The Solvency II standard formula includes risk charges for debt and equity investments; but they don’t differentiate between investments that are in infrastructure, and those that are not. The Commission would like these charges to be adjusted so that, if an insurer invests in infrastructure, the charges will be lower. The Commission hopes this will encourage insurers to invest in infrastructure, and help Europe’s economies grow. The Commission started this change process in late February 2015, when it asked EIOPA for a technical advice by the end of June. Although EIOPA is still working on some issues, it has recently published a “Consultation Paper … on the Call for Advice from the European Commission on the identification and calibration of infrastructure investment risk categories“. If EIOPA’s final advice is in materially the same form as the consultation version; it’s accepted by the Commission, and makes it into law, then insurers will be able to take advantage of lower risk charges if they invest in “infrastructure assets” through an “infrastructure project entity“, and the assets and entity meet certain tests.
For these purposes:
“Infrastructure assets” means “physical structures, systems and networks that provide or support essential public services and are subject to limited competition“; and
“infrastructure project entity” means “an entity which was created specifically to finance or operate infrastructure assets, where …: (a) the contractual arrangements give the lender a substantial degree of control over the assets and the income … they generate; [and] (b) the primary source of payments to lenders and equity investors is the income generated by the assets being financed“; and
The following tests apply:
- The infrastructure entity must be able to meet its financial obligations under sustained, severely stressed conditions;
- The cash flows the infrastructure project entity generates for debt and equity holders must be predictable;
- The infrastructure assets and infrastructure project entity must be governed by a robust control framework, which includes strong termination clauses;
- The debt or equity instrument (as the case may be) must have a credit assessment of at least credit quality step 3 (if it’s been rated; or equivalent characteristics, if not);
- The political and legal environment to which the infrastructure assets are subject must be stable and predictable;
- The assets and cash flows of the infrastructure project entity must be effectively separated from other entities;
- The capital structure of the infrastructure project entity must allow it to service all its debts under very robust assumptions;
- The infrastructure project entity must transfer the risk related to the design and construction of the infrastructure assets to a suitable construction company;
- The infrastructure project entity must transfer the material risks related to the operation of the infrastructure assets to a suitable operating company; and
- Fully proven technology and design must be used.
If these tests are met, and the insurer invests in the infrastructure project entity’s debt, then:
- The credit risk element of the spread risk charge associated with that investment will be between 0% and 22.8%, depending on the rating of the instrument and the time left to maturity (see the table in paragraph 1.162 of EIOPA’s paper); and
- (If it’s sufficiently clear that the investment will be held to maturity), the liquidity element of the spread risk charge associated with that investment will be between 0% and to 25.66%, depending on the same criteria (see the table in paragraph 1.151 of EIOPA’s paper).
If the 10 tests are met, and the insurer invests in the infrastructure project entity’s equity, then the equity risk charge will be between 30% and 39%.
These are significant reductions against the risk charges that would otherwise have applied. it remains to be seen whether they will be enough to meet the Commission’s objectives. We’ll see.
EIOPA will be holding a public hearing in Frankfurt on 4 September 2015, before submitting its final advice to the Commission at the end of that month.
In the meantime, it’s not yet entirely clear when or how these changes will be made – assuming, of course, that the Commission accepts EIOPA’s advice, when it’s given in two months’ time. If it does, because the changes will be effected (at least in part) by amending the Solvency II Delegated Regulation (2015/35), it appears that the Commission will obliged to adopt an appropriate delegated act before 23 May 2018 (when its article 301(a) power will expire), before giving notice to the Parliament and Council that it’s done so. If that happens, the act will enter into force 3 months later unless (a) the Parliament or Council objects, or gives notice that it requires another 3 months to consider the issues; or (b) the Parliament and Council expressly confirm that they will not object, so the act can enter into force more quickly. If this is right, the overwhelming probability is that EIOPA’s advice will not be implemented until sometime after 1 January 2016, at best.