Luxembourg: Destination: Solvency II

Last Updated: 28 November 2016
Article by Martin Reinhard
Most Read Contributor in Luxembourg, September 2019

It has been almost a year since the entry into force of Solvency II (SII), and the reporting efforts of (re)insurance undertakings and asset managers are finally converging towards business as usual.

...Right?

In fact, we're not quite ready to say so yet. Here are some reasons why we think that Solvency II reporting's wandering journey isn't quite over yet.

The blurred vision of the look-through approach

The application and reach of the look-through provision are extensive, with (re)-insurance undertakings (IUs) being required to gather exhaustive asset-level information on their positions in collective investment undertakings to determine solvency capital requirement (SCR) figures reliably.

Recent monitoring exercises done to verify the degree to which the look-through (L-T) principle is applied suggest that many IUs are not able to reach a significant coverage of their investments via the L-T. Moreover, even when the principle is applied, there is no homogeneous indication that the L-T is used as well on deeper layers of investments (e.g. funds of funds, derivatives), as is advised by the Regulation. But what's holding IUs back from achieving complete look-through? The answer is a lack of the quality of the data retrieved from asset managers: information gaps, inaccuracies (e.g. CIC, LEI information) and heterogeneity of the data—amongst other things.

Validation controls tightening up

Transparency and quality of investment information are key topics in SII. Information errors translate into higher capital charges and operational costs for (re)insurance undertakings. Consequently, investment funds that fail to provide look-through information on their holdings or don't do so with a sufficient level of granularity and quality will face a severe competitive gap within the SII environment.

Previous reporting rounds have been characterised by supervisory authorities taking a slackened approach towards the validation controls applied to input data sourced from IUs, so as to smoothen the transit of data for the early reports. Along with the ongoing normalisation of the reporting processes, it is expected that validation controls will be tightened up, meaning more responsibility for IUs and, in turn, on asset managers as the prime source of the investment information.

Full speed ahead towards annual reporting

The scope and breadth of annual reporting is palpably larger than quarterly reporting, demanding additional Quantitative Reporting Templates (QRT) and new narrative reports (Solvency and Financial Condition Report and Regular Supervisory Report). Although the preparation of QRTs should not come as a novelty for most IUs, the workload needed to prepare a higher number of templates and comply with the greater level of detail should not be underestimated. This is true especially for those IUs which were exempt from quarterly reporting obligations and will now have to gather detailed item-by-item information to produce the look-through and other asset templates for the first time.

Annual reporting also means that IUs must disclose sensitive company information to the public through the Solvency and Financial Condition Report (SFCR). Given the nature of such information, we foresee that IUs will consider this reporting requirement to be beyond a mere compliance exercise. Feeble reporting performances would convey a misleading message to the ultimate audience of the report, including shareholders, regulators, and competitors.

External audit of Solvency II reporting: a costly dilemma

Although in most member states the opinion of the supervisory authority has been to require external auditing of at least the core elements of SFCR and/or annual QRTs, in other cases the relevant authorities have decided to opt out. Arguably, the practice of external auditing would bring advantages in terms of faithfulness and comparability of the reports, though at the price of raising the costs borne by the industry. Accordingly, the appeal for external audit may have repercussions over the whole reporting process, meaning stricter data quality requirements for asset managers' feeds and further cost opportunity considerations.

Can't rest easy... yet

Both regulatory and industry forces will drive toward some (expectedly) remarkable changes in the approach to Solvency II reporting. In 2017 EIOPA will be expected to re-discuss the methods and assumptions applying to the look-through approach over investments through collective investment undertaking, shedding light on a topic where a lack of specific regulatory indications have left many open questions for IUs and asset managers. The advice will also contain references to the application of risk mitigation technique criteria and to methods for setting up a standardised approach to deriving alternative credit assessments (i.e. avoidance of reliance on external credit ratings). On the other hand, the standardised asset data reporting template (the Tripartite Template, or TPT, promoted by the European Working Group to foster the exchange of SII information from asset managers) is expected to undergo a revision by Q2 2017, covering the latest field taxonomy and regulatory updates (e.g. incorporation of infrastructure investments).

Strategic positioning within Solvency II environment

For IUs, Solvency II calls for an increased awareness of and attention to investment practices. It means introducing additional elements to the traditional value-drivers to assess the convenience of existing and prospective investment decisions. In an environment of low yields and risk-appetite constraints, the presence of embedded capital costs and operational inefficiencies will become even more an element of discrimination within the asset selection process.

Asset managers will have to choose their strategic positioning within this new environment. Whereas non-compliance may represent a deal breaker for IUs targeting full look-through, the level of reach, quality, and consistency of SII information represents a remarkable means to remain competitive and to promote new client mandates.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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