* EU legislator finally departs from EIOPA’s suggestions
* Changes may not be enough to change the game for insurers
By Anna Brunetti
LONDON, Aug 13 (IFR) - The European Commission has lowered capital charges for insurers and pension funds investing in securitisation making it less punitive for them to hold the asset-class, according to a final draft circulated among member states.
The EU’s main authority is set to publish proposals implementing capital requirements for the sector, under Solvency II, by the end of September. Co-legislators from the European Parliament and the Council of EU states will then have a maximum six months to either approve or reject them in full.
In a move that may give the insurance industry a much needed injection of optimism, the commission is proposing to further reduce the burden on insurers by lowering charges from a previous draft it drawn up in March.
This would make holding ABS instruments more attractive for this investor base at a time when the European Central Bank (ECB) is trying to revive it as a way to boost credit transmission onto the capital markets and the real economy .
The March draft had already halved numbers suggested by the European Insurance and Occupational Pension Authority (EIOPA) in December, cutting the “spread risk charge” - used as a starting point to calculate how much capital an insurer would have to set aside to cover for potential losses on its ABS holdings - to 2.1% per year of duration for the most senior bonds, from the 4.3% proposed by EIOPA.
In the new draft, the Commission has kept the same risk charges for Triple A assets, but has cut levels for Double A, Single A and Triple B investments to around 3%, 4% and 5% respectively from 4.2%, 7.4% and 8.5-10%.
Final capital charges would be even lower taking into account mitigating elements such as the offsetting of maturity and interest rate risk between assets and liabilities and the inclusion of deferred tax assets in the calculation.
EIOPA had proposed 8.45%, 14.8% and 17-20% respectively.
In a report published on Wednesday, Fitch said that the capital charges under the latest Solvency II proposals would be positive for the structured finance market as insurance companies are an important constituent of the investor base.
By bringing risk charges much closer to 3% - the level that applies to insurers’ investment into unrated loan portfolios - the commission is seeking to reduce the biased treatment of securitised assets versus loans and other asset classes. The current imbalance makes ABS assets much more expensive to hold than other products, and is thus seen by critics as a major, if not insurmountable, hurdle to ABS investment.
Under Solvency II proposals exposures to sovereign bonds or bonds guaranteed by agencies and governments would not incur a capital charge. Senior covered bonds would face a 0.7% risk charge and investments in senior corporate debt would translate into 0.9% a charge.
By comparison, EIOPA had originally proposed a flat 7% charge for all securitisation investment, before reviewing its stance in December and differentiating between levels of quality and soundness by staggering risk charges.
But that calculation was based on a much more limited sample of performance data for securitisation than for other classes, such as covered bonds. Going back only as far as 2006, data for ABS assets was restricted to the crisis era.
By lowering charges, the commission can mitigate this obstacle and ward off discriminating against and disincentivising ABS investment.
Over the last few years and through the different stages and revisions of the proposals, prospects of high charges under Solvency II have paralysed a significant slice of the ABS industry.
According to Gareth Davies, head of international ABS and covered bonds research at JP Morgan, insurers account for about a third of ABS investment, with direct investment representing about 10% of the market and indirect purchasing through asset managers accounting for another 20%.
“For insurers it has become economically challenging to hold securitisation”, he said, unlike in the banking sector which he says will be able to cope with proposed Basel III capital charges.
But the Commission’s softened proposals could still fall short of making a real difference for insurers, Davies said, as they ease charges for more junior tranches but leave them unchanged for the most senior slice of the market.
“At present, the securitisation market is basically a funding market, so new issuance is almost entirely Triple A - and senior bonds are not the beneficiaries of the changes,” he said.
Meanwhile, Fitch said that the latest revisions would bring “little benefit to the largest and most active European securitisation markets including those for UK and Dutch RMBS and northern European consumer loan ABS as most of the issuance from those structures is rated Triple A.” (Reporting By Anna Brunetti, Editing by Anil Mayre and Helene Durand)