ABS and Covered Bond Risk and Solvency II Capital Charges

This study analyses the relative risk of European Asset Backed Security (ABS) tranches and Covered Bonds (CBs) and draws lessons about how insurer capital charges should be calibrated in the context of Europe’s Solvency II regulations. The data employed in the study consists of information on all active ABS and European CB listed on the Bloomberg platform. The dataset runs from 1/1/2010 to 25/6/2021. Using these data, we construct our own indices that represent the values of diversified portfolios of securities.

We compare the risk of: Senior Simple, Transparent and Standardised (STS) ABS, Non-Senior STS ABS, Non-STS ABS, and CB by calculating VaR statistics estimated using return indices for these categories of security. Within the current Solvency II rules, of the four categories, Senior STS securitisations are subject to the lowest capital charges, at a level somewhat higher than the capital charges of CBs. Non-senior STS capital charges are around two to three times higher than Senior STS securitisations. Other securitisations (excluding re-securitisations) are not distinguished for their seniorities and are assigned a much higher (around 3 to 4 times before reaching the ceiling) capital charge than Non-senior STS securitisations.

The Solvency II SCR rules involve applying multipliers or ‘stress factors’ to exposures within an asset class and then aggregating across asset classes adjusting for diversification. To obtain a clear view of the stringency of capital charges, one must consider how they operate for typical insurer balance sheets since the nature of the balance sheet affects the diversification adjustment. We, therefore, compute the marginal capital charges that a typical European Life Insurer would face in holding securitisations after adjustment for diversification effects.

Our principal findings are that, for both Non-senior STS and for Non-STS ABS, the capital charges implied by our analysis are substantially lower than those contained in the current Solvency II rules.

The study, commissioned by AFME, is available here.