It's not clear how much capital European insurers will need to hold against their investments in U.S. securitizations or whether they can even invest in some of these deals at all.
That's the view of analysts at Bank of America Merrill Lynch, who put out a report Monday on the regulation Solvency II.
They're scratching their heads over the regulatory treatment for insurers investing in U.S. deals either directly or through funds holding asset-backeds.
After a few postponements, Solvency II due to take effect Jan. 1 2016. The B of A analysts would like to see the parts covering securitization pushed back until 2017.
Much of the uncertainty centers on retention requirements.
Under Solvency II, European insurers can only buy securitizations issued after Jan. 1 2011 if those deals follow certain risk retention criteria. This includes having the originator, sponsor or initial lender permanently retaining 5% of the deal. In addition, for risk retention to pass muster under Solvency II, a series of qualitative criteria has to be met.
There are exemptions to the risk retention rule, for instance, if underlying assets are linked to specified international organizations such as the IMF and the European Union.
If an insurer falls short on any of these, regulators will impose a higher capital charge on the investment, initially by increasing it by 2.5 times. In the analysts' view, these charges are already punitively high for securitizations all along the capital stack.
Using the example of a five-year, AAA-rated securitization deemed Type 1 — basically the senior tranche of a deal — the analysts said the standard 10.5% capital charge would jump to 36.75% if the insurance company broke any of the risk retention rules.
But there’s more.
"Each subsequent breach" of a risk retention requirement means additional capital charges for the securitization.
The analysts said it was unclear exactly by how much and whether it could actually exceed 100%.
They said the discrepancy in risk retention rules and implementation between the U.S. and Europe calls into question whether European insurers can invest in U.S. deals without facing exorbitant capital charges.
While retention rules are already in force in Europe, they won't take effect for U.S. RMBS until late 2015 and a year after that for other asset classes.
In addition, the analysts said it was unclear whether U.S. funds that hold securitizations would have to meet all the risk requirement rules that the securitizations themselves must follow. Given the difference between the EU and the U.S., this could be "impossible," the analysts said.
"If Solvency II prevents European insurers from such U.S. investments it will severely limit their investment options," they added.
Solvency II is not set in stone. The analysts believe that the more benign approach to securitization that is gaining currency among European policymakers could lead to changes in this regulation.
This could, for instance, happen when Solvency II is amended to incorporate the introduction of "simple, transparent and standardized" securitizations in Europe. This is a category of high-quality asset-backeds being developed by the European Commission. The idea is that deals that fit the bill would face lighter regulatory treatment.
But a meaningful change to Solvency II's approach to securitization is unlikely to come soon enough, in the analysts view.
Their advice to regulators: postpone implementing the rules for securitization until 2017.