Solvency II standards could threaten infrastructure investment, Labour MPs warn Government

In a joint letter (3-page / 35KB PDF) sent to Business Secretary Vince Cable and Chief Secretary to the Treasury Danny Alexander, shadow ministers Chuka Umunna and Rachel Reeves said that Solvency II and related proposals for pension funds could impact on funds' increasing interest in infrastructure investment if "not correctly designed and implemented". They have asked the Government to outline the steps it is taking to ensure that UK interests will be taken into account when the proposals are finalised.

"Given the huge impact of the financial crisis, which still continues today, we recognise, understand and support the rationale of making the financial system more stable," the letter said. "While this might be the intention ... the competitiveness of UK insurance companies outside the EU could be damaged [by Solvency II], investment in infrastructure projects could be reduced, it could restrict access to finance for UK business, and would place burdens on the UK economy."

The Solvency II regime, which will be implemented by the draft Omnibus II Directive (155-page / 3.7MB PDF) sets out stronger risk management requirements for European insurers and dictates how much capital firms must hold in relation to their liabilities. Once finalised, implementation is expected to happen on a phased basis from 2013 to 2014.

The European Commission has proposed the introduction of risk-based supervision and more stringent solvency requirements for pension providers as part of its revised Institutions for Occupational Retirement Provision (IORP) Directive, due next summer. The new system should, it has said, be compatible with the requirements for insurers under Solvency II "to the extent necessary and possible".

The proposal has been met with outcry from many in the UK pensions industry, with research by industry body the National Association of Pension Funds (NAPF) suggesting that such a requirement could cost UK businesses an extra £300 billion.

The Commission has claimed that the new rules are necessary to ensure a "level playing field" between insurance companies, which sell pensions in various EU member states, as well as to protect the savings of cross-border workers; however the UK has argued that it already has strict protections in place for occupational pensions including a Pension Protection Fund (PPF) which will pay out to scheme members in the event of an employer's insolvency.

In their letter Umunna and Reeves said that by failing to take account of the differences between pensions and insurance, the revised requirements could "force UK businesses to divert hundreds of billions of pounds away from business investment, growth and job creation" in order to plug increased pension deficits. There was a "real risk", they said, that this could push many UK businesses into insolvency while reducing the incentives for pension funds to invest in UK companies.

Of particular concern, said the shadow ministers, was the "proposed restrictions" on the level of 'BBB-rated' bonds insurers would be able to hold among their assets. Bonds issued for infrastructure projects are typically BBB rated; meaning that they are considered more of a risk than, for example, AAA-rated Government bonds.

"This is extremely worrying at a time when we must have a growth and investment strategy across Europe, to secure jobs for the future and renew and develop new infrastructure to keep EU countries competitive in an increasingly globalised marketplace," the letter said. "It is also critical for the UK given our infrastructure needs and to unlock the resources held in private companies and institutions."

Infrastructure expert Graham Robinson of Pinsent Masons, the law firm behind Out-Law.com, said that UK-based pension funds were becoming increasingly interested in investing in UK infrastructure debt. Pension funding has become an established way of funding infrastructure in countries such as Canada, he said, as in many cases infrastructure investments can offer better risk-adjusted returns than more traditional asset classes.

Together with investment consultancy Redington, Pinsent Masons is currently holding informal discussions with a number of pension funds on the design of a bespoke infrastructure investment platform. Such a platform could enable pension funds, which may be too small to invest individually on projects or lack the skills to invest directly in the market, to access a wider pool of investment opportunities.

Robinson said that while he agreed that Solvency II would likely mean "less money for investment and ultimately a drag on the UK economy, as well as the wider European economy", in theory the UK Guarantees Scheme announced by the Government last month could help with some of the concerns outlined in the letter.

"The aim and overall purpose of the UK Guarantees Scheme is to improve the attractiveness of key Government-promoted infrastructure projects as investment opportunities and to attract a wider range of private investors; therefore, it may not be an issue that is specific to new infrastructure if supported by the UK Guarantee Scheme," he said.

"In theory, UK pension funds and others should invest in new infrastructure so long as there is a government guarantee and where returns match liabilities. An issue is the longer lead-in period for new infrastructure before returns are generated," he said.

There was "no doubt", he said, that UK pension funds would play a much larger role in funding infrastructure in the UK in the future. "That is a key reason why we are engaged in helping our pension fund clients set up an infrastructure investment platform that complements the Pensions Infrastructure Platform developed by the NAPF," he added.

When announcing the UK Guarantee Scheme in July, the Government said that it would have "wide discretion" over the type of guarantee that could be granted in each case in terms of scale, timing, risk exposure and relationship to the project. A guarantee could, it said, cover any of the main types of project risk including construction, performance or revenue risk.