Reforming the European Union’s insurance rules to free up billions of dollars in capital is a key part of the UK government’s program to boost the economy. The market turmoil caused by the mini-budget could make such ambitions more difficult to achieve.
The combination of rising interest rates and jitters fueled by the near-explosion of liability-driven pension funds could undermine the government’s efforts to roll back EU-era Solvency II rules, which several financial and financial institutions say it is doing would make it harder to achieve their growth goals, according to regulators.
According to Huw van Steenis, a former adviser to Mark Carney when he was Governor of the Bank of England, there could be “small changes” to Solvency II, but the scope is likely to be limited. “More of a whimper than Big Bang 2.0,” said van Steenis. Two other regulatory experts, who declined to be named to discuss government policy, agreed that the push to relax insurance regulation may have been weakened by the market turmoil.
The Treasury said it would push it.
“We are absolutely committed to enacting Solvency II reforms that could unlock tens of billions of pounds of investment in long-term UK infrastructure,” said a government spokesman. Kwarteng has said he will announce “an ambitious set of regulatory reforms” this fall to reach a 2.5% growth target.
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Even if the changes are pushed through, higher interest rates could dilute the expected benefits of Solvency II reform anyway. Such an environment shrinks the amount of capital that can be released and reduces the relative attractiveness of returns on infrastructure projects, which the government hoped would be the primary target for funds released.
EU regulation
Solvency II, a technocratic regulation introduced in 2016 to harmonize insurance rules for 28 countries, has become a high-profile target in Prime Minister Liz Truss and Finance Minister Kwasi Kwarteng’s campaign to cut red tape and create a Brexit dividend.
While there is broad support in the financial community and across all political parties for a Solvency II reform to help UK companies and free up capital for investment in areas such as infrastructure and climate change, there have also been warnings that deregulation could increase risks.
The Prudential Regulation Authority, the Bank of England’s financial health arm, is backing changes to part of the Solvency II regime. But she wants stricter, not lighter, standards for the so-called matching adjustment, which balances long-term assets with liabilities in the form of promises to pay annuities to policyholders until they die.
The PRA did not comment.
pension fund jitter
The plight of liability-driven pension fund investing, triggered by falling gilt prices and forcing the Bank of England to launch a 65 billion program in selling relatively illiquid assets, van Steenis said.
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That likely increased the PRA’s caution about allowing insurers to invest in a broader range of assets, he said.
“The government’s signed Solvency II reform, which aims to free up tens of billions for green infrastructure, looks extremely unlikely after last week,” said van Steenis, co-chair of the World Economic Forum’s Financial Services Council. The BOE will be encouraged to make adjustments for “illiquid infrastructure” and insurers would also “proceed cautiously” amid market dislocations, he said.
Still, there are some differences between LDI issuance and insurers, analysts said, including the large amounts of liquid assets insurers operate with.
The current interest rate environment could also dampen the effects of the Solvency II reform. Rising interest rates reduce the capital that insurers can free up because of the way their risk margin is calculated. The PRA said in July that Solvency II reforms could generate £45bn to £90bn of insurers’ capital to invest in the economy, which would be lower in a high interest rate environment.
Another factor is improving yields on corporate bonds and other assets, which can make insurance companies and pension funds less keen to channel funds into infrastructure investments, further undermining government plans. “I think as yields rise, pension fund managers will likely be less enthusiastic about investing in alternative assets like infrastructure projects,” said Kevin Ryan, insurance analyst at Bloomberg Intelligence.
government push
Many in the City of London expect the Treasury to include Solvency II in its Financial Services and Markets Bill, its framework for post-Brexit rules for banks, insurers and wealth managers. But the government’s far-reaching plans to deregulate the City of London may be more difficult to achieve since Kwarteng’s speech.
“This is a broad issue that we are now addressing in the context of the government’s proposals for Big Bang 2,” said Richard Portes, professor of economics at London Business School. “The events of the last week suggest that financial markets are fragile and you deregulate at some risk.”
Photo: A commuter drives past the Bank of England in the City of London, Britain, on Monday October 3, 2022. The pound posted a two-day gain and UK government bonds fell as Prime Minister Liz Truss defended her package of sweeping tax cuts, raising investor concerns about the country’s fiscal credibility. Credit: Carlos Jasso/Bloomberg
Copyright 2022 Bloomberg.
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