Solvency II. November Sponsored by:

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1 The Data Management Implications of Solvency II November 2014 Sponsored by:

2 Legal Entity Identifiers Managing Editor Sarah Underwood A-Team Group Chief Executive Officer Angela Wilbraham President & Chief Content Officer Andrew P. Delaney Sales Director Caroline Statman Operational Marketing Director Jeri-Anne McKeon Client Services Manager Ron Wilbraham Production Manager Sharon Wilbraham Postal Address Church Farmhouse, Old Salisbury Road, Stapleford, Salisbury, Wiltshire, SP3 4LN +44-(0) The Data Management Implications of Solvency II Solvency II is on track for full implementation across European Union member states by January 1, While the regulation s aim is to create a single and stable insurance market, its data management requirements reach beyond insurance firms and have significant implications for asset managers and their custodians and fund administrators. Solvency II This report details the data management challenges of Solvency II, describes how firms are developing solutions to meet the regulatory requirement, and considers whether compliance with Solvency II will help firms comply with other incoming regulations. Anthony Belcher, Director of EMEA Pricing and Reference Data, Interactive Data; Tim Lind, Pricing and Reference Services, Thomson Reuters; and Devesh Shukla, Global Head of Reference Data Product Development, Bloomberg LP offer insight into the data management issues of Solvency II. We hope you find the report useful. Sarah Underwood Editor A-Team Group A-Team Group A-TeamGroup.com Reference Data 2 Thought Leadership from ReferenceDataReview November 2014

3 Sarah Underwood, Editor, A-Team Group (Moderator) Anthony Belcher, Director, EMEA, Pricing and Reference Data, Interactive Data Tim Lind, Pricing & Reference Services, Thomson Reuters Devesh Shukla, Global Head of Reference Data Product Development, Bloomberg LP The Data Management Implications of Solvency II A-TEAM Q&A: The Data Management Implications of Solvency II Please provide a quick review of Solvency II, its implementation timetable, the types of firms it covers and its implications for insurance and buy-side firms. Devesh Shukla, Bloomberg: Solvency II is a European Union regulation aimed at reducing the risk of insolvency and ensuring the capital adequacy of insurance companies. It includes three main pillars: ensuring firms are holding enough capital; ensuring firms have an effective governance and risk management programme; and creating transparency through mandatory disclosures. The results of the enhanced regulation are a single EU insurance market in which insurers that meet the requirements can operate in all member states and offer greater consumer protection. The implementation of Solvency II across all EU member states is slated for January 1, 2016, however firms in some countries are already starting to adopt practices aimed at complying with the regulation. As an example, in Denmark, insurance companies have already started to comply with Solvency 1.5, which was born out of the delays of the EU-wide Solvency II implementation. Another example of this is the Swiss market, where insurance companies have been complying with the Swiss Solvency Test for a number of years. In general, the Swiss and Danish markets appear to be further along, especially with regard to getting their risk models approved by regulators. While Solvency II primarily impacts insurance firms within the EU, there are also implications for the broader asset management community and custodians or fund administrators. Operationally, Solvency II forces insurance companies to take a more systematic, data centric approach to managing their assets and may introduce new policies around governance, risk management and portfolio construction. November 2014 Thought Leadership from ReferenceDataReview 3

4 The Data Management Implications of Solvency II These are challenges that insurance firms have not had to face in the past. Because many insurance firms rely on the traditional buy-side community to manage their assets, these firms may also experience an impact with regard to portfolio construction and disclosure requirements. Similarly, custodians and fund administrators are involved because they have transparency into the holdings of each fund and may be able to provide portfolio aggregation across multiple asset managers, especially for the look through requirement. The financial implications for insurance firms may include a potential shift in the asset mix across portfolios to meet the capital requirements set out in Pillar 1. For asset managers, compliance with Solvency II may be regarded as a competitive advantage as insurance firms will look to understand the capabilities of fund managers going forward. Anthony Belcher, Interactive Data: The main goals of Solvency II are to improve company stability through a capital adequacy regime, Pillar 1; reduce systemic risk through improved risk management, Pillar 2; centralise reporting of Quarterly Reporting Templates (QRTs), Pillar 3; and help create a single market for insurance firms. The timetable looks like this: - By 31 March 2015, deadline for transposition of Solvency II into UK law - By 25 May 2015, year end 2014 annual solo reporting to the Prudential Regulation Authority (PRA) - By 6 July 2015, year end 2014 annual group reporting to PRA - By 16 November 2015, third quarter 2015 solo reporting to PRA - By 1 January 2016, third quarter 2015 quarterly group reporting to PRA - 1 January 2016, application of the Solvency II regime in the UK Firms affected by Solvency II include all insurance and reinsurance entities operating in the European Union and European Economic Area with a gross premium income exceeding 5 million or gross technical provisions (liabilities) in excess of 25 million. The impact on asset managers, custodians and third-party administrators is significant. This arises from the funds look through principle in terms of data disclosure and the need to provide insurance clients with complete, accurate and timely asset and risk management data, as stipulated under Pillars I and III of Solvency II. What are the overarching data management issues raised by Solvency II? Shukla: Solvency II raises a number of data management issues. The foremost issue is that the directive forces smaller insurance companies, which typically have not managed their own data, to develop and implement new data management strategies while trying to comply with the other aspects of the regulation. Two additional data management issues are the availability of data for aggregation into capital requirement and stress testing calculations, as well as the consistency of data across multiple asset managers. A key component of Solvency II is being able to look through a fund to its underlying assets. This has proven to be challenging because asset managers and insurers have historically communicated data via ed spreadsheets. The challenge compounds as a single insurer may have multiple asset managers that deliver content using multiple formats and methods. Firms need to be able to streamline this workflow so they can aggregate data required for Solvency Capital Requirement (SCR) calculations for Pillar I, as 4 Thought Leadership from ReferenceDataReview November 2014

5 The Data Management Implications of Solvency II well as for the stress testing requirement in Pillar II more effectively and efficiently. Last, an interesting piece of feedback from asset managers has been that insurance companies are requiring data in multiple formats one for regulatory reporting and a secondary format for risk management which can complicate data management even further. Tim Lind, Thomson Reuters: Solvency II implies a significant data aggregation challenge requiring the collation of market, liquidity, credit and operational data to measure the risks faced by an insurance undertaking. The data management challenge will then be the collection of asset and liability information to determine the appropriate SCR, as well as an auditable understanding of risk to maintain adequate capital and liquidity levels to offset exposure. This will include determining the market risk of investment portfolios, developing and documenting internal governance and risk models for a firm s Own Risk and Solvency Assessment (ORSA), and the ability to map data accurately into quarterly disclosure templates within required timeframes. It will also demand the acquisition of new data classifications not previously used by the financial industry, while requiring greater transparency on structured products and compositions of collective investment vehicles. Belcher: The main issues around data for Solvency II are similar to those of other regulations. However, given the breadth and depth of the regulation, the issues can be more burdensome. They include: completeness, the need for all data around assets and liabilities to be complete and in one place; quality, this is key for SCR to avoid over allocating capital; complexity, data requirements are more complex and introduce a number of cross regulatory issues such as the valuation basis allocation; and timeliness, making the data required available when it is needed. In more detail, what are the data content challenges of the regulation s Pillar 1 capital requirement calculations and how can the necessary data be sourced and managed? Shukla: The data content challenges of the Pillar 1 capital requirement include the sourcing of high quality, accurate data ranging from basic terms and conditions and pricing content to more complex datasets including curves and spread data for use in the SCR and Minimum Capital Requirement (MCR) formulas. Complicating matters further is that this information is required at the underlying holdings level across potentially multiple asset managers. It is even more difficult if firms are investing in complex funds and structures. Because of the nature of this content, it will likely be acquired from multiple sources, including asset managers, vendors and internal databases, and will require a strong data management programme. Lind: The Pillar 1 challenge is focused on collecting the quantitative data inputs required to model and calculate the SCR and MCR. This means that from cash to high yield debt, every asset held in an investment portfolio must be assigned a risk weighting according to the nature of the instrument held by the insurance firm. Pillar 1 also introduces new data requirements related to coding conventions, classifications, credit ratings, benchmark curves and default probability analytics, as well as new data taxonomies for securities instruments. The classifications include new schemes that are not native to the security master files typically maintained by investment managers. Two prominent examples November 2014 Thought Leadership from ReferenceDataReview 5

6 The Data Management Implications of Solvency II include CIC asset class and country codes, and NACE industry sector codes used by the European Commission. Bringing together and reconciling this data, likely obtained from different service providers, will present a tremendous challenge for insurance firms. Belcher: Pillar I calculations are supported by a complex and wideranging set of data on assets and liabilities. On the asset side, the look through principle, which requires individual components of funds and associated weightings to be identified and reported, is proving challenging for insurers and asset managers alike, particularly for investments locked in funds of funds. Other areas of complexity include bond duration and the need for both clean and dirty bond pricing, detailed and accurate bond terms and conditions, comprehensive corporate actions and income events, ratings, transparent and regular pricing for unlisted and illiquid stocks, and details of valuation methodologies. What are the data and risk management challenges of Pillar 2, which covers governance and supervision? Shukla: The key functions within Pillar II include governance of the risk management function, supervision by the regulator, development of an internal model to manage risk, and an assessment of the risk and solvency, known as the ORSA, the firm faces or could face. There are a number of similarities between the data challenges presented by Pillar I and Pillar II namely the acquisition of high quality, accurate, consistent data and the ability to aggregate and report on this data in a timely manner. Additionally, because Pillar II effectively requires firms to stress test their balance sheet, the risk system required by the regulators must be auditable, transparent and well documented. Roles and responsibilities must be documented and adhered to as part of the governance process, and models must be approved through the enhanced supervision process. Lind: Pillar 2, the most comprehensive of the three pillars, is about developing a system of governance to produce an ORSA and all the processes and procedures necessary to identify, assess, manage and report the risks of an insurance undertaking. The challenges are very similar to the governance of core data management process and include organisational and operational structures designed to support the objectives of Solvency II. The system starts with the engagement of key operational functions that will need to contribute to the ORSA, including management committees, operations, portfolio managers, data operations, reporting functions, risk and actuarial functions. Governance includes documenting policies, procedures, understanding conflicts of interest and defining controls that can stand up to internal review. However, documentation of controls and methods related to the expert judgment applied to internal models and risk assessment is perhaps the biggest challenge, especially as the ORSA will need to be approved and audited by qualified third parties. Belcher: One of the main reported difficulties of Pillar 2 is that while the pillar s articles and implementing measures define underlying principles, they offer no standards on practical application. In terms of data quality, measuring and managing risks, and then applying them to strategic capital planning, requires confidence in the reliability of the data and calculation processes used. A wide range of data will need to be sourced, normalised and 6 Thought Leadership from ReferenceDataReview November 2014

7 The Data Management Implications of Solvency II vetted on an ongoing basis in order to meet the standards of risk management contained in Pillar 2. What are the challenges around new asset data required for Pillar 3 reporting? Shukla: One of the biggest challenges related to new asset data requirements for Pillar III reporting involves the definition and consistency of requirements set forth by the regulator. Only recently have three investment associations in the UK, Germany and France offered guidance on a common set of definitions and interpretations related to the type of data that must be exchanged between asset managers and insurers. As an example, duration can be calculated through different methods, but because Solvency II is principles based, the regulator has not necessarily provided sufficient detail on which data point the industry should use. Aside from the CIC and NACE asset and industry bespoke classification system, which most vendors are providing, the asset data required for Pillar III reporting is similar to that which other financial participants have historically used internally in risk and reporting functions. Lind: Pillar 3 is about meeting the supervisory demands of regulators for disclosure and the prudential oversight of insurance undertakings. This raises both technical and interpretation challenges when completing the changing requirements of QRTs and Solvency and Financial Condition Reports. One key element of implementing Pillar 3 reporting solutions is the appropriate mapping of asset and risk data into extensible Business Reporting Language (XBRL) according to the business definitions of EIOPA and their interpretation by industry associations. This calls for a reporting infrastructure that must be sufficiently robust to meet quarterly deadlines and flexible enough to manage changes in the disclosure templates as new guidance is provided by regulators. Belcher: QRTs introduce new bespoke instrument classifications, such as CIC and NACE 2 codes. Ultimate parent identification for investments and the use of the Legal Entity Identifier are another potential challenge for insurers. Other complex areas of QRT reporting include structured bond data and derivatives reporting. The complexity of the look through requirement described under Pillar 1 also applies to QRT reporting. For instance, duration information needs to include fixed income securities contained within funds. What are the data quality requirements of Solvency II and how can firms be sure to meet them? Shukla: In many respects, the data quality requirements of Solvency II are similar to those of other regulations and traditional middle- and back-office functions. Firms require consistent, accurate and timely data with a breadth and depth necessary for risk and reporting requirements. The challenge around data quality is related to sourcing the content. Firms must piece together data that has been sourced from multiple places asset managers, custodians, vendors, internally and so on as inputs to capital, risk and reporting systems. Because of the multitude of participants that firms must engage to obtain all of the data necessary to comply with Solvency II obligations, they will require a strong data management programme that is able to systematically obtain, cleanse, organise and format data for use in reporting and risk November 2014 Thought Leadership from ReferenceDataReview 7

8 The Data Management Implications of Solvency II management operations. Belcher: The directive includes three criteria of data quality: completeness, accuracy and appropriateness. Firms will need to ensure they have a way of assessing the three criteria with regard to their data suppliers and internal systems. This is a key component of Pillar 2. How can firms best meet the look through requirement of the regulation? Shukla: The look through requirement of Solvency II has proven difficult to meet, in large part due to the number of financial participants and the level of data aggregation required. In some cases, firms only need to look through one or two levels, in other cases, firms may need to look through the entire universe of assets. Firms are approaching these requirements in a variety of ways. For example, they are aggregating the data themselves and consulting with data management providers, such as Bloomberg PolarLake, to assist in the process. In addition, custodians and fund administrators will play a critical role in helping firms meet the look through requirement as they can aggregate holdings across multiple fund managers. Lind: Look through has two connotations in the context of Solvency II. First, it refers to a look through into the structure of a fund, or fund of funds, to the underlying instruments held by those vehicles. This will require extensive data on the constituent holdings and individual instruments held by funds. The second aspect of look through relates to asset-backed instruments and requires additional data on the value or performance of underlying assets such as loans or mortgage pools that make up a structured obligation. However, the availability of underlying performance data can be very limited on many asset classes and might be the biggest challenge of all. As a result, we should expect some asset managers to divest certain asset classes where underlying performance data is not available or where the instruments create a large capital charge. Belcher: Insurance firms may choose to approach their asset managers one by one for information. This task is labour intensive for both parties. It also runs the inherent risk of generating data files in a multitude of formats with potential data gaps and little information on the quality of the information therein. Specialised look through providers are working to promote their solutions to asset managers and insurers. Essentially, look through providers consolidate and manage underlying asset data from multiple sources on a common platform that insurers can plug in to. The providers aim to offer a joined up solution for what would otherwise be a hugely fragmented issue for insurers. Given the lack of a common standard between insurers and their asset managers with regards to the expected look through data flow, trade associations like the Investment Management Association in the UK, BVI in Germany and Club Ampere in France are working on implementing a common data template, the tripartite template, with their members. Are there common data requirements in Solvency II and other regulations such that Solvency II data management processes could be used to meet multiple regulatory requirements? Shukla: In many respects, the data requirements of Solvency II and other regulations are very 8 Thought Leadership from ReferenceDataReview November 2014

9 The Data Management Implications of Solvency II similar, if not identical, to the enhanced risk, reporting and compliance functions that many buyside and sell-side firms already operate. The data management processes, including acquisition, cleansing and aggregation of quality content, will apply to all. Solvency II specifically pertains to insurance companies, but its principles apply to many types of financial participants. As an example, AIFMD has similar, although not exactly the same, principles focused on alternative investment managers, such as hedge funds and private equity funds. Lind: Absolutely. Many new regulations will require financial institutions to manage new classification and descriptive data related to an instrument, a counterparty and an issuer. There is also overlap with other regulations that target capital adequacy and systemic risk management, such as BCBS 239 and Risk Data Aggregation (RDA). The common theme is the ability to roll up exposure of trading positions and market concentrations to the appropriate countries, sectors, asset classes and counterparties that are creating the exposure. For example, just like Solvency II, RDA requires the establishment of common data taxonomies and an architecture across a banking group in which the value of exposure can be aggregated. This includes common definitions and classifications of data and common identifiers, codes and naming conventions of entities and counterparties. Most of the burden of RDA is in the development of internal systems in the bank that can link information across legal entities, geographies and lines of business at the group level, which highlights the complexity of legacy IT and business silos. When it comes to regulatory compliance, the common theme is data governance and operations. Ultimately, I believe data used for risk aggregation and capital adequacy in all its forms must be managed with the same level of controls and attestation as that applied to accounting data for financial reporting. Belcher: On the positive side, pricing, valuation methodologies and ratings are generally common to all regulations. Entity and counterparty information, as well as ultimate entity data, are also common across regulations. Reference data and corporate actions are another common area, particularly where data is predefined by existing ISO standards. On the negative side, the data management process deviates in at least two key areas. First, bespoke instrument classifications do not overlap as they are tailored around specific activities such as the AIFMD sub-asset code for hedge fund managers, the Solvency II CIC code for insurers or the EMIR UPI code for derivatives transaction reporting. Second, the application of the common set of data required to meet different regulatory expectations varies. Formulae and risk measurement approaches may well operate under different assumptions, and frequency of reporting and aggregation methods for reporting can also vary substantially from regulation to regulation. Do you expect firms to develop Solvency II solutions in-house, use outsourced services, or implement vendor solutions? Shukla: As is the case in many implementations of regulatory initiatives, firms will leverage a variety of solutions that best fit their needs. Some insurance firms, especially the larger ones that manage their own assets, may already November 2014 Thought Leadership from ReferenceDataReview 9

10 The Data Management Implications of Solvency II have or will develop in-house solutions. On the other hand, small- to mid-sized firms may rely on either outsourced or vendor based solutions. In particular, the look through requirement continues to pose an industry challenge that may be best solved by using a vendor or thirdparty solution that is able to bridge the gap between asset managers concerns about public disclosure of investments with insurance firms and their regulatory reporting obligations. Lind: Sourcing data inputs for SCR, ORSA models and disclosure templates will require unprecedented cooperation between insurance companies, their investment advisors and data vendors to provide portfolio and new instrument data. From a data management infrastructure perspective, we would expect institutions to leverage and extend their existing capabilities rather than deploy any specific solutions just for Solvency II. We would also expect insurance companies to license credit ratings, benchmark curves and default probability analytics from market data vendors. Likewise, asset managers will meet new data requirements on instrument valuation, look through and classification taxonomies using reference data suppliers. Belcher: Based on feedback, we expect firms to use a mix of in-house development, outsourced services and vendor solutions to comply with Solvency II. The important thing is for affected institutions to start data planning now to ensure ontime compliance, especially with the first deadline dates coming up very soon. Finally, what advice would you give to data managers tackling the challenges of Solvency II compliance? Shukla: Solvency II is a comprehensive regulation aimed at ensuring the capital adequacy of insurance providers. It will require firms to adopt thorough data management, governance and risk programmes. Firms must also have confidence in the quality of their data, and for that, they need to understand where data originates and how to manage and make use of the data. Vendors and other market participants may be able to assist with some of these tasks, but the onus is on the insurance industry to leverage content to drive decision-making processes. Solvency II gives us the opportunity to use data as an asset by leveraging content to drive enhanced risk and governance programmes, while also optimising the construction of a firm s portfolio. Lind: I would recommend that data managers engage with service providers, audit firms, data vendors and industry associations that have developed expertise in Solvency II compliance and the new data requirements. Various trade associations are demonstrating value to their members and are engaged in the interpretation of the regulation and preparation for 2016 deadline dates. Notably, the Investment Management Association in the UK, Club Ampere in France, and BVI in Germany have worked together to develop a tripartite data exchange table containing around 130 fields that are needed for Solvency II. This is a clear attempt to standardise the data exchange process and make the insurers aggregation processes a little easier. The PRA in the UK has also been active in establishing working groups that can offer valuable insight into Solvency II. 10 Thought Leadership from ReferenceDataReview November 2014