1 October 2015

Commission orders cut to Solvency II charges on infrastructure and ABS

The European Commission rolled out on 30 September a bundle of amendments to Solvency II, intended to incentivise insurers to plough into high-quality infrastructure and asset-backed securities.

The European executive is proposing to reduce the capital charges on infrastructure bonds and loans and equity shares, and European long-term investment funds (Eltifs). A legislative proposal to reduce the charges that apply to investments in high-quality asset-backed securities will follow in the coming months.

The capital treatment of private equity and privately placed debt is also up for review, the Commission revealed, adding the rules could be changed as part of a planned review of the standard formula in 2017.

The proposals are among the early initiatives in the Commission's plan to build a capital markets union. The European Parliament and the European Council have until the end of the year to object to the changes, which will be made to the secondary legislation or 'delegated acts'. The timing coincides with the start date of Solvency II.

The Commission's announcement has come hot on the heels of the publication of a technical report by the European Insurance and Occupational Pensions Authority (Eiopa) on the treatment of infrastructure (IAR, 29 September, Eiopa finalises plan to slash SII infrastructure debt charges).

Commissioner Jonathan HillIn a dramatic reversal of its position, the authority recommended the creation of an asset class for high-quality infrastructure under the standard formula and put forward technical arguments for treating these assets more favourably than corporate bonds.

The Commission largely adopted Eiopa's recommendations, ordering a 30% cut in the capital charges on qualifying infrastructure bonds and A-rated loans, while the charges for unrated infrastructure debt drop 40%.

Infrastructure equity investments attract a charge of 30%, compared to the 49% risk factor that applies to other unlisted equities – the category in which most infrastructure investments would otherwise fall.

The amended version of the regulation also extends the scope of the transitional measure for equities to all categories of equity shares –in the original version of the delegated acts it was restricted to listed equities. This allows insurers to phase out the capital charges on equity shares currently in force for a period of seven years, hence it should discourage rapid divestment.

The Commission also delivered on plans to reduce the charges for Eltifs to 39%, down from 49%, in line with the treatment of venture capital and social entrepreneurship funds. Eltifs are primarily equity funds investing in unlisted companies, in particular SMEs, that need long-term financing.

A revision of the capital treatment for asset-backed securities is next on the list. The Commission adopted a framework to identify standardised and transparent securitisations (STS). Once this legislation comes into force – which could take a few months – an amendment to the Solvency II delegated acts to reduce the capital charges for these assets will be adopted.

Commissioner Jonathan Hill said he expects the STS charges for banks to come down by as much as 25%, but did not advance a figure for insurers. The revised charges will apply to banks and insurers, at the same time, though.

In addition to the amendments to Solvency II, the Commission also launched consultations on venture capital funds and covered bonds and a call for evidence on the cumulative impact of financial regulation.

Trade body Insurance Europe said the proposals are one step in the right direction, but the charges remain overly high and represent a barrier to investment.

European insurers have about €22bn ($25bn) invested in infrastructure, which accounts for 0.3% of their overall portfolios. The industry is keen to ramp up its exposure, attracted by the stable cash-flows and the illiquidity premium in the asset class.