Cross industry impact from regulations - Why fund management companies should care about Solvency II (and Insurance companies about data management)

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27 January 2016

Michael Weitman, Senior Consultant/Manager with over 20 years of experience at VPD, discusses “Cross industry impact from regulations - Why fund management companies should care about Solvency II”

It is natural to focus on the regulations that directly impact your company. However, that may lead to that you miss some important side effects that will sooner or later take you by surprise. An area where we see a growing interest is the need to disclose the underlying nature and composition of investment funds.

Why? The Solvency II directive that affects most insurance companies has like the Basel III directive for banks imposed new stricter and more diversified capital requirement and reporting regimes.

Institutional investors such as insurance companies are often a major client base of investment funds, and when they are targeted by stricter capital and reporting requirements (e.g. see article 84 in the EU regulation 2015/35) they will require more detailed and timely information about the funds they have invested in. This will soon be regarded as a must-have institutional client service.

Insurance companies which have invested in pooled investment products such as AIFMD funds (private equity, real estate and special funds) and UCITS funds need to classify and categorise these investments and apply risk weights on these assets together with other assets that are held directly.

In order to minimise the hair-cut on assets and the negative effect on capital requirements, more data on the underlying investments need to be collected by insurance companies. Fund companies that are unprepared and unable to disclose and provide information in a timely, concise and effective manner may suffer in the competition for new and existing institutional clients.

Failing to look-through investment funds and other pooled investments on some level could mean that insurance companies are limited by the capital requirements and even unable to add attractive investments such as private equity funds, and the overall investment opportunity could diminish.

Even if capital requirement is not a restraint on the investment opportunities for insurance companies with a high solvency ratio, the regulatory reporting requirements have raised concerns both from a compliance perspective and from an operational data maintenance perspective among insurance companies. Failing to validate, categorise, aggregate and report exposures, including the underlying exposures of investment funds, correctly may lead to future sanctions from the supervising authorities.

An effective data collection and validation process supported by effective systems with mechanisms to extract, transform and load data efficiently is necessary to control the data management costs and operational risks involved. The large number of data points to collect and maintain for each investment is a daunting task. As regulatory pressures on the insurance companies grow they will require more data at a higher frequency, more efficiently and with low operational risk.