(April 10, 2014) — The European insurance and pensions regulator has ruled out recommending lower risk charges for infrastructure project finance.
The move by the European Insurance and Occupational Pensions Authority (EIOPA) has dealt a blow to investors’ hopes that infrastructure might carry a lower risk rating under Solvency II.
EIOPA Chairman Gabriel Bernardino wrote in a newsletter yesterday that despite evidence of the risk profile for infrastructure assets improving over time, the body had concluded lower risk charges for infrastructure project finance could not be recommended.
The regulator noted that a possible alternative would be to introduce reduced risk charges for individual infrastructure segments. There was evidence, Bernardino said, to support a slight reduction for unrated availability-based infrastructure debt, but there wasn’t enough evidence for EIOPA to recommend it.
The lack of empirical evidence was a key theme in EIOPA’s statement, stressing that the dearth of publicly available data had made it impossible to offer any recommendations.
“We are confident that the current calibration will allow for a good alignment between risk and capital management and, therefore, can support the long term growth objectives in a prudent and sustainable way,” Bernardino wrote.
“A review should be made when further data would be available.”
The decision flies in the face of pleas from Pensions Europe Chair Joanne Segars, who last year called for regulators to reassess their views on infrastructure risk.
Speaking in September, Segars told aiCIO of her frustration at the regulations coming out of the EU.
“One of the more positive developments from the commission is the green paper directive on long-term investing, which puts pension funds at centre-stage of how they can help create jobs growth and held the recovery by investing for the good of the economy,” she said.
“There is now a willingness by trustees to look at a broader set of asset classes, including infrastructure. But there’s a mismatch here between what the trustees and CIOs want and should be able to invest in, and what the regulations are pushing them to do—they’re pushing for risk-free assets.”
JP Morgan Asset Management also believes the regulator has applied too broad a brush to infrastructure investment and its solvency requirements, adding EIOPA had over-estimated the capital requirements needed by insurers.
Investment in this area by insurers has been cautious to date: the proposed Solvency II regime requires insurers to invest in accordance with the “prudent person principle”. But ranking the assets against other alternatives is difficult as the funds are, for the most part, unlisted.
Due to its characteristics, infrastructure equity would generally be considered as “type two equity” under the standard formula and, as such, capital requirements are calculated using a potential 49% fall in market values (plus or minus any symmetric adjustment).
“The capital requirements for infrastructure debt are captured under the spread risk sub-module, irrespective of whether the debt is held in the form of bonds or where insurers are providing investment through long-term loans,” a white paper on the topic by JP Morgan Asset Management said.
“Under this, the capital requirements are calculated in relation to the duration and credit rating of the instrument. Where the infrastructure debt is unrated, the spread risk charge to be applied falls between that for A and BBB rated bonds and loans.”
EIOPA has fundamentally missed the fact that the volatility of infrastructure cash flows is materially lower than those of equities and property, that infrastructure cash flows are not highly correlated to those of equities and property, and that the cash flows of infrastructure assets grow faster than consumer price inflation, the paper continued.
Related Content: Infrastructure Investing Isn’t Homogenous—So Why are the Solvency Rules? and Why Infrastructure is Back on the Menu for Insurers