Read in this article why Frank Dornseifer, Managing Director of Bundesverband Alternative Investments e.V. (BAI), thinks that PE investments are becoming more attractive under Solvency.
PE investments becoming more attractive under Solvency
Both, insurance and private equity industry have identified in a very early stage significant shortcomings of the current SCR calibration under Solvency II for private/unlisted equity investments. In the context of the project Capital Markets Union (CMU) and the Solvency review, EIOPA therefore currently elaborates under a mandate of the EU Commission criteria and methods to identify portfolios/types of unlisted equities to which the type 1 equity risk charge of Solvency II could be applied.
Indeed, this appears to be a step forward to reflect increasing PE appetite of insurance companies. However, an approach which simply leads to a qualification as type 1 equities is not truly reflecting the real risk-return-profile of PE. Of course, this criticism also applies to the treatment of – long term – public equity investment strategies under Solvency II in general, however, regarding the current EIOPA work with its focus on unlisted equities, this is the segment one can await the earliest outcome.
New equity risk sub module Qualifying PE
BAI therefore advocates for a new equity risk sub-module for so-called “Qualifying Private Equity Fund Investments” (Qualifying PE) to the standard formula of Solvency II, which goes beyond the concept outlined by the Commission and taken over by EIOPA in the consultation which is simply linked to type 1 equities. The idea behind is that most PE investments of insurance companies are structured via AIFs or fund of funds governed by AIFMD or corresponding regulation outside the EU.
Such AIF investments are already positively acknowledged under Solvency II (c.f. Art. 168 (6) (c) of Commission Delegated Regulation (EU) 2015/35). Therefore, this vehicle is just the starting point. Combined with further criteria BAI suggests an approach which will follow – in principle – the approach which has already been implemented for qualifying infrastructure investments being related to further criteria as set out in the following:
- Within the AIF not more than 30% of the NAV should be allocated to one investment, the AIF portfolio should contain – in average – at least 6-8 investments; furthermore, the use of derivatives within the AIF should be limited to risk mitigation; and the AIF is subject to reporting obligations (e.g. chapter V of delegated AIFMD regulation 231/2013).
- The qualification process has to be performed on the investor level and consists of (i) the assessment and (ii) the independent validation of each criteria.
- The insurance company has to pursue a PE program with ongoing investments and prudent person principle (PPP) requirements such as know-how, capacity, risk management etc. with regard to PE have to be fulfilled and the investor should be able to demonstrate that he can hold the investments to maturity. Finally, the investor has to perform regular stress-tests & scenario analysis. In this context, the insurance company may employ external experts. As long as the investor is involved into the assessment and validation itself, the involvement of external experts should not be considered as outsourcing.
On the basis of these qualifying criteria a SCR treatment below type 1 equities can be justified, and comprehensive calculations already affirm a VaR for qualifying PE in a range of 25-30%.