Fixed Income
The case for municipal bonds
US municipal bonds are worth considering for European investors portfolios as they may provide a source of diversification and for their relative value compared to Euro corporate bonds.
For many in the insurance industry, the path to reform of UK and EU Solvency II rules has been long and winding. In the EU, preparation for the formal review kicked off in February 2019 with the Commission making clear it wouldn’t be seeking to make major structural reforms, stating that “the fundamental principles of the Directive should not be questioned”1. In the UK, the starting gun was delayed by Brexit, with the (then) Chancellor, Rishi Sunak, only announcing a review in June 20202. However, since then the UK Government’s reforming ambition has grown, leading ministers to claim that reshaping the EU-inherited regime to suit the structural features of the UK market could “unleash £100 billion into all parts of the UK” over the next decade.3
Despite well-publicised differences between the UK Government and the Prudential Regulation Authority (PRA) in relation to changes to the Fundamental Spread4, UK reforms to Solvency II look set to provide a significant degree of capital relief for insurers. Other promised benefits include reducing red tape and simplifying the overall regime.
The UK will finalise its reform package in three tranches:
By contrast, EU reforms to Solvency II looks set to be more protracted, split between changes to the Solvency II Directive (the Level 1 legislation) followed by reform of the Level 2 regulation (the Delegated Act) that sits beneath the Directive – which will only be timetabled once reform of the Directive is complete. The process is somewhat further complicated by differences in opinion between the European Commission, the European Council and the European Parliament as to whether reforms to key parts of the Solvency II framework – such as to the Risk Margin – should be part of the Level 1 or Level 2 reviews.
Currently, the Commission, Council and Parliament are engaging in a process of trilogues – a mix of technical and political negotiations to agree the final text of reforms to the Solvency II Directive. On current planning, the aim is to reach final agreement by the end of 2023. But with significant differences between the three parties in a number of areas – including, for example, on the addition of requirements for insurance companies to develop climate transition plans – there is a risk that negotiations could run on into the first quarter of 2024. Ultimately, the revisions to the Solvency II Directive are expected to enter into application in mid-2025.
Through the parallel reform processes, the risk of increasing regulatory divergence between the UK and EU is clear. Once finalised, implementing and operationalising two different sets of reforms will create additional challenges for insurers operating cross-border. However, such firms will also need to be alive to future risks. For example, in the broader context of the EU’s Strategic Autonomy agenda, there is a risk that the degree of divergence could generate fears of regulatory arbitrage among EU policymakers – which could in turn lead to calls for economic substance requirements for EU insurers to be strengthened. So far, the topic appears only to have emerged at a technical level; but it will be one to monitor under the next European Parliament and new political leadership of the European Commission.
UK Solvency II (to become Solvency UK) |
EU Solvency II |
---|---|
End 2023: HM Treasury legislates to reduce the Risk Margin Q2 2024: PRA publishes final policy and rules on revised Matching Adjustment 30 June 2024: entry into force of revised Matching Adjustment 30 December 2024: entry into force of remainder of UK Solvency II reforms |
Q3/Q4 2023: trilogue negotiations on EU Solvency II reforms End 2023: earliest likely political agreement on EU reform package Mid-2025 (tbc): expected entry into application of the EU Solvency II package. TBC: reforms to Solvency II Delegated Acts |
The case for municipal bonds
US municipal bonds are worth considering for European investors portfolios as they may provide a source of diversification and for their relative value compared to Euro corporate bonds.
Coming down the mountain: Why the descent from peak interest rates should be favourable for corporate bonds
Matthew Chaldecott thinks that there is a window of opportunity in corporate bonds, with the environment looking favourable for returns in 2024 as policy rates fall. Find out what investors can expect as we “come down the mountain”.
Insurance 2024 investment outlook
2024 should mark the beginning of the end for reforms to Solvency II. Having fired the starting gun in February 2019, almost four years later the Commission, European Parliament and European Council are negotiating the final contours of the reform package.
1Formal request to EIOPA for technical advice on the review of the Solvency II Directive (europa.eu)
2Rishi Sunak MP, WMS, Financial Services Update 23 June 2020
3Insurers braced for fresh battle with UK regulators over City reforms | Financial Times (ft.com)
4Specifically in relation to the design of the Fundamental Spread. BoE Evidence to Treasury Select Committee
5Draft_Insurance_and_Reinsurance_Undertakings__Prudential_Requirements__Regulations__1_.pdf (publishing.service.gov.uk); and Draft_Insurance_and_Reinsurance_Undertakings_Prudential_Requirements_Regulations_2.pdf (publishing.service.gov.uk)
6CP19/23 – Review of Solvency II: Reform of the Matching Adjustment | Bank of England
7CP12/23 – Review of Solvency II: Adapting to the UK insurance market (bankofengland.co.uk)
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