EUROPE: ESRB- Market Illiquidity and Implications for Asset Managers and Insurers

Tuesday June 9 2020

On 8^th June 2020, the General Board highlighted that the monitoring of liquidity risks in the insurance sector needs to be improved. It also noted that the European Insurance and Occupational Pensions Authority (EIOPA) and national insurance supervisors have already been considering developing a liquidity monitoring framework for (re)insurers as a response to the COVID-19 pandemic. In a communication to EIOPA, the General Board strongly encouraged EIOPA and its members to finalise and operationalise that framework promptly. This would facilitate a more informed and timely assessment of any potential financial stability risks stemming from liquidity risks in the insurance sector (including any liquidity risks stemming from the mismatch between the redemption profile and the asset liquidity of their unit-linked products).

Beyond the need to address risks and vulnerabilities stemming from the current crisis, and as the ESRB has emphasised in the past, the Solvency II review provides an opportunity to better enable supervisors to address liquidity risk in the insurance sector. The COVID-19 crisis highlights the need to better equip (re)insurers to deal with future periods of stress. Reflecting this, as already noted in the past, the Pillar 2 provisions in the Solvency II regulatory regime should be enhanced in the medium term to enable supervisors to require individual (re)insurers with a vulnerable liquidity profile to hold a liquidity buffer.

Liquidity risks arising from margin calls

The General Board highlighted that greater central clearing of derivatives and the collateralisation of non-centrally cleared derivatives positions has significantly strengthened the resilience of derivatives markets in the aftermath of the global financial crisis. These reforms – led by the G20 and the Financial Stability Board – helped to ensure that market stress at the onset of the COVID-19 pandemic did not generate widespread concerns about counterparty credit risk. Furthermore, the General Board acknowledged that margins are fundamental to how a central counterparty (CCP) manages counterparty credit risk and that, as an integral part of risk management, they support the systemic resilience of a CCP. At the same time, the General Board noted that market shocks, such as sharp drops in asset prices and high levels of market volatility, translate into increases in variation margins and may also lead to significant initial margin calls on positions in cash securities, commodities or derivatives. Such conditions could have major implications for the liquidity management of market participants, for their funding needs, and possibly even for their solvency if the liquidity stress leads to systematic fire sales of assets.

Therefore, the General Board decided to issue a Recommendation aimed at

• limiting cliff effects in relation to the demand for collateral, also including client clearing services and non-centrally cleared markets;
• enhancing CCP stress test scenarios for the assessment of future liquidity needs;
• limiting liquidity constraints related to margin collection; and
• promoting international standards related to the mitigation of procyclicality in the provision of client clearing services and in securities financing transactions. The Recommendation is published together with a background

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