Solvency II Standard Formula SCR: Market
Risk Module – Spread Risk Sub-module
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This sub-module is covered in DA
Articles 175 - 181 and covers:
-
bonds and loans
-
securitisation positions
-
credit derivatives, such as credit default swaps, total return swaps and
credit linked notes
For bonds and loans, the computation depends on a
combination of the duration and the credit quality assigned to the bond, see DA Article
176.
For securitisations, the computation is split between Type 1
and Type 2 securitisations (Type 1 securitisations generally being ones that
meet specified criteria including ones relating to credit quality, listing,
documentation etc. and Type 2 being all others). Exactly how securitisations
should be split between these two types and what contribution to capital
requirements that they then generate is set out in DA Articles
177 and 178.
The computation for credit derivatives is set out in DA Article
179.
Overrides are applied to some specific types of
spread-sensitive asset such as covered bonds and bonds or loans to central
governments, see DA Article
180.
The spread risk component went through several iterations
during the Solvency II consultation process and set out below are some of the
elements of these iterations.
QIS4 (Quantitative Impact Study 4)
In QIS4 it involved the following, according to CP70:
Capital charge calculated by multiplying the market value of
the bond or structured credit product bond with its modified duration and a
function F (for bonds) or G (for structured credit products) based on rating
class of bond or structured credit product, the modified duration being subject
to a floor and sometimes a cap as follows:
|
Rating class
|
F(rating)
|
G(rating)
|
Duration floor
|
Duration cap for corporate bonds
|
Duration cap for structured credit products
|
|
AAA
|
0.25%
|
2.13%
|
1
|
-
|
-
|
|
AA
|
0.25%
|
2.55%
|
1
|
-
|
-
|
|
A
|
1.03%
|
2.91%
|
1
|
-
|
-
|
|
BBB
|
1.25%
|
4.11%
|
1
|
-
|
-
|
|
BB
|
3.39%
|
8.42%
|
1
|
8
|
5
|
|
B
|
5.60%
|
13.35%
|
1
|
6
|
4
|
|
CCC or lower
|
11.20%
|
29.71%
|
1
|
4
|
2.5
|
|
Unrated
|
2.00%
|
100.00%
|
1
|
4
|
1
|
For credit derivatives, the QIS4 capital charge was
determined as the change in the value of the derivative (i.e. as the decrease
in the asset or increase in the liability) that would occur following whichever
was the more onerous of a widening of credit spreads by 300% or a narrowing by
75%.
CP70
CP70
proposed a change to this which involved factors dependent on rating and
maturity buckets as follows (no longer then multiplied by the duration):
|
F(rating, maturity)
|
AAA
|
AA
|
A
|
BBB
|
BB or lower
|
Unrated
|
|
0-2.9 years
|
3.4%
|
4.5%
|
6.8%
|
7.7%
|
14.0%
|
8.0%
|
|
3-4.9 years
|
5.4%
|
7.1%
|
11.5%
|
14.6%
|
27.0%
|
15.0%
|
|
5-6.9 years
|
7.9%
|
10.3%
|
16.5%
|
20.1%
|
38.5%
|
21.5%
|
|
7-9.9 years
|
8.5%
|
13.5%
|
21.5%
|
25.9%
|
49.0%
|
27.5%
|
|
10+ years
|
11.5%
|
19.1%
|
24.0%
|
27.5%
|
52.0%
|
30.0%
|
|
G(rating, tenure)
|
AAA
|
AA
|
A
|
BBB
|
BB
|
B
|
CCC or lower
|
|
0-1.9 years
|
0.8%
|
1.9%
|
4.3%
|
7.8%
|
19.8%
|
41.1%
|
64.7%
|
|
2-3.9 years
|
1.6%
|
3.1%
|
8.1%
|
15.9%
|
34.5%
|
59.7%
|
82.9%
|
|
4-5.9 years
|
2.3%
|
5.4%
|
11.6%
|
22.1%
|
43.4%
|
67.8%
|
88.4%
|
|
6-7.9 years
|
3.5%
|
7.4%
|
14.3%
|
27.5%
|
50.8%
|
73.6%
|
90.3%
|
|
8+ years
|
4.7%
|
9.7%
|
17.4%
|
32.9%
|
56.6%
|
76.7%
|
91.9%
|
Recovery rates were taken into account (for structured
credit) using a function R as follows, overlaid on which was a methodology to
capture the impact of the waterfall structure of the product (the attachment
and detachment points of the relevant tranche):
|
R(rating)
|
AAA
|
AA
|
A
|
BBB
|
BB
|
B
|
CCC or lower
|
|
Recovery rate
|
50%
|
45%
|
40%
|
35%
|
30%
|
25%
|
20%
|
When calculating the spread charge for structured products,
a cap of 100% and a floor of 10% of market value was also applied.
For credit derivatives, the CP70 capital charge was
determined as the change in the value of the derivative (i.e. as the decrease
in the asset or increase in the liability) that would occur following whichever
was the more onerous of a widening of credit spreads by 600% or a narrowing by
75%.
CEIOPS (2010)
In its finalised Level 2 advice, CEIOPS reverted to a
somewhat simpler approach for corporate bonds more akin to that used in QIS4
(in which the stress involved a factor multiplied by the modified duration),
but now involving both up and down movements:
|
F
|
F(up,rating)
|
F(down,rating)
|
Duration floor
|
Duration cap
|
|
AAA
|
1.0%
|
-0.4%
|
1
|
-
|
|
AA
|
1.5%
|
-1.0%
|
1
|
-
|
|
A
|
2.6%
|
-1.7%
|
1
|
-
|
|
BBB
|
4.5%
|
-3.0%
|
1
|
-
|
|
BB
|
8.4%
|
-6.3%
|
1
|
8
|
|
B or lower
|
16.2%
|
-8.6%
|
1
|
6
|
|
Unrated
|
5.0%
|
-3.3%
|
1
|
4
|
G and R were adjusted to include, amongst other elements, an
unrated bucket, with similar but not identical calibrations used for G:
|
G(rating, tenure)
|
AAA
|
AA
|
A
|
BBB
|
BB
|
B
|
CCC or lower
|
Unrated
|
|
0-1.9 years
|
0.8%
|
1.6%
|
4.7%
|
8.1%
|
20.9%
|
41.5%
|
65.9%
|
9.7%
|
|
2-3.9 years
|
1.6%
|
3.1%
|
8.1%
|
14.7%
|
34.1%
|
59.7%
|
83.3%
|
17.6%
|
|
4-5.9 years
|
2.3%
|
5.4%
|
10.9%
|
20.2%
|
43.0%
|
68.2%
|
88.4%
|
24.2%
|
|
6-7.9 years
|
3.5%
|
7.4%
|
14.0%
|
25.2%
|
50.4%
|
73.3%
|
90.7%
|
30.2%
|
|
8+ years
|
4.7%
|
9.7%
|
17.1%
|
30.2%
|
56.2%
|
77.1%
|
91.9%
|
36.2%
|
|
R(rating)
|
AAA
|
AA
|
A
|
BBB
|
BB
|
B
|
CCC or lower
|
Unrated
|
|
Recovery rate
|
50%
|
45%
|
40%
|
35%
|
30%
|
25%
|
20%
|
35%
|
If the originator of the structured credit product did not
comply with the 5% net retention foreseen in the CRD (Directive 2006/48/EC)
then it was proposed that the capital charge for the product be set to 100%
regardless of the seniority of the position.
For credit derivatives, including credit default swaps
(CDS), total return swaps (TRS) and credit linked notes (CLN), it was proposed
that the charge be determined (if the (re)insurance undertaking did not hold
underlying instruments with immaterial basis risk or where the credit
derivative is not part of the undertaking’s risk mitigation policy) as the
change in the value of the derivative (i.e. as the decrease in the asset or
increase in the liability) that would occur following whichever was the more
onerous of a widening of credit spreads by 600% or a narrowing by 75%
A somewhat different approach was mandated for exposures
secured by real estate (i.e. ‘property’ in UK English parlance), see sections
3.206 onwards of CEIOPS (2010).
Solvency II Delegated Act
Further changes were made to some of these formulae in the Delegated
Act. Readers are advised to refer to it for further details.
Version dated 7 December 2015
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