Solvency II Creates Big Data Challenge for Fund Managers

If regulations such as AIFMD, EMIR and the Dodd-Frank Wall Street Reform Act weren’t enough to prompt fund managers to shore up any deficiencies in their data management capabilities, Solvency II could finally do the trick — and quickly.

Called the Basel III of insurance firms, Solvency II has also been called a “data nightmare” by operations experts at fund management shops. The reason: it requires more data than any other regulation to be located, classified and cleansed to make the necessary calculations and file the correct regulatory reports.

Although insurance firms have the legal onus of complying with Solvency II, its their fund managers who will be have to deliver information on holdings and valuations. It’s also like that those asset managers will be tasked with calculating capital requirements or pass the buck to custodians or risk specialists.

Fund managers that service insurance firms have until January 2016 to file their first regulatory report on behalf of insurers, but the European Insurance and Occupational Pensions Authority (EIOPA) wants a test run of data on their holdings in March 2015. They will also need to be testing the models for calculating regulatory capital next year before reporting officially begins. An independent advisory body to the European Parliament and Commission, the EIOPA is responsible for protecting insurance policy holders.

Concerned about the potential for default because of too much leverage or too little capital, regulators want insurance firms to set aside sufficient regulatory capital to buffer them from changes in market conditions which could hurt their ability to pay policy holders and pensioners. Solvency II takes a common approach to measuring assets and liabilities so that insurers can meet minimum capital requirements (MCR) and solvency capital requirements (SCR). An insurer can calculate its SCR using a standard regulatory formula or its own internal model, but if its resources fall below the MCR, the European Commission will allow its liabilities to be transferred to another insurer, withdraw its license, or liquidate its business. At the very least, if regulators are unhappy with an insurer’s assessment of its risk, they can impose higher regulatory capital requirements.

Insurance firms hold an estimated 42 percent of the €11 trillion in European institutional assets under management and the legislation has a far wider impact than just European asset managers. “Any asset manager anywhere in the world that manages insurance assets will be required to contribute portfolio data to assess the total risk and SCR for the overall investment holdings of an insurance company falling under the jurisdiction of Solvency II,” says Tim Lind, global head of regulatory solutions at financial information vendor Thomson Reuters in Boston.

Despite the large amount of data required, insurers appear to be lagging in their preparations, based on a recent study conducted by Ernst & Young. About three-quarters of insurers said they had not met all or most of the reporting requirements, while about two-thirds said their systems and data were not advanced enough for them to support one of their responsibilities — that they evaluate and monitor their own risk management capabilities.

Preliminary Preparations

Of the six large European fund management firms servicing insurance companies contacted by FinOps Report, all acknowledge they have only started their necessary legwork. That involves selecting a Solvency II project manager to divide the work among valuation, data, and regulatory reporting specialists. Chief operating officers will likely not want to dedicate the time necessary to oversee the swat team, so they will pass the buck to an overworked junior staffer, one of the operations managers told FinOps.

The ideal outcome, according to Lind: a data management program with data governance, completeness and accuracy of portfolio data, ready to calcaluate and report by the first Solvency II reporting deadline. “We’re working on it,” was the way each of the six European fund management firms described their state of readiness. That readiness includes determining who would be responsible for data quality and access policies and who would sign off on the regulatory reports. In the case of one fund management firm, a centralized regulatory data repository was also in the works.

“Although there is a substantial amount of overlap in data required by multiple legislations, Solvency II has three overarching pillars, each of which has its own set of data requirements,” explains Anthony Belcher, director of pricing and reference data for Europe, the Middle East and Africa for information vendor Interactive Data in London. Among the three pillars — or types of information — required by regulators, Pillar I and Pillar III were cited by the six European fund management firms as the most data-intensive.

Pillar I, which calls for calculating the actual regulatory capital, will require fund managers to track down the data attributes of all of the financial instruments they trade as well as their valuations. If any of the financial instruments are not traded on an exchange, they will need to be priced separately using proprietary models, assumptions and inputs. By contrast, Pillar II requires a qualitative Own Risk and Solvency Assessment (ORSA) to verify that the firm is following correct risk management procedures

Sound easy? Hopefully, fund managers can locate and make sure the data and valuations are accurate. will know where the data is located and can make sure ensure they are accurate. If they have established consistent policies throughout the firm, they are in luck. If not, the data attributes or elements could be inconsistent. Likewise, if the trading desk, risk management desk, or valuation desks don’t use the same methodologies and inputs, chances are there will be different prices for exactly the same instrument.

Not only will fund managers be required to value their books of business and each individual asset held, but they must classify each of the financial instruments they trade and hold by asset class as well as industry sector when they file their regulatory reports.

Conflicting Taxonomies

At this point, even the best managed data can turn out to require heavy handling. “Fund managers may have their own terminologies, but in attempting to standardize the process, the EIOPA has mandated the use of new classification taxonomies to describe asset class type and industrial sectors,” explains Lind.

The asset class dictionary, called the Complimentary Identification Code (CIC), and the industry sector dictionary, coined NACE, are not typically used in the fund management industry; hence fund managers cannot count on their own classifications being acceptable to EIOPA. “We estimate we will have differences at least twenty percent of the time on the type of asset and industry,” predicts one data manager.

Fund managers will have to check each financial instrument and match their classifications to those developed by EIOPA — and that will be pretty cumbersome for the largest fund managers with several million instruments to research. That is unless they rely on a third-party data vendor such as Thomson Reuters and Interactive Data which will do the work for them. The giant information providers are offering Solvency II datafeeds which add data fields to the descriptive information on financial instruments, mapping them to the EIOPA’s taxonomy.

As if reviewing and updating data on all the financial instruments they own and trade weren’t enough, European regulators are also requiring asset managers do a “look-through” into any fund of hedge funds, structured asset pool, or UCITS-enabled fund they own.

What does that mean? For starters, they will have to include investment in those funds in their preliminary SCR calculations in 2015. “The more onerous task is not knowing just what regulators mean by “look-through” when it comes to understanding just how much information regulators want about the holdings of the specific funds,” cautions Belcher. Apparently, no standards have been created, leaving fund managers in the dark for now.

But if fund managers want to gripe about all the work and potential cost involved in complying with Solvency II, they should also consider the silver lining. “Once they have established the correct data management procedures for Solvency II, it will help them comply more easily with the other data-intensive regulations,” explains Belcher.