Solvency UK: Matching Adjustment Attestation – Requirements and Expectations

Overview

In its November 2022 statement, the Government announced that the design and calibration of the Fundamental Spread (FS) would be broadly unchanged and that it would legislate to expand the range of Matching Adjustment (MA) eligible assets. In line with this statement, the Prudential Regulation Authority (PRA) proposes that firms would be required to attest to the PRA on the sufficiency of the FS and the quality of the resulting MA calculation.

The PRA proposes the attestation wording to be defined in the PRA Rulebook and would be as follows:

‘As at the effective date of the firm’s Solvency and Financial Condition Report (SFCR): the FS used by the firm in calculating the MA reflects compensation for all retained risks, and the MA adjustment can be earned with a high degree of confidence from the assets held in the relevant portfolio of assets.’

The attestation must be provided by the PRA senior management function (SMF) holder in the firm responsible for the prescribed responsibility of the production and integrity of the firm’s financial information and its regulatory reporting.

The attestation must be provided:

• Annually, no later than 14 weeks after the firm’s financial year end to which it relates.

• As soon as is reasonably practicable after a material change in the risk profile of the firm.

Internal Governance for the Attestation

• Before providing any attestation, a firm must analyse and justify that the FS used by the firm reflects compensation for all retained risks, and that the MA can be earned with a high degree of confidence from the assets held in the relevant portfolio of assets.

• A firm must have in place appropriate internal processes, systems and controls to allow it to produce the analysis and justification required to comply with the points covered in the above statement.

• A firm must put in place and maintain a policy on providing the attestation and the analysis and justification required and must ensure that its governing body has approved that policy.

• If there has been a material shift in a firm’s risk profile, then additional out-of-cycle attestation will be required. Triggers for an out-of-cycle attestation could be:

  • A large bulk purchase annuity transaction where the assets transferred have a materially different profile to those currently held.

  • The merge of two MA portfolios.

  • Shift in the economic outlook for assets comprising a material proportion of the MA portfolio.

Form of the Attestation

An attestation document must be provided to the PRA, setting out the attestation itself alongside a supporting attestation report.

The attestation document must include:

• The attestation itself.

• The name and role of the SMF giving the attestation.

• The relevant portfolio of assets to which the attestation applies.

• The date of the attestation.

The supporting attestation report must include:

• A copy of the latest version of the policy in place.

• Confirmation that the firm and attestor complied with the terms of the policy. If not, provide the alternative approach followed by the firm.

• A list detailing the evidence the attestor relied on in making the attestation.

• Any increase(s) in the FS that the firm has elected to use, alongside:

  • A list of all assets in each relevant portfolio of assets to which these apply.

  • The reasons for the increase(s).

  • The amount of the increase(s).

  • The MA resulting from those assets.

Attesting to the Quality of the MA

The PRA expects firms to adopt a systematic approach to reviewing the evidence for the attestation, which should include an assessment of whether the MA portfolio has a risk profile that is consistent with the assumptions underlying the MA. Under this approach firms should review the FS and MA independently of each other. An example process is set out below:

Step 1

Identify assets in the MA portfolio with a risk profile that is consistent with the assumptions underlying the MA. While these assets are generally not expected to require increase to the FS, firms should consider whether exceptions apply.

• Firms should consider risks that may not have been captured by the corporate bond historical credit performance data used to calibrate the FS.

• Firms should consider rating lags, rating inaccuracies and factors that increase the probability of future downgrades.

Step 2

Identify assets in the MA portfolio with a risk profile that is not consistent with the assumptions underlying the MA, such as assets that are internally rated, internally valued, private, restructured assets, or assets with HP cash flows.

• Firms should consider retained risks that are common to assets covered in Step 1.

• Firms should consider additional risks that may result from high uncertainty such as political, reputational, conduct or legal, or complex features for which limited data exists.

• Firms should consider additional risks that arise from sources of cash flow variability.

• Where credit is taken from the collateral, consider illiquidity and reinvestment risks.

• Where proportionate, firms should develop their own, more sophisticated model and processes to come up with an FS that reflects compensation for all retailed risks.

Step 3

Review all assets in the portfolio and explain (or modify) the MA on assets that are material contributors to the MA. There should be clearly articulated metrics for identifying material contributors.

Action and decisions – Reviewing FS and MA

Firms must prepare for the additional work required to attest to the quality of the FS and MA. The following considerations are likely to become part of the firm’s attestation policy and key considerations for the attestation report:

• The basic approach is likely to tie into the three-step approach contained in the consultation paper (detailed previously in this article.)

• The basic data that will be required for all assets, including those that fit into Step 1.

• The additional data that will be required for assets fitting into Step 2 (i.e. those with a risk profile not consistent with the PRA’s assumptions underlying the MA).

• The methods and models that will be used to demonstrate the FS and MA.

• How the firm will show that the FS reflects all retained risks.

• How the firm will show that the MA can be earned with a high degree of confidence. Firms will need to take a view on how to interpret “high”. This may need to be reviewed over time.

Attestation Requirements Evidence

The PRA requires a firm to list the evidence relied upon making the attestation and expects the evidence to include:

• Evidence that the credit ratings or assessment for all assets were accurate, reliable, and up to date.

• Analysis of the credit risk exposure and how this compares to the risks underlying the assets used to calibrate the FS and assumptions underlying the MA.

• Justifications that the methodology and amount of any FS additions for assets with HP cash flows remain appropriate.

• Details of assets that have been identified as material contributors to the MA and justification for that amount of MA.

• Explanation of how any voluntary FS additions were determined.

4most are actively engaging with clients to discuss the potential impacts of these changes, please get in touch if you’d like to discuss ways in which we can support your organisation – info@4-most.co.uk

Further reading: CP19/23 – Review of Solvency II: Reform of the Matching Adjustment (Bank of England)