Increasing regulation in the financial services industry over the last few years may have some insurers bemoaning the higher requirements, including stricter accounting and liquidity management practices, but they have also opened up opportunities for insurance firms in Asia.
That was among the key messages on the second day of AsianInvestor’s 13th Asian Investment Summit as panellists shared their experiences working under a tougher regime and mulled the nagging risks still lying ahead.
“We complain about regulations but what it has meant for asset owners who traditionally have held a lot of high-quality liquid assets is these have suddenly become quite valuable,” Benjamin Rudd, chief investment officer for Prudential Hong Kong, told delegates.
The Third Basel Accord, or Basel III, is the latest in a set of global regulatory frameworks that sets out minimal capital requirements for banks for the purposes of risk management. The latest revision was released in December 2017, outlining an implementation schedule from 2022 to 2027.
The opportunity for insurance firms lies in providing that capital relief to the banks, Rudd said.
For example, insurance companies may hold a large amount of US Treasuries on their books, the kind of high-quality assets banks want. So there is scope for financial arrangements that benefit both parties.
“Effectively, you do asset swaps whereby over certain periods of time you’re swapping that onto the bank’s balance sheet, effectively getting paid for that,” Rudd said. “The holding assets, which traditionally just sat on the balance sheet, primarily used for duration or matching, suddenly drive a much higher degree of return.”
This should dramatically change the way insurance groups look at their balance sheets, though not all have been quick to recognise the opportunities. “This has been an area where particularly Asian institutions have been quite slow to actually identify with that,” Rudd said.
Such securities lending opportunities are especially relevant for investors who hold a large pool of US Treasuries or very-high-grade corporate bonds, William Chan, chief investment officer for Hong Kong at HSBC Insurance, said on the same panel.
However, HSBC Insurance has a different view on securities lending and how best to use high-quality asset holdings. “The same set of securities can be used to help with our cash management, so we have a preference to reserve those instruments for liquidity management,” Chan said.
While securities lending can offer additional returns uncorrelated with equity and bond returns, Chan is doubtful about whether these strategies are worth pursuing. “In other words, these additional returns that we are looking at, we do not think [they are] significant,” he said.
They are hardly going to drive your whole portfolio return, Rudd conceded, but if it’s incrementally delivering 30 to 40 basis points compounded over the longer time frames of insurance portfolios, that’s no small amount either.
“It can reduce or actually cover virtually all of your costs, particularly related to things like fund administration,” he said.
Still, by ensuring that capital solvency issues are taken care of, as well as implementing proper asset and liability management (ALM), insurers can both enhance returns and help the capital efficiency of their investment portfolio, even without securities lending, Chan said.
“Optimising what you get from the portfolio means to me simply optimising returns within the governance framework,” he said.
Improving the governance of portfolios is a positive for insurance firms, where managers have often been inefficient in the way that they’ve pursued investment returns, Prudential’s Rudd said.
There are a lot of areas where investors have tended to go after a lot of low-hanging fruit and they haven’t been very efficient in terms of how they generate returns, and now insurers are being forced to take into account issues like solvency, liquidity management, and ALM because of regulation in many cases, Rudd said.
The International Financial Reporting Standard 17 (IFRS 17) is a global regulatory framework that standardises reporting procedures worldwide that requires insurers to have separate underwriting and finance results, as well changing the way they record profits and how they draw up and value insurance contracts. The standard will be formally implemented in January 2021.
A number of Asian countries have also implemented solvency capital requirements for insurers in the last five years, including Australia, Malaysia, New Zealand, Philippines, and Sri Lanka. That is in addition to jurisdictions who had such requirements earlier, like Hong Kong, India, Japan, Taiwan, and Thailand, according to an October 2017 report by reinsurance broker Aon Benfield.
“These changes that we’re going through really should see investors take a wholesale re-look in terms of how they’ve built up their portfolio and how they manage their money,” Rudd said.
THE NEXT CRISIS
Markets have a tendency to produce a crisis after a period of stability, whether its investors chasing after yields or going for higher risks, HSBC’s Chan said. “I think that’s inherently good if we have a healthy degree of respect for risk taking,” he said.
After so many years of low interest rates and compressed risk premiums, investors are chasing yields and taking all sorts of risks, Chan said. “Potentially in some of the asset classes, we are already in a situation where valuations are in the bubble area.”
In the lead-up to the global financial crisis, many companies in Asia were buying structured products, despite liquidity concerns, and they lost a lot of money when the financial crisis hit, Philip Cheng, associate professor of finance at the Hong Kong University of Science and Technology, said on the same panel.
“So as smart as most CIOs are around the world and in Asia, people sometimes still forget that what they can measure in liquidity in a normal time is one thing. When a crisis hits, that liquidity is something else,” Cheng told the audience.
“I have the feeling right now that many portfolio managers are getting a little lax,” he added.