Solvency II Impact on Existing Asset Management Arrangements: PART 1
The new Solvency II Directive (2009/138EC) which entered into effect on 1st January 2016 in the European Union (EU) has ushered in a new regulatory framework for the insurance industry. It aims to establish an enhanced risk-based approach to capital requirements for EU insurance and reinsurance undertakings (Firms), to improve internal control and risk management frameworks, to establish enhanced disclosure requirements, to enhance consumer protection, and to stimulate market competition. Whilst the Directive is not directly applicable to asset management firms, it will nonetheless have a profound impact on the asset management industry.
Data Provision, Portfolio Management, and Asset Allocation
Pillar 1 will require Firms to calculate a Solvency Capital Requirement (SCR) through the Standard Formula or an Internal Model using seven Risk Modules.[1] The SCR reflects the amount of funds that a Firm is required to hold in order to absorb significant losses, to avoid insolvency, and to ensure all quantifiable risks are taken into account. Asset managers will often manage data that is required to populate key risk modules such as Market Risk and Counterparty Default Risk. Asset managers will therefore need to decide if they will source and provide this data as an added-value service, increase fund or management charges, or implement a one-off charge for additional services provided. They may likely be asked by insurance clients to manage portfolios and optimise asset allocation in order to ensure capital efficiency under Solvency II, whilst also addressing solvency ratio volatility concerns. Finally, asset managers may need to make a business decision about whether they should develop Solvency II capital charge modelling and calculation capabilities or to source third party administrators (i.e. custodians, risk specialists).
Client Reporting and Solvency II Strategy
Solvency II Pillar 3 will require Firms to provide data at an increased frequency, volume, and at a higher level of granularity.[2] The significantly increased data requirements under Solvency II may require some asset management firms to adapt and improve existing data management programmes, or to roll out new programmes. These will need to ensure that all aspects of data management under Solvency II (i.e. data delivery, governance, quality, exchange formats) are effectively addressed in order to ensure robust and accurate portfolio data. Asset managers may have to identify and classify financial instruments by asset type, asset class, and industry sector, and ensure existing industry classifications do not conflict with the new EIOPA taxonomies and are accurately mapped (e.g. industry sector dictionary (NACE), asset class dictionary Complimentary Identifier Code (CIC)). Asset Managers may also now be required to ‘look-through’ to structured asset pools and fund of fund structures (i.e. UCITS, hedge funds), which may prove to be particularly challenging to implement. Asset managers should therefore aim to ensure they adopt a proactive approach to developing a clearly defined Solvency II strategy (e.g. defining revenue targets, new product development) in order to achieve significant competitive advantage.
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[1] Non-Life underwriting risk, life underwriting risk, health underwriting risk, market risk, counterparty default risk, intangible asset, and operational risk modules.
[2] There are a large number of Solvency II Quarterly Reporting Templates (QRTs) which cover fields such as Minimum Capital Requirement (MCR), SCR, Premium Claims and Expenses, Assets, Balance Sheet, Own Funds, Technical Provisions, and Group Reporting.