Proposed capital charges under Solvency II regulation will incentivise European insurance companies to invest in asset classes such as covered bonds and corporate bonds to the disadvantage of securitisations, said Fitch in a report today (Monday).

The rating agency said that new measures under the Solvency II framework could lead to disproportionately high capital charges, thereby restricting funding opportunities for European banks, with the European securitisation market particularly hard hit.

The proposed regulation could disincentivise insurance companies from investing in highly rated and historically strongly performing securitisations, said Fitch.

It noted that the proposed capital charges for securitisations are a multiple of existing charges as well as those for asset classes such as covered bonds and corporate bonds, which will encourage insurance companies using a standard formula to invest in these asset classes over securitisations.

Fitch said that the report also highlights anomalies such as a small differentiation in capital charges from the triple-A to triple-B rating categories, and also questions the extent of the preferential treatment given to other securities such as covered bonds, “even where these are backed by the same assets as would typically back a securitisation”.

The rating agency said that it understands that latest Solvency Capital Requirement (SCR) draft rules extend the favourable treatment given to covered bonds under a quantitative impact study (QIS-5) by lowering capital charges for covered bonds in the double-A rating category in addition to lower capital charges already applicable to triple-A rated covered bonds. (Click here for previous coverage of this in The CBR.)

Fitch said that with most covered bonds rated in the triple-A to double-A categories the proposed capital charges under Solvency II are lower than for a similarly rated corporate or securitisation bond.

“Though lower rated covered bonds are treated in a manner similar to corporate bonds they do attract a lower capital charge than similarly rated securitisation bonds,” it added. “This preferential treatment is likely to skew asset allocation in favour of covered bonds in contrast to securitisations.

“As a consequence we expect issuance of covered bonds to be further incentivised.”

The report also highlighted differences between the approaches to setting capital charges under Basel III and Solvency II, with the former focussed on credit risk and the latter on market risk.

Krishnan Ramadurai, managing director, credit policy group at Fitch, said that the difference between the approaches could create an imbalance of investment incentives between banks and insurance companies.

“It would appear counterintuitive to force insurers to mark to market assets that they seek to hold to maturity,” he said. “Furthermore, the calibration of market volatility for all securitisation exposures is against a small, highly stressed asset class that no longer exists in the market.

“It effectively ignores more significant and stable asset classes such as European RMBS.”

Source: Fitch