10 December 2012

Risk.net: The clearing revolution

New rules on over-the-counter derivatives are set to have a significant impact on the insurance industry. The rules will require certain OTC derivatives to be centrally cleared and high-quality collateral posted upfront and during the contract to cover counterparty exposure.

Insurers, as significant users of derivatives to hedge risk, will need more high-quality assets – cash or liquid securities – to post as collateral under these new regimes. This has implications for companies. Insurers will need to identify whether they have the appropriate collateral and, if not, take steps to obtain it through collateral optimisation techniques, such as using the repo markets to transform assets.

Insurers will also need to consider to what extent they will continue to be able to use their liquid assets to generate additional income, such as through liquidity swaps or collateral upgrade trades with banks, if they need these assets to post as collateral. Conversely, for companies with plenty of cash and highly rated bonds the new cleared environment could provide an opportunity to generate more income by lending securities to banks and other insurers that need these assets to post as collateral.

Insurance Risk’s collateral management survey provides some insight into how insurers are approaching the challenges and opportunities of clearing. As the survey reveals, many insurers expect to use the new cleared environment and extend their use of derivatives, but the majority of companies do not believe they will have enough of the required quality to post as collateral. At the same time, it appears many insurers have yet to assess the potential opportunities to generate additional income from an OTC cleared regime through a securities lending programme.

It should perhaps come as no surprise that, at the time of writing, European lawmakers have still not agreed on the terms of reference of the impact assessment of the effect of Solvency II on long-term guarantees. The European Commission is pushing for it to begin in January, after earlier hopes of an end-November/early-December start date were dashed.

Yet the delay in commencing the assessment is enormously frustrating for the insurance industry, which wants to begin the assessment as soon as possible. Insurers are now likely to be undertaking the assessment at the same time as gathering data for year-end reporting. This will be a challenge for companies.

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