Both the Bank of England and HM Treasury have raised concerns about aspects of the Solvency II regime in their submissions in response to a European Commission Call for Evidence on the EU Regulatory Framework for Financial Services (launched in September 2015). The Commission Call for Evidence requested that responses identify current obstacles to the ability of the wider financial sector to finance the economy.

Points raised by the Bank of England:

  • Consideration of inclusion of macro-prudential tools in Solvency II. The Bank of England states that it isn’t sure whether the use of powers to declare an exceptional adverse scenario that would enable firms to have an extended recovery period is productive. The ‘ladder of intervention’ under Solvency II means that national authorities such as the Bank of England have limited scope to tackle system-wide crises as the ladder applies on an individual firm basis. The Bank comments that one explanation for the lack of pro-cyclical behaviour in the insurance sector during the recent financial crisis was the ability of the regulator to take steps on an industry wide basis.
  • Excessive volatility of the risk margin in Solvency II. The Bank comments that the sensitivity of the risk margin under Solvency II is likely to have significant absolute and hedging costs for undertakings where there are short term variations in the risk-free rate. This degree of volatility is undesirable from both a micro-prudential and macro-prudential perspective. The Bank proposes that the risk margin should better reflect the valuation of risks that a third party would be taking on and be sensitive to interest rate conditions but should be designed to deliver more stable outcomes so that insurers are supported as long-term investors in the economy.
  • The Ultimate Forward Rate under Solvency II. As differences remain in the way that discount curves are derived and applied under different currencies and in different national markets, Solvency II can lead to large differences in the solvency positions of firms according to where they are located in the EU. The Bank suggests that finding a common basis would improve comparability between European jurisdictions.
  • Treatment of sovereign exposures under Solvency II. The absence of spread risk and concentration risk charges for EU government bonds should be considered by the Commission.
  • Definition of Financial Institutions under Solvency II. Solvency II requires that entities which would be financial institutions according to the Capital Requirements Regulation (575/2013) (CRR) should be treated according to CRR valuation in the group solvency calculation. The definition of “financial institution” however extends to holding companies that are not intermediate insurance holding companies or mixed financial holding companies and dedicated finance vehicles. The result is that groups which do not have entities regulated under CRR may have to apply CRR valuation procedures for the capital resources, posing a significant burden upon those groups.

Points raised by HM Treasury:

  • Timing of the planned Solvency II review.  HM Treasury makes the case for giving the planned review of Solvency II a broader scope than planned and suggests that the review might even be brought forward to an earlier date than planned. HM Treasury states that –  although in the very early days of implementation – there are already issues around the impact of Solvency II on long-term investment and the competitiveness of the European insurance industry.
  • Implementation timelines. The  deadlines and sequences for the implementation of Solvency II (alongside other contemporaneous legislation in the financial sector) failed to have regard for the challenges that authorities would face in meeting these timetables. HM Treasury proposes ensuring that schedules for legislation where similar types of firms will be effected should be planned at the same time.
  • Need for anti pro-cyclical tools. The efficacy of tools to counter pro-cycality have not been tested in a real life scenario. Accordingly, HM Treasury requests that these tools are closely monitored to ensure that they are fully effective.

For further information: Bank of England response to call for evidence; HM Treasury response to call for evidence