Real estate lending under Solvency II CONSULTING LLP

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Charles Lester
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1 Real estate lending under Solvency II CONSULTING LLP!1

2 Solvency II and IORP Solvency II A fundamental reform of the capital adequacy regime for the European insurance industry. It aims to establish a revised set of EU-wide capital requirements and risk management standards to reduce systemic risk in the insurance industry IORP Institutions for Occupational Retirement Provisions Directive - the equivalent provisions to Solvency II for pension funds. CONSULTING LLP!2

3 Solvency II Solvency Capital Requirement Reserves SCR For investments, market risk of a fall in values Market value of assets Market value of liabilities Insurers can use the standard model prescribed by the EU regulator or get approval from the local regulator to use their own model CONSULTING LLP!3

4 Solvency II timetable EU trilogue negotiations completed in November 2013, agreed compromise level 1 text. EU Vote (11/3) Publication of full level 2 regulation Other clarification Transitional implementation Transition period Approval of internal models Detailed implementation steps Full implementation Crucial for standard models CONSULTING LLP!4

5 Solvency II timetable Draft level 2 regulations, October 2011 Not officially published but widely leaked. Treatment of real estate lending fails to take account of collateral. See slide 6 EIOPA consultation on long term assets Published on 19/12/2013. Does not include real estate but does include RE securitisation See slide 8 Updated draft level 2 regulations Not published not leaked. No public consultation. See slide 10. Not expected to be significantly different from October 2011 draft. CONSULTING LLP!5

6 Solvency II SCR treatment of investments under standard model Real estate Real estate funds Equities Real estate debt Original treatment 25% SCR shock on gross value of assets SCR shock on net value of equity Listed: 39% Unlisted: 49% +/- 10% dampener Originally used SCR RE shock for collateral but then switched to bond rating. See slide 7. Current position Default to transparent real estate treatment. Not clear when opaque equities treatment is possible For equities held prior to Solvency II, 7 year transition from 22% SCR shock to full equities SCR shock Will there be another consultation exercise? Not a public one CONSULTING LLP!6

7 Solvency II SCR treatment of investments under standard model Treatment of real estate lending Under the 31st October 2011 draft, commercial real estate lending has been moved to the general provisions for corporate bonds. The starting point under this provision is a credit rating by a nominated credit rating agency. Bonds and loans for which a credit rating is not available are assigned a risk factor, in an example of presumably unintended humour, termed by the regulator F-up. Duration risk factor F-up up to 5 3% * (duration) More than 5 and up to 10 15% % * (duration -5) More than 10 and up to % % * (duration -10) More than 15 and up to % % * (duration -15) More than 20 35% % * (duration -20) CONSULTING LLP!7

8 Solvency II SCR treatment of investments under standard model Treatment of real estate CMBS Risk Credit quality step factor F- up original calibration 7% 16% 19% 20% 82% 100% 100% Type A under 19/12/13 Type B under 19/12/13 4.3% 8.45% 14.8% 17 to 20% 82% 100% 100% 12.5% 13.4% 16.6% 19.7% 82% 100% 100% Notes overleaf on slide 9 CONSULTING LLP!8

9 Solvency II SCR treatment of investments under standard model Treatment of real estate CMBS - notes The credit quality step refers to the rating, 3 being equivalent to BBB The "F-Up"s are apparently per annum of the duration of the note. This gives a crippling high charge for any securitisation. A AAA note for an A-type securitisation has a 50% higher SCR capital requirement than an unrated corporate loan. CMBS will be type B securitisation. As such an AAA note will have a capital charge 4 times higher than an unrated corporate loan. The capital cost of participating in a securitisation for an insurer using the standard model is crippling. CONSULTING LLP!9

10 Solvency II Updated level 2 measures We have been told that this new draft will not be subject to any further public consultation but will be considered by the EU Expert Group on Banking, Payments and Insurance. It is intended to be implemented by the summer. For further details: CONSULTING LLP!10

11 Solvency II and real estate lending Conclusions The treatment of real estate lending under the standard model for Solvency II is muddled; The treatment of CMBS is worse; Most large insurers will be seeking approval to use their own internal models rather than the standard model and may well therefore avoid the more bizarre outcomes of the standard model requirements. CONSULTING LLP!11

12 This presentation has been prepared for general guidance and does not constitute professional advice. You should not act upon the information contained in this presentation without obtaining professional advice. No representation or warranty is given as to the accuracy or completeness of the information contained in this presentation. To the extent permitted by law, John Forbes Consulting LLP and its members do not accept or assume any liability, responsibility or duty of care for any consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this presentation or for any decision based on it John Forbes Consulting LLP. CONSULTING LLP!12

Hot Topic Publication of final EIOPA guidelines signals renewed effort towards Solvency II finalisation

Hot Topic Publication of final EIOPA guidelines signals renewed effort towards Solvency II finalisation FS Regulatory Centre of Excellence 10 October 2013 Summary On 27 September 2013 EIOPA published its