In the consultation paper CP1/21, PRA has proposed an approach to deep, liquid, and transparent, or DLT, assessments and the transition of Solvency II technical information from the London Interbank Offered Rate (LIBOR) to the Sterling Overnight Index Average (SONIA) in 2021. The proposals in CP1/21 would result in changes to the statement of policy on the approach of PRA to the publication of Solvency II technical information (Appendix). PRA proposes to implement the transition for GBP technical information to SONIA from, and including, July 31, 2021. The consultation period ends on March 31, 2021.
CP1/21 is relevant to all UK Solvency II firms, including in respect of the Solvency II groups provisions, and to the Society of Lloyd’s and its managing agents. Non-Directive firms are out of the scope of this consultation. From December 31, 2020, PRA is required to publish technical information for each relevant currency. The technical information includes the basic risk-free rates and fundamental spreads used in the calculation of the matching adjustment and volatility adjustment. The proposals in CP1/21 cover the following:
- Proposed approach to the deep, liquid, and transparent assessment process for all relevant currencies
- Transition of the GBP risk-free rate and associated technical information from LIBOR to SONIA and transition timetable for other LIBOR currencies
- Determination of the credit risk adjustment for SONIA technical information and the proposal that, given the characteristics of the SONIA rates, the residual credit risk is considered to be negligible
- The way in which the calculation of long-term average spread would reflect the transition to SONIA
- Impact on the transitional measure for technical provisions for business written before 2016
- Impact of the transition on firms with approval to apply the matching adjustment and internal models
The Working Group on Sterling Risk-Free Reference Rates recommended that SONIA be used as the preferred replacement for LIBOR for sterling markets. PRA will, therefore, transition the GBP Solvency II technical information to reference SONIA swap rates before the end of 2021. The Solvency II technical information for GBP, USD, and JPY currently references LIBOR rates. In December 2020, ICE Benchmark Administration, which is the administrator of LIBOR, published a consultation on its intention for the GBP, JPY, and some USD LIBOR panels to cease at the end of 2021 and for the remainder of USD panels to cease at the end of June 2023. PRA will also transition the JPY and USD technical information references from LIBOR to an Overnight Indexed Swap (OIS) rate although the date and approach to these transitions will depend on the liquidity of swaps referencing the Tokyo Overnight Average Rate and the Secured Overnight Financing Rate.
The GBP LIBOR-based rates are currently higher than the equivalent SONIA-based rates. If this continues to be the case at the time of the proposed transition, this would generally result in an increase in technical provisions. This issue is in part mitigated by several proposals included in CP1/21, notably the proposals on transitional relief and the calculation of the long-term average spread. The proposals set out in CP1/21 have been designed in the context of UK having left EU and the transition period having come to an end. Unless otherwise stated, any references made to legislation, including that which is "retained EU law," relate to the UK version. PRA will keep the policy under review to assess whether any changes would be required due to changes in the UK regulatory framework.
Comment Due Date: March 31, 2021
Effective Date: July 31, 2021 (proposed)
Keywords: Europe, UK, Insurance, Solvency II, SONIA, LIBOR, Interest Rate Benchmarks, Risk-Free Rates, PRA
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