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EIOPA conducted a peer review focusing on the supervision of investments in complex assets, in particular derivative products.
EIOPA recommended to the ACPR to ensure a common understanding and application by insurance and reinsurance undertakings of the use of derivatives for efficient portfolio management by either (i) issuing guidance to the market, (ii) setting clear expectations, or (iii) issuing specific internal guidance to support supervisory work.
Rules for the management of derivatives and other complex assets by insurance and reinsurance undertakings may evolve.
In line with its mandate, the European Insurance and Occupational Pensions Authority (EIOPA) conducted a peer review of the supervision of the Prudent Person Principle (PPP) for insurance and reinsurance undertakings under Solvency II. The review focused on the supervision of investments in complex assets, with a particular emphasis on derivative products.
The report, published on 2 May (available here), contains recommendations for action to various national competent authorities, including the French Autorité de contrôle prudentiel et de résolution (ACPR).
Regarding the use of derivatives, EIOPA found that the use of derivatives by insurance and reinsurance undertakings is mainly concentrated in 10 EU Member States (France, Denmark, the Netherlands, Germany, Sweden, Ireland, Norway, Spain, Belgium and Italy). In these countries, the average exposure (in notional amounts) is above 1.5% of total assets, according to EIPA findings. The most common types of derivatives used are currency and interest rate derivatives.
According to Article 132(4) of the Solvency II Directive, insurance and reinsurance undertakings may use derivatives in two cases (except for unit-linked and index-linked assets without guarantees): (1.) for hedging purposes or (2.) to facilitate efficient portfolio management.
EIOPA’s recommendations focus mainly on the latter.
- For hedging purposes, national competent authorities are expected to assess the effectiveness of the hedging strategy during on-site inspections. EIOPA indicates that national competent authorities may assess the net gain or loss of the hedging activity or the hedge ratio based on the “delta” of the derivative.
- With regard to efficient portfolio management, EIOPA notes that derivatives can be used to reduce investment costs, and thus act as an efficient portfolio management tool. However, EIOPA recognises that there is no generally accepted definition of all cases where derivatives should be considered to facilitate efficient portfolio management. EIOPA has identified three main risks associated with the use of derivatives for efficient portfolio management. These are that it could lead to a material leverage effect, unlimited losses and/or a change in the risk profile of the relevant insurance or reinsurance undertaking.
EIOPA expects national competent authorities to communicate to the market (through national regulation, recommendation or guidance) how the concept of the use of derivatives for efficient portfolio management should be interpreted, or at least to have developed internal guidance to ensure consistency in supervision.
In this respect, the ACPR (together with five other national competent authorities) has indicated that it does not have such guidance. In light of this, EIOPA has recommended that these national competent authorities ensure a common understanding and application by insurance and reinsurance undertakings of the use of derivatives for efficient portfolio management. This will complement EIOPA’s SRP handbook, which recommends best practices to EIOPA members and observers for the supervision of insurance and reinsurance undertakings. In practice, EIOPA recommended that these authorities issue guidance to the market, set clear expectations or provide specific internal guidance (handbook) to support supervisory work.
