Solvency II regulation, which is aimed at European insurance providers to improve transparency on the cost of capital related to their underlying assets – think of it as Basel III for insurers – is set to make managed accounts an even more popular vehicle moving forward.
Due to be ushered in on 1 January 2014, the European Insurance and Occupational Pensions Authority (EIOPA) stated that the market wasn't ready and that it should be pushed back two years. As such, the insurance community must now demonstrate a plan to demonstrate how they will be Solvency II compliant when the regulation comes into effect on 1st January 2016.
In France, meanwhile, the Autorité de contrôle prudentiel (ACPR) decided last year that all French insurers commence Solvency II-like reporting as a preparatory exercise for two years, leading up to the 2016 implementation date. This, says Sarj Panesar (pictured), Global Head of Business Development, Insurance, at Societe Generale Securities Services, lead to a number of clients to ask, `We invest in funds, we manage money ourselves and we also have capital allocated to managed account platforms, how can you help?'
"As a result, we built a Solvency II reporting solution. We collect underlying holding data from funds that they manage, take data from managers who manage segregated mandates and data from managed account platforms, which we then normalise. We bring all of that normalised data into our fund accounting platform, which is the same platform we use for mutual fund accounting across Europe."
The reporting starts off with a tri-party template (TPT), which typically suffices for fund managers. Under Solvency II, however, this is just a starting point for insurers. "They will then say they want more data here, additional fields there, and so on. If the data is within our data repository, it can be reported upon. We deliver the data via our standard website called SGSS Gallery within which there is a report rights tool, whereby you can simply drag and drop various data points to construct a table and produce a report.
"If the data isn't in there, we will try to source the data and create a customised report," confirms Panesar.
Insurers are putting in place solutions to make more efficient use of capital in terms of how they manage their reserves within the constraints laid down by the regulator. Be it for hedge funds, real estate debt, infrastructure debt, or private equity, insurers will increasingly need to have consistent look-through capabilities on their underlying investments to ensure that capital costs – calculated by using the Solvency Capital Ratio (SCR) – are not too high.
"Simply put, Solvency II is another way of saying `transparency'," says Daniele Spada, Head of Lyxor MAP. "One of the main reasons to invest in managed accounts is also that the client can segregate the assets allocated to a given manager and get full position-level transparency and risk monitoring. That helps insurers to calculate more easily and more precisely the capital consumption of these investments. By default, Solvency II says that if you put money in hedge funds without any specific model or transparent way of calculating the capital consumption of those investments, there is a 49 per cent cost SCR."
"We have done the calculation on the managed accounts on our platform and there are only a few strategies that have a 49 per cent capital cost. Having the transparency really helps investors to determine more precisely the SCR at both the single fund level and an aggregated portfolio of managers. Regardless of whether they can invest in a single managed account – either segregated or commingled – or a portfolio of managed accounts, we can easily help them in the calculation of the SCR number."
Martin Fothergill is Global Head of Hedge Funds for Deutsche Asset & Wealth Management. He notes that 2015 has been one of the best years for Deutsche AWM's Alternatives & Fund Solutions (AFS) platform as investors continue to see the virtues of gaining exposure to hedge funds via managed accounts.
"The platform has attracted north of USD2.5billion of inflows so far this year. Managed accounts per se, don't solve the problem, but some of the features that MAPs can offer are a great solution for Solvency II," says Fothergill, noting that Solvency II does represent a jurisdictional challenge for investors as, say, AIFMD does. He says that there are two approaches that investors can take for Solvency II.
"One is a transparency route: providing clients with the transparency and/or the SCR for them. That lends itself very well to managed accounts because of their inherent transparency. Second is more of a structuring approach where you can effectively put a stop:loss into a client's investment so that they only have a certain amount of capital at risk, and then the SCR is based on that amount of capital.
"Investors will have different views on those two approaches depending on their own specific needs," explains Fothergill.
The structuring approach that Fothergill refers to involves using a total return swap arrangement within the managed account mandate.
Say an investor makes a EUR100million investment. Using a swap arrangement, they might only need to put down EUR20million to get that level of exposure. "This is the stop:loss or floor that I referred to, whereby you only have that amount of capital at risk. If your SCR is 49 per cent for hedge funds, but you're only putting EUR20million `at risk', then that dramatically reduces the impact of that 49 per cent SCR; it is based on EUR20million as opposed to EUR100million," says Fothergill, who notes that when calculating the SCR for Deutsche Bank's clients, the key is having transparency in the first place. This is achieved by using the same system for daily risk monitoring and reporting, and having data in a format that can be used across multiple accounts.
"This is the infrastructure challenge of running a successful MAP. You're pulling in a lot of data, but it is the management and the cleaning of that data that has to be consistent across multiple managers and accounts. Once it's all set up it's relatively straightforward but the devil is in the detail," says Fothergill.
Panesar says that one of the big issues in the alternatives space has been the lack of transparency in terms of providing investors with look-through capabilities; something that is vital for insurers (and potentially pension funds in future) and which explains why they have a preference for investing via a MAP.
"I don't think the alternatives world has been adept at marketing themselves to insurance companies – it tends to be that insurance companies seek out fund managers rather than vice-versa," says Panesar, who refers to a number of instances where insurers have decided to divest their assets from fund managers unwilling to disclose their holdings to those who are more Solvency II friendly.
"I spoke to the COO of a fund manager in March, who said that they weren't interested in Solvency II because they had only had one insurance client. I saw him again in September and asked how it was going. He responded: `Well, I've now got about 30 insurance clients, and they've all come via platforms so we've had to do something'."
For MAPs to support insurance clients, it is important to provide a broad range of strategies that go beyond the usual suspects of equity long/short, global macro, etc, especially as institutional investors look for more exotic, niche alpha-generating strategies.
Josh Pickford is a director at London-based Sciens Capital Limited. He thinks that the industry is moving away from the traditional black box hedge fund investment model towards the requirement for full position-level transparency for many institutional investors. He says that Sciens' risk management expertise has always been a core part of its offering.
"That comes from our long history and experience in asset management as a fund of funds, allowing us to define appropriate risk management for individual fund strategies. Something that platforms have been criticised for is focusing too much on equity and managed futures strategies, which are relatively simple to report on. We don't stick to those strategies. We have a diverse line-up of strategies, such as aviation-focused, credit and structured credit, which are quite different to the usual strategies people associate with MAPs."
Bringing an investor perspective to its MAP, and a well-honed risk framework, should make Sciens well positioned to support Solvency II reporting, according to Pickford. He confirms that over the last 12 months they have added a volatility trading strategy, a European structured credit strategy, an event-driven strategy, an Emerging Markets strategy "and we are about to launch a Nordic power trading fund. We are able to establish the infrastructure for such funds precisely because we have that direct experience as an investor.
"A structured credit strategy has a very different risk reporting set-up and requires different data feed. As such, we have added data licenses on index / single name CDS and synthetic CDOs, for example, to effectively report on the underlying holdings of that fund," confirms Pickford.
Aside from the full reporting and analytics service that SGSS provides for Solvency II, it also provides the SCR calculation; not just for investors, however, but increasingly for asset managers.
"Fund managers who are insurance company-friendly are putting together strategies that include an SCR. This indicates to the insurer that the manager is thinking about how they allocate their capital. They are thinking like their investors.
"The smarter ones are providing this SCR as part of the presentation pitch; performance numbers against benchmarks, VaR, but also the SCR number," says Panesar.
Over the years, SS&C GlobeOp has built its administration platform to bring and capture data and publish it in multiple formats. This is helping it provide Solvency II reporting as part of its regulatory solutions capability.
As alluded to above, the SCR is a critical number for insurers in order to become capital efficient. This means that the quality and integrity of the fund data is paramount.
"We spend a lot of time and effort cleansing the data and making sure that what we publish is accurate," says Colin Keane, Ireland Country Head at SS&C GlobeOp. "We integrated into our systems the likes of Advent, which send us data that we clean and push it into our internal systems ready to be published to our clients."
"For Annex IV reporting under AIFMD, we build a structure around how we populate it. The client gives us the data, the assumptions they want to use, and we then perform the calculations process for them. They then review the outputs of the report to make sure they make sense before approving submission to the regulator. It's a very interactive arrangement that we have. We collate the information based on client and regulator requirements, and aim to make the AIFMs' lives as straightforward as possible," adds Keane, who confirms that a similar approach is used for Solvency II.
"One important point is that we can offer regulatory solutions as a bundled service or on an individual basis i.e. for AIFMD reporting, UCITS, Solvency II. Provided we can get the data from the client, there is a wide range of solutions we can provide to meet the regulatory challenge," adds Tom Kirkpatrick, European COO at SS&C GlobeOp.
Spada confirms that Lyxor has been providing Solvency II reporting for its clients for the last 18 months. Looking ahead, he says that another emerging trend is pension funds fully outsourcing the construction and management of their investment platform.
"They are looking to outsource their global alternative allocation to a platform provider and they are looking for a full set of expertise in manager selection, advisory, risk management and customised platform services. Some pension funds in the US are doing that, and we are starting to see this trend in Europe, not only in the alternative investments space. The transparency needs faced by insurers will probably apply to pension funds in the coming years," opines Spada.
"If managers think it's complicated putting all the data together for Solvency II, the complexity is only going to increase when European pension funds themselves require Solvency II-type reporting," concludes Panesar.
