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Solvency II to have major cultural impact on asset managers, says Fitch

Date: Monday, June 27, 2011
Author: Wendy.Chothia, Hedgeweek.com

itch Ratings believes that asset managers will have to adapt to the changes brought by the new Solvency II capital regime which comes into effect 1 January 2013. European insurers are the biggest institutional clients of European asset managers, with EUR6.7trn of assets under management. This equates to a third of European asset managers' client base.

"Solvency II will have a major cultural impact on asset managers, as investment mandates move from beating a market index toward beating swap rates plus the illiquidity premium and greater transparency required on portfolios' assets," says Aymeric Poizot (pictured), Senior Director in Fitch's Fund and Asset Manager Rating team.

As certain risky asset classes such as equity will lose their appeal under Solvency II, asset managers stand to potentially lose out as the management of these assets carry higher fees. Nevertheless, some of this lost margin could be regained in new service or product offerings. For example, asset managers will be incentivised to provide financial engineering in order to compete with investment banks in areas such as hedging or duration matching programmes.

Likewise, certain asset classes or strategies will better fit the new risk framework, such as short duration credit, duration management using derivatives, higher return alternative funds or real estate debt financing. Asset managers with expertise and products in those fields will be better positioned to gain market share, in Fitch's view.

"Life insurers are also likely to move towards products with lower investment guarantees, particularly unit-linked contracts," says Clara Hughes, Director in Fitch's Insurance team. "To appeal to policyholders who want to avoid significant downside risk, asset managers will increasingly focus on absolute return or flexible balanced funds, and structured portfolios."

Solvency II is set to transform how insurers invest their assets and could lead to asset reallocations, as discussed in Fitch's report titled "Solvency II Set to Reshape Asset Allocation and Capital Markets", published on 23 June 2011. Fitch expects a shift from long-term to shorter-term debt; an increase in the attractiveness of higher-rated corporate debt and government bonds, and shift away from equity; and a preference for assets based on the long-term swap rate.

Fitch also expects to see better duration matching with derivatives such as swaps and floors and an increase in downside protection to mitigate the impact of the new capital charges. An increase in financial engineering to create Solvency II-friendly assets such as reverse repos and structured notes, which can optimise return on capital, is also likely.

Transparency in pooled vehicles or mandates will become a required service, allowing for a look-through analysis by insurers and therefore avoiding punitive default equity treatment. When insurers use an internal model, quick access to very granular data (potentially as detailed as CUSIP/ISIN level) will be required, implying the development and maintenance of dedicated reporting systems.