Updated Solvency II specifications published by the European Insurance & Occupational Pensions Authority (EIOPA) last week are positive in that they formalise favourable treatment of AA-rated covered bonds, according to a Danske Bank analyst.

The industry authority on Thursday released revised technical specifications for Solvency II, which would form the basis of another, sixth, quantitative impact study (QIS). According to Søren Skov Hansen, analyst at Danske Bank, the latest version differs from QIS 5 in three main ways: increasing a base capital charge capital for triple-A rated covered bonds, introducing a separate spread risk category for double-A rated covered bonds, and introducing a new formula for calculating capital charges.

“This is the first time this treatment has been presented in more formal, concrete terms,” said Hansen. “We had seen separate charges for double-A covered bonds before, when the Norwegian FSA did stress tests, but this time it’s from EIOPA.

“I wouldn’t be surprised if there are further changes, but it is positive to see the favourable treatment of double-A rated covered bonds being formalised.”

The extension of favourable treatment from triple-A to double-A covered bonds was already included in European Commission Solvency II proposals released in the spring this year.

In the context of EIOPA specifications, under QIS 5 only triple-A rated covered bonds received preferential treatment, according to Hansen, with double-A rated covered bonds treated similarly to corporate bonds.

“Under the new QIS 6 specifications,” he said, “adjustments have been made for both the AAA and AA class of covered bonds.”

These involve increasing the base charge for holding triple-A covered bonds from 0.6% to 0.7%, although the calculation method has changed, noted Hansen, and introducing a separate spread risk class AA-rated covered bonds, which are assigned a base charge of 0.9%.

“In our view, the effects of the changes in the specifications are neutral for AAA covered bonds as the difference is minor and positive for AA covered bonds,” he said, “due to the significant reduction in capital charge coupled with AA covered bonds now being treated more leniently than AA corporate bonds.”

Relative change in capital charge from QIS 5 to QIS 6 for AAA covered bonds, and versus AA corporate bonds under QIS 5 for AA covered bonds

Source: Danske Bank

Photo: EIOPA