After the 2008 financial crisis, where ABS securitisations had a major impact on the market downturns, several new regulations were implemented to avoid unpredictable risks. Overall, this led to significant volume drops in the securitisation market.
With the first introduction of Solvency II, the regulation divided securitisations into 3 categories in descending order of capital intensity: type 1, type 2 and re-securitisation positions. However, the risk factors used for the calculation of capital charges were very high i.e. a risk factor of 67% for a CMBS with a AAA rating and 5 years of duration. This led to a significant decrease in securitisations in the insurance industry.
To strengthen investment in securitisations, Solvency II was adjusted as follows:
- The tiering model has been replaced by the approach of simple, transparent and standardised (STS) securitisations from the Securitisation Regulation EUSR
- The categories are now as follows: senior STS, non-Senior STS, non-STS and re-securitisations
- The requirements of whether a securitisation qualifies as a specific STS are defined in the CRR (Capital Requirements Regulation under Basel III). This includes external analyses by a rating agency.
- As one of the major impacts, for STS capital charges are significantly lower than before the amendment, however, compared to other asset classes such as bonds, loans, and covered bonds, the capital charges are still significantly higher i.e. 4,5% for covered bonds vs. 17% for STS non-senior (AAA rating)
- The changes didn’t show the expected impact on the investment behaviour of insurance as several different market studies have shown i.e. EIOPA
As there are currently reviews for Solvency II in the EU and UK, market participants are calling for changes in the treatment of securitisations under Solvency II.
While in the UK, easements for the treatment of securitisations are very likely to come into force, the European Authorities do not see an urgent need for further adaptions.
The HM Treasury and PRA have proposed the following:
- a substantial reduction in the risk margin by around 65% for long-term life insurance business and 30% for general insurance business
- a more sensitive treatment of credit risk in the matching adjustment portfolio
- allowing for the inclusion of assets with ‘highly predictable’ cash flows in matching portfolios. This could motivate UK insurers to strengthen their investments in securitisations.
- removing the disproportionately severe treatment of assets in matching adjustment portfolios with ratings below BBB
- introducing greater flexibility in the treatment of matching adjustment applications and breaches
PRA published a first draft of the UK Solvency II matching adjustments in September 2023 (https://www.bankofengland.co.uk/-/media/boe/files/prudential-regulation/consultation-paper/2023/september/cp1923.pdf). It is planned that the final policy will be published during Q2 2024 with an effective date of 30 June 2024, with all other changes relating to the Solvency II review taking effect on 31 December 2024. This implementation timeline means that firms can already take advantage of the matching adjustments before 31 December 2024.
In the EU, in 2022, EIOPA conducted a detailed study on the securitisation market under the Solvency II regime (EIOPA(2022)0026630). EIOPA’s main conclusion on the existing framework is as follows:
“Overall EIOPA considers that the current framework is fit for purpose. At this stage, the evidence is not sufficient to justify a change in the calibration for securitisations which meet the STS criteria.“
However, market participants from the securitisation industry are calling for action to adopt new measures in the upcoming Solvency II changes. The first draft of the new Solvency II regulation has not been published so far. In parallel the policy-making process for Basel IV including CRR III is ongoing. Basel IV is planned to come into force on 1st January 2025. As part of the ongoing discussions, facilities for the treatment of STS securitisation are expected (i.e. lowering of p-factor, output-floor etc.) to be part of the new regulation. As a result, market participants are claiming that it would only make sense to align both policies in terms of lowering capital requirements for STS securitisation.
If you want to learn more about the capital requirements and the classification of your securitisation assets, please contact our team anytime.
Sources: Clifford Chance, Deloitte, Skadden, EIOPA, Bank of England, EU
