Key developments from PRA PS10/24 - Review of Solvency II: Reform of the Matching Adjustment

Following a few days of speculation about whether the upcoming general election would impact on the publication of any PRA policy statements, the PRA has published policy statement PS10/24 which provides feedback responses received to the September Solvency UK consultation paper (CP19/23 – Review of Solvency II: Reform of the Matching Adjustment).

The policy statement can be found here: https://www.bankofengland.co.uk/prudential-regulation/publication/2024/june/review-of-solvency-ii-reform-of-the-matching-adjustment-policy-statement

PS10/24 contains the PRA’s final policy in the form of updated policy materials including supervisory statements and statements of policy.

Following responses to CP19/23, the PRA has reflected on feedback provided in response to the consultation across the eight topics covered within the CP and has made a number of updates to provide further clarity or amend draft policy.

The final policy set out in the PS will come into force on 30 June 2024 unless otherwise stated in specific chapters. The PRA provides a summary of changes that firms will be able to use from 30 June 2024 such as including assets and liabilities based on the expanded eligibility criteria and removing the sub-investment grade MA cap amongst others.

Given the implementation timelines, firms have been working on the basis of the draft expectations set out in CP19/23 and so will now need to consider the detail in PS10/24 and allow for any changes arising in their preparations for implementation.

Below is an overview of some of the key changes and developments compared to CP19/23 for the topics covered in the PS.

Investment flexibility

• A number of paragraphs in SS7/18 have been amended or removed to clarify the PRA’s policy intent about the treatment of existing ‘fixed’ cashflow assets to avoid any unintended changes for those assets.
• Wording in SS7/18 relating to internally restructured assets has been amended to clarify that such assets can be MA eligible subject to firms explaining the reasons for restructure and why the level of MA benefit is appropriate.
• The thresholds for Matching Tests 4 and 5 for highly predictable (HP) assets have been increased from 3% to 5%.
• Worked examples for the application of standard approaches to FS additions for HP cash flow assets have been provided with expectations on FS additions for HP cash flows also being updated and clarified.
• There is clarification that best estimate cash flows for HP assets should generally be consistent with those used for IFRS fair valuation, but firms should be able to justify any deviations from this.

Liability eligibility

• Group death in service dependants annuities (GDAs) will be eligible to be included in the MA portfolio alongside in-payment income protection liabilities.
• There have been minor amendments on PRA expectations in respect of in-payment income protection liabilities to avoid in-payment parts of group income protection policies being excluded from the MA portfolio.

Credit ratings under the MA

• A wider range of metrics has been included in SS7/18 that could be considered when assessing the contribution of sub-investment grade (SIG) assets to their MA portfolio.
• There is clarification that firms should ensure the appropriateness of the MA arising on SIG assets post-stress.
• There has been an amendment to expectations for the individual with responsibility for the internal credit assessment function to consider the nature, scale and complexity of asset to reflect that there is no policy intent to impose a specific organisational design.

MA permissions, breaches and consequential rule changes

• References to ‘new risks’ triggering variations of MA permissions has been removed with the exception of where new combinations of features give rise to material risks resulting from interactions and/or dependencies not considered as part of the existing permission.
• A new chapter has been included in the MA Statement of Policy (SoP) which sets out how the PRA will publish regular reports on the MA framework covering application review timelines and decision rates with the first being published in 2025.
• The new chapter of the MA SoP also reiterates the six month target for decisions with shorter timeframes possible for streamlined applications.
• The PRA has clarified that its approach to considering applications relating to future assets or liabilities will be proportionate and reflect a firm’s specific circumstances.
• It has been clarified that the outcome of one MA application does not preclude another application from being submitted.
• The expectations for firms submitting MA applications, including a reduce scope of required documentation, have been amended to provide further clarity.
• A new Application Readiness Assessment Process (ARAP) is being introduced which will assist the PRA in assessing a firm’s readiness to submit a formal MA application and create consistency in the PRA’s engagement with firms.
• The PRA has clarified that firms that have applied a reduction to the MA as a result of a breach of MA eligibility conditions will not be expected to recalculate the SCR to reflect this reduction.

MA attestation

• Firms are generally expected to rely on the basic FS for corporate bond portfolios where these broadly reflect the calibration data and have up-to-date accurate credit ratings.
• Firms are permitted to perform an initial top-down analysis by grouping assts into homogeneous risk groups when determining whether FS additions are needed which can then be followed up with examination of specific assets where necessary.
• There has been a minor clarification to the expectations over the definition of a high degree of confidence refencing the degree of confidence over a portfolio of liquid corporate bonds with fixed cash flows and their MA attestation review process.
• The PRA has clarified that where the Effective Value Test (EVT) is used to support MA attestation for ERMs, firms are expected to use assumptions that they judge to be appropriate for attestation which shouldn’t fall below the PRA’s minimum parameters.
• Examples on corporate bond idiosyncratic risk and rebalancing costs have been included in SS7/18 to support expectations on FS additions.
• The reference date for out-of-cycle attestations should be no later than three months after the date of the material change in risk profile.
• Further detail has been provided to clarity that the purpose of discussing an out-of-cycle attestation with the PRA is to bilaterally agree the most appropriate reference date and timescales for completion of the attestation.
• The PRA has clarified that there is no change to the scope of external audit arising from the attestation requirement or the option for firms to apply voluntary FS additions.
• While the PRA considers that firms are free to disclose the statement on attestation in any suitable part of the SFCR including any rationale for the attestation and FS additions, it has been clarified that this is not a requirement.
• Firms may, but will not be required to, provide any annual or out-of-cycle attestations with a reference date before 31 December 2024.

Assumptions underlying the MA

• Minor changes have been made to update references, give more background on the operation of the MA, clarify the intended meaning of the term ‘objective’ in the context of credit ratings and address minor comments provided by respondents.

Matching adjustment asset and liability information return (MALIR)

• The requirement to submit cash flows extending beyond 50 years has been removed and instead those cash flows will have to be discounted to the last month of the 50th year.
• The PRA has clarified the definitions of asset types with more substantive changes being made where the PRA considers most ambiguity may exist, namely for ‘Corporate Bonds’, ‘Covered Bonds’ and ‘Sale and Leaseback Loans on Commercial Properties’.
• Two new asset type definitions have been introduced to cover ‘Other loans’ and ‘Other Sovereigns, Sub-sovereigns, Quasi-government/Supranationals’.
• ‘Other/Unknown’ has been split out as separate options in the ‘Capacity Enhancing Assets’ field.
• The MALIR fields for Asset ID Code and Asset ID Code type have been combined to align to the approach taken in QRTs.
• There have been other minor changes to improve clarity such as field names and update refences to QRTs.

Notching

• The PRA has clarified what it means by a notched rating being ‘available’ through expectations that firms have six months from the date at which an asset first becomes an ‘assigned asset’ for a notched rating to become ‘available’ with firms being expected to explain why they are unable to rate on a notched basis where this is not the case after six months.
• The requirement to reflect notching will now be effective from 31 December 2024 in recognition of the required updates to systems and processes to allow for notching but firms will have the option to implement notching from 30 June 2024.