Finextra: On regulation... Solvency II

26 April 2012

While Solvency II is of European origin, it has global implications, and while it is primarily targeted at the insurance industry, it has ramifications that reverberate deeply into the global asset management community.

The Solvency II Directive seeks to harmonise the capital adequacy requirements for insurance firms operating in the European Union - think of it as the Basel II of the insurance world.

What pray tell does this have to do with the asset management industry? Well, on closer inspection, the third of the three pillars of the Directive requires each insurer to disclose and make transparent the risky assets they have on their balance sheets, and in turn they must ensure they have the correct amount of capital to hand to deal with any investment risk. Since insurers are quite open to outsourcing the management of assets, this directive has knock-on implications for any asset manager currently managing investments owned or mandated by insurer clients.

Pillar III of the Directive requires each insurer to complete annual and quarterly QRT (Quantitative Reporting Template) reports, which in turn translates to a requirement for the asset manager to facilitate this report build in a timely and efficient manner for their insurer clients on an investment by investment basis. The asset manager will have to facilitate a timely report of line level holdings for any collective investment scheme they are managing (funds, structured products, separate accounts, etc.), i.e. they must provide a full look-through to the Nth level until the report has just ‘leaf’ level holdings.

In addition to working through the investment portfolio to the individual security lines, the insurer also needs to codify each line with a CIC (Complementary Identification Code) which combines each security’s risk profile and asset characteristics. Many insurers and asset managers are struggling to understand how they implement a codification schema in their security master to handle CIC coding, although the codes were defined to work with existing ISO classification schemes and thus could be mapped from current implementations.

Naturally, the asset manager is going to be uncomfortable with demands to disclose share holdings, after all the holdings for an active manager is their “special sauce”, not something to be shared readily!

Naturally the asset manager is going to look to their Fund Administrator or Custodian to take on the pain – after all, that’s what they do!  All of the major TPA players are working feverishly to prepare themselves to meet the avalanche of requests to support QRT generation, and the look-through and CIC codification issues that goes with it. But the TPA will still suffer when it comes to solving look-through, since for the same reason asset managers have issues sharing holdings with each other, means they will not be open to share willingly with a TPA they are not in contract with.

From an asset manager's point of view:

• Firstly, they cannot accurately assess how much of their existing AuM is held indirectly by European insurers, so they are unsure at this point in time of how much of their revenues are at stake.
• The asset manager wants to market themselves as being ‘Solvency II’ friendly.
• Fund-of-Fund managers in particular will be screening their target investments more carefully to ensure the funds they invest in are Solvency II friendly.
• Insurer-owned asset managers, or asset managers which have originated from an insurer, will all be taking direct action to put themselves in control of their destiny and will not be relying on their TPA to pick up the slack, although they will (and are) putting their service providers under serious pressure to support their own internal efforts.
• Non-insurer related asset managers will (in the main) be relying on their Administrator or Custodian – where they have one – to play the leading role.

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