EUROPE - The final details of Solvency II are still far from certain. What is clear is the lobbying efforts to reduce the 25% standard capital charge for real estate is entering a new phase.
Last week, the European Insurance and Pensions Committee (EIOPC), which has been working on its recommendation to the European Parliament on Solvency II rules, issued its latest draft. The announcement had been eagerly awaited by those in the campaign to reduce the standard capital charge, but resulted in disappointment, with the 25% shock factor left intact.
"I don't understand why [they] do not hear the arguments," says Michael Morgenroth, member of the board at Gothaer Asset Management, the investment arm of German insurance company Gothaer. "It is more of a political issue to keep the distance between the capital shocks for government bonds and real estate to have some incentive to still invest in government bonds."
Morgenroth is also chairman of the European Association of Investors in Non-listed Real Estate Vehicles (INREV), which has been leading the lobbying. Its argument to reduce the market shock for real estate from 25% to something closer to 15% is based on research by Investment Property Databank (IPD). Regulators have based the 25% threshold on the UK real estate market, where data is deeper, but IPD argue that continental European markets are less volatile and so are being unfairly penalised.
Last week, Jeff Rupp, head of public affairs at INREV, said the latest draft from the EIOPC showed that lobbying efforts must now move to the European Parliament and national regulators where the debate over the implementation of Solvency II will migrate. "Its transmission to the Parliament is a major step in the evolution of the debate and shifts the focus of our lobbying efforts," he said.
But it is uncertain that the opportunity to persuade the EIOPC to reduce its 25% capital charge for real estate is necessarily over. Marieke van Kamp, head of real estate at ING Insurance Benelux, says "it is too early to fully shift the focus of the lobbying", citing the fact the latest update from the EIOPC is not its final recommendation.
Van Kamp believes the objective of the update draft was to show that progress was being made by the EIOPC on its Solvency II recommendations. This does not necessarily mean the committee has made its mind up about the treatment of real estate. "It still says 'property shock 25%', but that does not mean they have finally chosen," she says. "It might still be a discussion."
The asset class continues to be a side issue and not a major priority of the regulators, who may have simply retained the 25% capital charge because they have been focusing on other areas of the regulation. So the 25% threshold might not be set in stone, but some believe the implication is there for all to see.
Rupp says INREV still "clings to the hope it will still change", but he is not as optimistic as he was when speaking to IP Real Estate in October. Rob Martin, head of property research and strategy at Legal & General Property, a subsidiary of UK insurer Legal & General, is similarly pessimistic about the prospects of lobbying EIOPC. "The probability of success in achieving an adjustment to the 25% shock for the standard model is modest," he says. "But the chance will be maximised by a concerted effort to influence legislators in the European Parliament and national financial regulators."
Perhaps one shred of evidence that the EIOPC has settled on the 25% threshold for good is the fact that the latest draft included clarification of the treatment of real estate funds under Solvency II. This is good news as far as real estate investors and fund managers are concerned, but it does also challenge the notion that the property asset class had been overlooked entirely in the latest draft.
There had been concerns that real estate funds using any amount of leverage would be treated in the same way as private equity funds and slapped with a higher capital charge of 50%. The latest draft clarifies that insurance companies can treat real estate funds transparently and apply the standard property charge to the underlying assets and any attached leverage. In other words, a 25% capital charge would be applied to the gross asset value (GAV) of real estate funds, rather than 50% applied to the net asset value (NAV).
"This is important because it makes clear that they will not be treated as funds subject to the private equity market shock factor, and in addition, being based on GAV, leverage does not affect the treatment," Rupp says. "An insurance company can opt not to 'look through', but would have to apply that approach consistently across its portfolio and not pick and choose the preferred treatment. It would also have to continue to apply the option for the future."
This really is good news, particularly given that applying a 50% shock on NAV would effectively give an advantage to funds with higher levels leverage and conversely penalise those with moderate amounts.
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