Last month, the UK’s City Minister John Glen revealed his vision for the future of financial regulation in the country – and that vision is change. His attention is currently focused on Solvency II, which since its inception in 2009 has been the most important piece of EU legislation governing insurance companies.
Under the proposed plans, policymakers will go back to square one to try and release billions in capital for investment currently constrained by Solvency II capital requirements. While this approach is well-intentioned, it is perhaps too radical. It does also, however, raise interesting questions for the future of investment regulation.
There’s no doubt that there’s room to improve Solvency II, particularly to help encourage long-term investment. Up until now the substantial capital requirements it stipulates for investments have made allocating sufficient funding to public equities a considerable challenge. This hampers insurers’ ability to invest in listed real estate, which is an asset class that has delivered stable and strong performance and contributed to the retirement of millions of people for many years.
Leaving the EU means the UK can create new financial regulations from scratch. Just because it can, however, does not mean it should. Since the regulation was introduced, it has always been EPRA’s view that it was overly complex and prescriptive and didn’t properly reflect the nature of long-term investment risks.
The European Commission is already consulting on areas for improvement to remedy these issues as part of its review expected this year. This includes removing the barriers to long-term investments for listed real estate by properly classifying risk. The introduction of a sub-module to the regulation which covers investments in long-term equity has made some impact, but even that is not perfect – it rested on nearly unworkable conditions that still didn’t reflect the fundamentals of long-term investment. We are confident that as the consultation progresses this will improve, and the noises coming from the European Insurance and Occupational Pensions Authority (EIOPA) so far are encouraging.
John Glen wants to see more growth and the right policyholder protections – if these changes come to pass, they will achieve this without the need to wipe the slate clean and start from the beginning. To do so would be perhaps more a politically motivated decision rather than one based on concrete benefits complete divergence could offer. If the UK wants to retain its place at the heart of European finance, it must retain a high degree of alignment to make it as easy as possible for foreign capital to be injected into the system.
That said, the UK does have an opportunity to go further and faster than the EU is planning. Lessening the requirements for matching adjustments, where interest rates are artificially raised to a ‘risk-free’ point, will make it easier for insurers to back their liabilities, and a more relaxed reporting and administrative regime would also remove hurdles to investing. In this way, the UK could be a trailblazer and leading partner rather than putting more distance between itself and the EU.
There are wider implications to getting this decision right – the UK’s housing system is facing increasing public-funding deficits and private capital is badly needed. In particular, it can help to increase the stock of state-owned housing through public-private partnerships, which make both financial and moral sense for the government and the insurers that could invest and make a difference in this area. Any new regulation the government introduces should make it as easy as possible for insurers to inject their cash reserves into the sector and kickstart long needed development.
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