The European parliament voted to adopt the Omnibus II Directive for Solvency II this week, but there is still great uncertainty over how the new regulations will affect the institutional real estate industry.
John Forbes, an independent consultant, has warned that the way real estate investments are treated will not become clear until the final regulations are published.
The regulations will be fully implemented by the start of 2016 and are expected to require European insurers to hold capital reserves to the value of 25% of their property investments, potentially forcing them to reduce their real estate allocations.
“Some fund managers are going to struggle to meet the demands of insurance clients.”
Many large insurers are opting to use internal risk models rather than the regulators’ standard model, which might enable them to hold less capital aside, but Forbes has warned that there is still uncertainty surrounding this approach.
“At this stage there is uncertainty as to the extent to which local regulators will allow internally generated models to differ significantly from the calibration under the Standard Model,” he said.
Forbes added: “The Solvency Capital Requirements for investments, including real estate, are dealt with in the level 2 regulations. A draft from October 2011 has been widely leaked but never published.
“EU officials have confirmed that there is an updated draft, but that this will not be subject to public consultation and will not be published until finalised and translated into the various EU languages. It is being reviewed by an expert group.
“Although it is suggested that the treatment of real estate remains the same as the October 2011 draft, the real estate industry will not get certainty on this until the regulations are published.”
Forbes also warned fund managers to be aware that the focus of insurers and regulators was moving beyond the solvency capital requirements to other aspects, particularly the Own Risk Solvency Assessment (ORSA).
“The requirements for improved governance and risk management will feed through to those real estate investment managers with life insurance companies as clients,” he said.
“Solvency II represents a major challenge for the real estate investment management industry. With the extraordinarily short timeframe to implementation, most insurers have yet to start looking at what this means for their investment managers. When they do, some fund managers are going to struggle to meet the demands of insurance clients.”
The real estate financing industry is still concerned about the treatment of commercial mortgage-backed securities (CMBS). The regulations will apply a uniform capital charge to CMBS regardless of the fact that individual loans differ in risk profile.
“Lobbying efforts to remedy the punitive treatment of securitisation has not had the desired effect,” Forbes said. “The EU regulator’s consultation on the treatment of long-term assets, published on 19th December 2013, makes the treatment of CMBS worse rather than better.”
In January, European associations INREV and CREFC Europe wrote to the regulators in response, arguing the approach could “undermine financial stability”.
Peter Cosmetatos, CEO of CREFC Europe, has since spoken to the European Insurance and Occupational Pensions Authority (EIOPA).
He said: “The development of Solvency II has suffered from some of the problems we often encounter in European rule-making: poor transparency on process and work in progress; limited regulatory understanding of (and even interest in) affected industry sectors; and a silo mentality that means too little weight is given to the broader implications of proposals for the economy and for financial stability.
“Even after the continuing uncertainty in many areas is resolved, Solvency II seems set to create distortive regulatory incentives for capital allocation that may well encourage risk build-up and market failures in areas like the commercial real estate debt market and the exposure to it of one of its most natural investor bases, the insurance industry.”