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Sovereign debt crisis: stating the case at Eurofi for prudent risk management and coordinated regulatory reforms

As Swiss Re Chief Risk Officer David Cole explained at the recent Eurofi High Level Seminar, there is an urgent need to define the vision of the EU financial services sector in order to protect long-term investment strategies and strengthen financial stability.

Eurofi, in association with the EU Danish Presidency, hosted its 2012 high-level seminar in Copenhagen on 29 March, ahead of the EU Council Meeting. The event brought together senior industry players and EU policymakers, with Chief Risk Officer David Cole representing Swiss Re. Cole participated in a panel discussion chaired by Jacques de Larosière (President of Eurofi) titled “Broad lessons from the current sovereign debt crisis and possible options for reducing the impacts of sovereigns on the financial system”.

The Vice-President of the European Commission, the State Secretary of the Germany Ministry of Finance as well as CEOs and Chairmen of major European insurance groups also participated in the panel discussion. The article below was originally published in the Eurofi event newsletter (PDF) and presents Swiss Re’s arguments that greater regulatory coordination and economic governance are required in order to protect the long-term investment strategies of insurers and reinsurers as shock absorbers.

Long-term investment and financial stability

Photo+of+Swiss+Re+CRO+David+Cole+at+seminar+table Swiss Re CRO David Cole (l) at the 2012 Eurofi High Level Seminar

The financial crisis and the subsequent sovereign debt crisis are leading to increased and more conservative regulatory requirements, aimed at restoring stability to the financial sector. However, unless the cross-sectoral and cumulative impacts of these regulatory reforms are considered, they could result in unintended consequences, such as a restriction in the role of insurers as risk absorbers and risk capital providers for long-term growth.

Regulatory requirements, and the uncertainty surrounding them, are heavily impacting the investment landscape by influencing the asset allocation of long-term oriented investors, such as re/insurers. For example, the upcoming Solvency II regime foresees no regulatory capital requirements for European Economic Area (EEA) sovereign debt bonds and this is resulting in a strong bias towards sovereign debt among insurance firms.

At a time when interest rates are exceptionally low and banks are in a deleveraging mode, the resulting convergence in global asset allocation decisions into more sovereign bond holdings is not without major risk. Consequently, the global and cross-sectoral implications of regulatory changes should be more prominently taken into account by regulatory bodies.

Returning to the example of Solvency II, this sovereign bond bias is exacerbated by the fact that capital charges for non-EEA debt are also substantially lower than similarly rated corporate debt. The result is an overweighting of sovereign bonds in the portfolios of European insurers, which does not offer enough incentive for insurers to continue contributing to the financing of the real economy through corporate bonds, shares and alternative investments, such as private equity. Ensuring that regulatory reform does not adversely impact long-term economic growth is of critical importance given the ongoing sovereign debt crisis.

At the same time, the assets that are considered ‘risk-free’ under Solvency II are not immune from turning into risky assets, as the Greek sovereign debt has illustrated. As the financial crisis has demonstrated, any notion of a ‘risk-free’-investment is an illusion. For this reason, it is important that insurers counterbalance the zero-risk weighting of EEA sovereign debt in the regulation with prudent risk management, consistent and well-founded ‘top-down’- driven investment strategies, while considering each investment

Published 12 April 2012

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