The European Commission’s decision to officially propose an extension of the STS label to unfunded synthetic securitisations last month as part of its landmark reforms to resurrect the European securitisation market, was a development that was welcomed by both the sell side and the buy side.
However, multiple insurers and brokers contacted by RTRA Intelligence that have reviewed the proposals within the context of the capabilities of the insurance market, concur that only two reinsurers are capable of meeting the proposed criteria putting any notion of an unfunded STS market on hold unless supervisors proceed with adjustments.
The Commission has proposed an extension of the STS designation to unfunded synthetic securitisations subject to various requirements. Yet there’s two requirements in particular that render any notion of an unfunded STS market unfeasible according to multiple insurers and brokers contacted by RTRA Intelligence.
First, is the fact that the insurance or reinsurance undertaking should use an approved internal model to calculate capital requirements for unfunded credit protection agreements. Second is the criterion that the insurance or reinsurance undertaking should meet a Є20bn size threshold.
According to one industry participant, ‘’the use of supervisory approved internal models is a constraint since insurers utilize standard models for various reasons. In particular, it can take two or more years to implement, and unlike banks, this isn’t typically at an asset class level, but instead for the whole organization.’’
Nevertheless, some insurers have partial internal models but it’s not clear whether this will be applicable to SRTs.
Insurers are subject to certain regulatory requirements designed to ensure financial stability, safety and soundness, regardless as to whether they are under the internal model or the standardized approach.
Indeed, the consensus in the industry is that requiring insurers to specifically adopt an internal model approach will only serve to raise barriers for currently active insurers as well as potentially block new ones that might otherwise be willing to participate in the European SRT market.
‘’Having two durable pathways for banks to safely and prudently distribute credit risk is a hallmark of more mature markets such as the U.S. Credit Risk Transfer platforms’’ says the same industry participant.
The second main challenge with the Commission’s unfunded STS proposals is the €20bn size requirement.
Insurers and brokers that RTRA Intelligence has spoken to concur that the key issue is that the EU carrier for these insurers won’t be large enough to enable them to participate in unfunded STS.
Hence, the market is pointing by default to two main changes. First, there’s a clear message that there needs to be a recognition that the standardized approach can’t be excluded.
Second, regarding the €20bn threshold, supervisors can adjust accordingly by targeting the group level as opposed to the operating company and decreasing the threshold.
Moreover, participants suggest the use of an alternative metric to AUM. The latter is more relevant to asset managers with participants pointing to ‘’Total Assets’’ as the substitute measure.
Yet interestingly, not everyone shares the same view with some even suggesting forsaking such metrics entirely since banks from their viewpoint have robust models, policies and procedures to address counterparty credit risk.
If the €20bn threshold was intended to represent an insurer’s total assets, multiple industry sources believe that only two reinsurers would be able to meet the threshold at the EU carrier level. Unsurprisingly, this puts any notion of an unfunded STS market on hold.
