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Musing on Solvency II - A Follow Up

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1. Introduction

In the past few weeks, the European directive: Solvency II has made its way to the front page of the broadsheets and lead item on the evening news. Prudential is threatening to relocate to the Far East and the deputy Governor of the Bank of England warning of the increased costs associated with Solvency II and of regulators “drowning in masses of data”. It isn’t too often that European regulatory machinations get hearts pumping and tempers flaring. One cause for this reaction is the long, convoluted and opaque process Solvency II has travelled with the flood of rumours that have accompanied it on its that journey.

Solvency II has the primary objective of strengthening protection for insurance policyholders by ensuring that insurers and reinsurers fully understand the risks inherent in their businesses and allocate enough capital to cover those risks. Although focused on the insurance industry it has particular implications for asset managers who have European Insurance companies as investment clients.

2. Rumour and Reality

Towards the latter end of last year the rumour mill indicated that the implementation date of Solvency II would shift from the start of 2013. Initially, articles and stories were published in the UK financial press indicating that the UK insurance industry was determined to stick to the original implementation time frames in the face of the delay rumoured by Europe. Following rapidly after those articles, the FSA issued a statement clarifying it position: that it had revised its own implementation assumptions noting that there would be a bifurcation of implementation dates where responsibility would be 'switched on' for the local regulators and EIOPA as at 1/1/13 and the Solvency II requirements switched on for firms as at 1/1/14. There will be no twin track approach to the adoption of Solvency II. The IT investments made by the UK Insurance industry have been large given the relative size of the industry and its complexity; this was admirably demonstrated by the fact that at the end of 2011, the UK industry had presented 19 internal models to supervisors compared to 3 by German firms and 2 by French firms.

The extra year to implement allows some firms additional breathing space to catch up, for others it increases costs of maintaining existing processes and being unable to bring their investments to market.

The industry having coalesced around the new approach, the adoption of the new dates was wrapped in the Omnibus II directive which was due to be voted on by the Econ committee and thereafter a plenary vote in the European Parliament. However, the Econ committee vote has been postponed until the end of March with the plenary vote being postponed until July 2. It should be noted that despite these postponements and the content of the Solvency II Pillar 3 reports (which have asset management requirements) not being finalised until June 2012, the implementation timetable remains the same. However, the moving target dates and the 400 or so, tabled amendments to the directive which have to be addressed, all point to a timetable under stress. Further delays are being whispered about.

3. Requirement

Notwithstanding the delays, as part of Solvency II, Asset Managers will be required to make substantial investments in time and resources to fulfil their obligations to their insurance clients by providing data for Solvency II Pillar 3 risk reporting. Although the reporting covers a sliver of the full reporting requirements it probably has the largest footprint with regard to data. Solutions for providing the additional reporting will be dependent on an asset manager’s operating model: outsourced operations and accounting may shift the solution to the outsource provider, organisations which still retain operations, accounting and data management in-house, may need to flex their operational, data management and business models to accommodate the new cross disciplinary requirements. Assets (and in some cases liabilities) which form part of the client’s holding will need to be reported to the insurance client including assets held by 3rd parties which may form part of pooled and/or segregated funds. The coverage of holdings, reference and security data held in client portfolios, spans the reporting of open and closed (during the reporting period) derivative contracts, assets held as collateral, security lending contracts, profitability on assets, look through to security level for securitised funds, and the reporting of all other assets held in the fund. The issues surrounding the sourcing and distribution of this data are numerous and will need to be addressed within any solution:

  • Sourcing the different data elements may require the integration of standalone systems/spreadsheets and/or administrator/custodian data sources;
  • Standardised data quality checks will need to be applied to diverse sources of data which could affect delivery schedules;
  • Mechanisms, protocols and templates will need to be agreed between asset managers to allow for the passing of information between asset managers;
  • Security data will need to be decomposed and re-classified according to a predefined asset structure: the CIC table. The reclassification of securities into the current CIC structure is open to interpretation and its coverage of non-equity asset classes is not complete.
  • The corporate structure of the client may entail multiple reporting of the same data to different legal entities.
  • As with any client reporting solution, the output will be eventually distributed to clients globally, all in acceptable formats within tight client driven deadlines.

Timely and consistent provision of Solvency II Asset Management data may well be seen as an additional requirement in the RFP process for fund selection. It is easy to see that a scalable and efficient Solvency II reporting platform will be seen by many as a source of competitive advantage.

4. Challenges

The challenges which Solvency II presents to Asset Managers are twofold: 1) a moving target with a degree of uncertainty on a regulatory level, 2) a new reporting deliverable with a large data footprint where sourcing the required data will cause problems.

Many organisations may delay their preparations due to point 1, but there is risk in this approach. There will be a regulatory requirement in one form or another in the next couple of years. This will need to be addressed; the question is whether asset management organisations will have enough time and resources to do it.

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