Regulations – Will Transparency Fall Short?

Welcome to my new blog – On Solvency II, Transparency and other Musings. This is my first post. Hope you enjoy it… John

The decade of regulation is amongst us – there are regulations coming at us from all angles – just consider everything from FATCA to Dodd Frank, Solvency II to UCITS V, AIFMD to EMIR, Basel III to UCITS V – we are literally being bombarded. One thing is certain though, regulators & investors are demanding more transparency. The requirement is on us as an industry to show evidence that we understand the health and well-being of our investments.

As complex as it may be, this is now the new norm in the world of asset management, and while many agree with the principles in this new norm, it’s the actual implementation that will cause the most pain. New data sets, lack of connectivity, lack of linkage between instruments and ultimate parents and new information on investors are all required. The new era of transparency is new to all.

Consider Solvency II and the principle of look-through: whilst the idea of look-through is not in itself new.. .investors have historically asked for holding look-through in the past… but they were in the minority and in many cases their requests were rebuffed. Now it’s likely over the coming decade all institutional investors will demand it, and not just for Solvency II! It’s likely the ECB, ESRB and the FSB will require G-SIBS, LIGs, LBGs to all face this level of scrutiny.

Solvency II in its inception put forward the core principle of look-through. In plain terms, the regulator wanted to know what insurers were truly investing in by removal of black-box investments, and to ensure they based their risk management process and decisions on this granular information.

So, how have things evolved since the initial technical specifications came out?  Well, the impact of look-through as part of the ethos of the regulation has been diluted. If look-through cannot be achieved, the mandate of the fund can be used, and if not investors can apply the capital charge for other equity (49%).

This beggars belief – the dilution of principles which are completely logical is inherently wrong!

If we go back to the start of the financial crisis, one thing became clear. When people went to find out their exposure to Lehman, they couldn’t. More than 5 years later they still can’t. With the introduction of the LEI over the next few years, the possibility of doing this will hopefully increase…but it will only come if complete transparency of  funds is available.

Lehmans does not stand alone in the fact that it was made up of more than 7,000 entities, most of which would have issued instruments that were invested in by funds. We could list many such firms across the globe.

For firms to say that their investment exposure is 60/40 bonds/equities quite frankly defeats the purpose of what we learned through the crisis. It is up there with telling the regulator that we invest in nothing less than AA rated securities and trusting others to validate and guide our investment process. This approach ignores the point of concentration risk and exposure. When regulations seek to apply the right principles, that will in the future benefit all, from investors to asset managers, this should be embraced and not diluted.

In the coming years, we will see those who stands tall and leads, and those who find this new norm overly prescriptive. Remember one thing, ratings agencies are watching. Stick with the principles and follow the ethos of these new regulatory norms and you won’t go far wrong, take the risk of diluting them and …….