types of supervisors."
- Combining conduct-of-business with prudential supervision in the same institution would likely "distract resources and management attention from prudential supervision" given the "relatively high public profile of conduct-of-business issues."

### Making the model work — overall assessment
- The "Dutch variant of the cross-sectoral framework is well thought out, well suited to the circumstances of the Dutch market, and appears likely to enhance the flexibility and efficiency of supervision."
- The design is "tailored to the specific situation of the Netherlands" but "should be relevant for other countries considering the adoption of cross-sectoral supervision, especially where financial systems are dominated by LCFIs."
- Strengthening incentives for effective prudential supervision is particularly relevant where LCFIs are "highly systemically important," since "dropping the ball" in prudential supervision could be more damaging.

### Implementation and transition arrangements
- Changes entail "substantial changes in bureaucratic duties and organization for each of the supervisory agencies."
- The authorities have "been very careful to introduce the changes in a gradual manner; they have avoided a ‘big bang’."
- Integration of DNB and PVK "has progressed very deliberately" including:
  - Beginning integration "at a high level, through cross-appointments at management level."
  - Providing "close cooperation and coordination of activities" through the Covenant.
- Integrated supervision began in May 2004, but "the intention is not to move to a fully-integrated cross-sectoral approach in all areas right away."
  - Initially, DNB-PVK is establishing some joint departments, notably "the new Financial Stability Department and the Supervision Policy Department."
  - Early establishment of the Financial Stability Department is anticipated to "help sharpen the monitoring and analysis of macro-prudential indicators at the operational level" and feed into aggregated analysis and public reporting.
- Operational supervision will not be fully integrated at the outset:
  - "Aside from the largest groups, PVK will continue to provide prudential supervision of pensions and insurers, while DNB will continue to focus on banks and securities firms."
  - Use of integrated teams to cover the LCFIs from the outset may "facilitate integration of supervision at the operational level" by bringing together personnel with shared knowledge and experience.
  - Integration on a team-by-team basis offers "the potential for experimentation and to tailor the pace of integration to the needs and capacity of the particular teams."

### Institutional transformation and stakeholder responses
- The metamorphosis of the securities supervisor, STE, into the conduct-of-business supervisor, AFM, "is probably the most substantial institutional make-over."
  - A major effort was required to develop AFM's supervisory framework while it "has seen a rapid increase in staffing."
  - "Growing pains" are expected for AFM, financial institutions supervised by AFM, and other supervisory agencies relinquishing conduct-of-business responsibilities.
  - Industry complaints about AFM's activities "are not very surprising"; more important is the nature of problems and how they are addressed.
  - It may be helpful "to clarify for financial institutions the reasons for the differences in approaches taken by different supervisors and to reassure them that AFM is operating in accordance with international standards and is subject to proper safeguards."
- Some complaints concern AFM's less-confidential style; the report notes "this is a transitional problem" and that "financial institutions will get more accustomed to AFM’s different approach, and AFM may also modify its style over time."

### Overlap, mandates, coordination, and review
- Overlapping supervision by AFM and DNB-PVK has raised concerns; this may reflect transitional issues but also an ongoing challenge inherent in a functional approach where "there will be more than one supervisor for most financial institutions."
- To avoid inefficiencies from supervision overlaps:
  - "It is important to ensure, in the first instance, that the supervisors have very clear mandates, and that these are made clear to those being supervised."
  - The revision to supervision legislation is "expected to provide such clarification at a higher level at least."
  - One key matter to clarify is "the respective powers of the two supervisory authorities to grant, withhold or revoke licenses."
  - Within the concept of lead regulator, "either regulator can take licensing decisions where necessary to uphold the regulatory standards for which they are responsible."
- Coordination mechanisms recommended:
  - Establish "a process for regular consultation and review" to minimize problems.
  - The RFT "clearly has an important role to play in ensuring close coordination between the supervisory agencies on a routine basis."
  - It is also important to have "a less frequent, but more comprehensive review process."
  - The review of the Covenant between AFM, DNB and PVK currently underway may serve as a model: it offers the opportunity "to take stock of developments over time, as well as to solicit and take into account the views of supervised firms and other interested parties, in modifying supervisors’ activities."
  - The review process "should probably be formalized, and the substance of the agreement made readily available to the public."

*Source: _cr04311 - 22. Given their own circumstances, the Dutch authorities have considered such*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2004/_cr04311.pdf_