EIOPA proposes new asset class for infrastructure investments and identifies preferred categorisation

In its final report on a call for advice from the European Commission on infrastructure investment risk categories under Solvency II, EIOPA advised creating a separate asset class for high quality infrastructure as part of a "more granular approach" to risk categories to make it easier for insurance companies to invest in infrastructure.

A comparison of the credit risk for similar portfolios of corporate and infrastructure project debt showed that the former were at least twice as risky, EIOPA said.

The new asset class will help insurance companies with investment decisions, although they will still need "robust risk management" including active monitoring of their exposure to infrastructure projects and stress testing of their cash flows, EIOPA said in a statement.

Gabriel Bernardino, chairman of EIOPA, said: "EIOPA has made remarkable progress in proposing a new asset class and a prudentially sound regulatory treatment within a very short timeframe. Investments in infrastructure could be very important for the insurance business because, due to their long-term nature, they may be a good fit to match long-term liabilities while also increasing portfolio diversification. However, infrastructure projects can be very complex and require specific risk management expertise".

Insurers will need to show they have performed "adequate due diligence" before investment, with written procedures for monitoring performance and regular stress tests on the cash flows supporting the infrastructure project, EIOPA said.

EIOPA also identified the "credit risk approach" as its preferred way of categorising investments, using a mix of risk assessments from external credit assessment institutions for larger deals and, for smaller investments, qualification criteria linked to political risk, structuring and an analysis of construction and operating risk.

EIOPA said it recommends the credit risk approach because there are disadvantages to other approaches such as the liquidity approach and also to using a combination of approaches.

Infrastructure expert Stephen Tobin of Pinsent Masons, the law firm behind Out-Law.com said "It's good to see that EIOPA has made recommendations to the Commission on how to allocate an appropriate risk allocation to infrastructure debt and recognised its importance by giving it a separate classification, stating that a similar portfolio of corporate debt is twice as risky as infrastructure debt. By getting the right risk allocation, insurers and pension funds should be able to offer competitive terms to borrowers and investors, reducing the long-term cost of infrastructure to taxpayers."

However, not all investors will agree with EIOPA's proposals, Tobin said.

"Political and regulatory stability remain crucial for long-term investments like infrastructure, a fact not lost on EIOPA and one to be borne in mind by governments across Europe. Equally, having the right definition of what counts as 'infrastructure' will drive the breadth of investment by insurers and pension funds – keeping an unduly narrow definition to infrastructure, and limiting it to project financed infrastructure, will drive competition into smaller markets, which will not be helpful in encouraging wider investment in infrastructure," he said.

EIOPA issued a consultation paper on its advice to the European Commission on the identification and calibration of infrastructure investment risk categories in July. It asked for views on: definitions and criteria to identify qualifying infrastructure debt and equity investments, which may warrant a different standard formula treatment; calibration for qualifying infrastructure investments; additional risk management requirements; and possible obstacles to infrastructure investments that are not justified by prudential considerations.

Infrastructure investments are increasingly important to growth, and insurers are an important source of funds for these investments, EIOPA said in its consultation document.

The long term nature of the liabilities involved in infrastructure investments fit well with the risk profile of insurers, EIOPA said.

EIOPA chose to focus on debt and equity investments for infrastructure projects, as these have a "higher degree of revenue certainty", it said at the time. It put together proposed criteria and definitions for these investments, and looked at how to establish parameters for the new risk categories in line with the new Solvency II directive.

The Solvency II regime comes into force across the EU on 1 January 2016, and sets out broader risk management requirements for European insurers, requiring firms to hold enough capital to cover all their expected future insurance or reinsurance liabilities.