High capital charges for securitizations under the new Solvency II directive could lead European insurers to dramatically reduce exposure to the asset class and invest in covered bonds instead, Standard & Poor’s said in research published this week.
In October 2012, the European Insurance and Occupational Pensions Authority (EIOPA) released the latest draft technical specifications for Solvency II, the upcoming regulatory overhaul of the European insurance industry. Capital charges for senior securitizations under the draft Solvency II rules' standard formula is up to 10 times higher than those for similarly-rated covered bonds, meaning that return on capital is generally lower for securitizations.
Triple-A rated ABS would attract a capital charge 10 times greater than triple-A rated floating rate covered bonds with the same duration (7% for each year of duration, compared with 0.7% for each year of duration). For double-A rated ABS, the multiple is 18 times compared with covered bonds.
Fitch Ratings said in a report on the updated directive that that the calibration of ABS spread risk was carried out using U.S sub-prime RMBS data. The ratings agency, like S&P, said that the capital charges for ABS under the standard formula appear overly punitive, when compared with those for covered bonds and corporate bonds.
"Given that the insurance sector potentially represents more than 10% of the investor base, we expect that the regulation could cause securitization volumes to fall, while covered bond investment could rise," said credit analyst Mark Boyce in a press release this week.
The Solvency 2 directive has been planned since 2004-05 and was originally scheduled to come into force in 2012. It has been delayed on several occasions and the new implementation date is scheduled for early 2014 but ongoing delays in reaching a final vote on the directive could push that date into early 2016.
"Solvency II regulation remains subject to change, and transitional periods could soften the blow on the insurance industry, said Boyce. “The implementation date of the legislation could be delayed for another one or two years, and even then, insurers may have up to 10 years of additional breathing room before having to implement the new capital adequacy rules.”
Still, Boyce said that some insurers have already begun to move away from investing in securitizations, and this exodus will continue if the final Solvency II rules closely resemble the current draft.