23 December 2013

Risk.net: New Solvency II capital charges still threat to ABS demand

The European Insurance and Occupational Pensions Authority (EIOPA) last week proposed a more granular treatment of securitisations. Under the proposals, the capital charges for less risky issues would be reduced to 4.30 per cent while those for riskier ones would rise to 12.50 per cent. Current draft rules apply a uniform 7 per cent spread risk charge for AAA-rated securitisations.

But experts say the proposed capital charges for low-risk securitisations are still too high compared with other asset classes and fail to reflect the real economic risk in the class. "A capital charge of 4.3 per cent per year won't make much difference at all. If you compare that to competing products, such as single-A corporate bonds or AAA covered bonds, you are looking at a capital charge three to six times higher for the highest quality AAA-rated ABS", says David Covey, head of European ABS strategy at Nomura.

Covey suggests a capital charge equivalent to that for an A- or AA-rated corporate bond would be more appropriate for a AAA-rated asset-backed security (ABS), equating to 1.1–1.4 per cent. "The charge itself is less important than how it compares to other products of similar risk", he adds.

But experts are warning that maintaining a high capital charge for securitisations relative to other assets will discourage insurers from investing in new securitisations. The EIOPA review aimed to examine whether the design and calibration of the standard formula could be adjusted to support long-term investment by insurers.

The reduction in the capital charge may encourage insurers to hold onto some existing ABS assets rather than sell them, suggests Simon Richards, head of insurance solutions at Insight Investment. In addition, it may be attractive for insurers to have small allocation to ABS for diversification. "Where we have corporate bond mandates we often ask for permission to invest in ABS securities. When the proposed rules were at the extreme, most insurers would – and have – pushed back. If we can argue that we will only invest in low-risk ABS they might be happier to give a smaller allocation for diversification benefits. But that will be at the margin, it won't make much difference", Richards says.

EIOPA claims the new classifications will support long-term investment. Gabriel Bernardino, chairman of EIOPA, says: "Our analysis has shown that those securitisation issues meeting a set of quality criteria have a good track record of performance, and from a supervisory perspective should meet lower capital requirements".

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