Speaking at the European Commission's public hearing for the 2018 review of Solvency II last month, Dombrovskis said the move – which is part of the Commission's Capital Markets Union programme – "will give markets the opportunity to reach their pre-crisis average and generate up to €150bn ($190bn) in additional funding for the economy."
The European Parliament introduced the STS rules last year in order to make securitisations less complex and more transparent, as part of an initiative to revive the European securitisation market.
Our publication has learned the new framework is due to be introduced in June and is set to apply from 1 January 2019.
The amendment is being introduced to ensure the consistency of Solvency II with the newly drafted STS Securitisation regulation. It sets revised risk factors for investments in securitisations, with lower charges for higher quality and shorter duration investments. It also includes transitional provisions, to ensure that insurers invested in type 1 (senior tranche) securitisations are not forced to liquidate their positions.
The revised calibrations are based on the existing ones but with the addition of a spread risk module which serves to lower capital charges by better defining factors like credit rating and duration of the securitisation. Solvency II places securitisations within type 1 and type 2 categories according to their risk levels.
Until now, despite high ratings, many securitised instruments have fallen into the type 2 designation, which has penal capital factors that have deterred many standard formula insurers from investing in them. For example, an AAA-rated collateralised loan obligation (CLO) with five-year duration currently has a spread charge of 63% despite being a highly rated instrument.
According to the draft amendment, the risk factor applicable to underlying exposures will in future be increased "by a non-neutrality ratio," which is based on the 2015 advice by the European Banking Authority (EBA) and will add an extra layer of quality to the STS securitisation regime, similar to the treatment seen in banking currently.
The new rules will also introduce a risk sensitivity factor across ratings and tranches to better assess the underlying risk of the security and provide greater assurance to investors. Lastly, securitisation risk factors are also reduced for durations longer than five years, in the same manner as they are for corporate bonds in Solvency II.
Our publication understands the proposed formulas will result in significantly lower capital charges especially for type 1 securitisations. The draft amendment shows a huge range of capital charges, depending on the credit quality and duration.
Some examples based on those formulas can be seen below:
The changes could materially impact the attractiveness of securitisations under Solvency II and result in increased interest from insurers reporting under the standard formula. For example, an unrated senior STS securitisation of five-year duration would attract a capital charge of 23% under the proposal compared to 100% under the current rules.
Positive for industry
The amendments have been welcomed by the industry with most insurance asset managers stating it will provide a higher quality of securitised products to invest in.
"These are positive changes," a London-based asset management firm told Insurance Asset Risk. "The STS regulation creates a framework to harmonise the definition of securitisation within the EU and help with due diligence, risk-retention and transparency requirements for parties involved in securitisations. It also establishes securitisation repositories to centrally collect and maintain the records of securitisation."
Gareth Haslip, head of strategy and analytics, global insurance solutions at JP Morgan Asset Management says the changes will help the industry on many levels.
"These changes will assist insurers undertake their existing due diligence requirements by aligning originator and investor obligations," he says. "If Solvency II is appropriately amended to recognise STS designated securities, this significantly reduces the existing burden placed upon insurers who currently have to manually check a large number of quantitative and qualitative criteria for eligibility and capital treatment of securitisations."
Haslip adds that Solvency II will now be aligned to Undertakings for the Collective Investment of Transferable Securities (UCITS) regulations implemented to create a harmonised regime for the management and sale of mutual funds.
"In expanding these requirements to UCITS funds, this will open those funds that hold securitised positions to those that need to adhere to Solvency II," he says.
The Solvency II amendment has, however, caused some concerns in the way the regulation could apply to different actors and how their relationships may affect the desired outcome.
For example, as Haslip points out, originators, sponsors and issuers will be jointly responsible for assigning the STS designation, requiring a collaborative understanding of the underlying securities.
"The success will depend on the quality of their collaboration, execution and delivery frameworks, in addition to ensuring the process is undertaken in a timely, effective and transparent manner," he says.
"Proliferation, lack of transparency, issues with access to the data are potential challenges that will need to be addressed. Issues can also include parties electing to not align to the STS requirements or cross-border application."
However, the representative of the London-based asset management firm said that the issues may be contained provided the European Insurance and Occupational Pensions Authority (Eiopa) - which was not involved in the making of these amendments – take on a supervisory role for the harmonisation of the insurance sector with the STS securitisation regulation.
"Eiopa could really fulfil its role as a supervisor in this instance. If Solvency II and STS securitisation is to be aligned, then insurers should be guided by their European supervisory body."