Infrastructure Investing Isn’t Homogenous—So Why are the Solvency Rules?

(September 26, 2013) – Regulators must reassess their views on infrastructure risk, as investors are being frustrated by the capital requirements needed, according to Pensions Europe Chair Joanne Segars.

Pension funds and insurance companies have long been interested in investing in infrastructure projects, but many CIOs have been put off by the capital requirements European solvency regulations will force them to observe.

Although EU Commissioner Michel Barnier appeared to rule out applying Solvency II rules to European pension funds, EIOPA— the European Insurance and Occupational Pensions Authority—is still looking at proposals to revisit it in future.

Speaking today ahead of the Allianz-Oxford Pension Conference, Segars—who is also chief executive of the National Association of Pension Funds—told reporters of her frustration at the regulations coming out of the EU.

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“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.

For example, due to its characteristics, infrastructure equity would generally be considered as “type 2 equity” under the standard formula and, as such, capital requirements are calculated under a 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,” JP Morgan Asset Management’s white paper 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.

It also ignores the diversification opportunities within the asset class itself, and investing in equities of infrastructure corporates has a different risk profile to investing directly in an infrastructure asset, alone, or investing through a portfolio of infrastructure bonds.

The whitepaper concluded: “EIOPA’s proposed calibrations may materially overestimate the capital requirements for insurers looking to hold these assets. The use of an internal model to calculate Solvency II capital requirements allows firms to adopt a more granular treatment than set out in the current draft of the Solvency II standard formula.”

The fund manager suggested those looking to hold significant levels of investment in infrastructure could consider moving to an internal model approach in order to more accurately reflect the risks inherent in this asset class.

The JP Morgan Asset Management whitepaper can be read here.

(September 26, 2013) — The largest Abu Dhabi sovereign wealth fund could be about to haul Citigroup back to court with further claims to recover some of the bank’s bailout, after its prior attempts were thwarted in March.

In a document unsealed in a New York court this week, Citigroup said that a claim filed in August by the Abu Dhabi Investment Authority (ADIA) had made an “assault” on a federal court ruling in March, Reuters reported.

The March ruling saw ADIA’s claim—and subsequent appeal—to recover $4 billon of the investment it made in the bank during the crisis refused.

Citi’s deposition said only after losing the battle for the $4 billion did ADIA discover it had further grievances against the bank. It is now seeking $2 billion for each claim against it, citing breach of contract and of the implied covenant of good faith and fair dealing.

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“ADIA’s new arbitration is nothing more than an improper attempt to litigate claims that ADIA knew about, could have brought, and in significant part did bring to light in the first arbitration,” Reuters cited from Citigroup’s lawsuit.

The bank is seeking an injunction against the new ADIA arbitration, which was filed last month with the American Arbitration Association. A week later, Citigroup filed a lawsuit against the fund, with ADIA moving this week to try and have the lawsuit dismissed claiming arbitrators, rather than a court, should hear the bank’s arguments.

The case has been on-going for several months.

ADIA initially claimed in late 2009 that its November 2007 investment of $7.5 billion into Citigroup was based on fraudulent statements by the US bank. At the time, Citigroup battled record losses tied to subprime mortgages. If the investment was unable to be canceled, the Abu Dhabi fund had sought $4 billion in damages. Meanwhile, the bank had asserted that the suit lacked merit, promising to “vigorously” defend itself.