Progressing with Solvency II – Best practice for market risk

As we wait for the local authorities to report back to EIOPA on the interim guidelines on June 19^th in a ‘comply or explain why not’ way, it’s worth stepping back and having a look at how and why we have gotten to this point? And why there are hundreds of thousands of pages of regulation out there? Today we face not only Solvency II, but also FATCA, AIFMD, RMORSA and UCITS VI to name a few.

Let’s step away from Solvency II and back to 2009, a year after the financial crisis. In 2009,  PWC  issued an article about the impact on Lehman’s and the lessons learned by the survivors. In the article they identified the elements of risk management and best practice required by the industry. Some snippets were ‘measure, monitor and manage liquidity risk’ , ‘know your investments’ , ‘understand and monitor counterparty, market, and credit risks’ , ‘the financial crisis of 2007-2009 has highlighted the importance of transparency’.

So where are we today four years later? Is there transparency and granularity in the risk process, as advised? Well for many products in the market I think we can say that significant progress has been made, but there are still complexities for the likes of investment funds. An industry of the size of $25 trillion is one of the sole outliers when it comes to transparency. This is down to one obvious fact, intellectual property and investment strategy. It is not that the industry does not want to provide transparency, it is just that needs to control the process of doing so.

I listen to many on the insurance or investor side, they state that they can create proxies for their funds with about 99% comfort that the model is accurate. But Lehman’s was that 1% that was wrong. The reality is that best practice for market risk means granular access to position level data, so that market risk, credit risk and counterparty risk can be measured in real terms.

For the Solvency II world, this is how firms should look to progress over the coming months and years irrespective of what final form the regulation takes. Philippe Trainer, CRO at SCOR recently stated in an article that “it would make sense to complete Solvency II programmes now and adjust later.” When it comes to market risk and granularity of data on investment funds, firms will find if they follow best practice in this area it will serve them well from both a business perspective and a regulatory one.