The European Commission has quietly resurrected the idea of a ‘brown’ penalising factor in its latest proposals for reform of the Solvency II directive.
The Commission has proposed that the European Insurance and Occupations Authority (EIOPA), one of the EU’s three financial supervisory authorities, is mandated to review evidence on “the risk profile of environmentally or socially harmful investments”, reporting back by no later than 2023.
“While there is not sufficient evidence at this stage on risk differentials between environmentally or socially harmful and other investments, such evidence may become available over the next years,” the Commission says in the review package of Solvency II, which governs how insurers operate, their disclosures and capital requirements, published by the Commission earlier this week.
If EIOPA finds a risk differential for harmful investments, the report could be a prelude to an introduction of the ‘brown penalising factor’ – increased capital requirements for investments which are environmentally or socially harmful to counterbalance increased risk. The idea was first floated as an alternative to the ‘green supporting factor’, which would see insurers and banks have looser capital requirements for green investments to reflect the benefits of the investments in reducing climate risk.
The Commission also proposes mandating EIOPA to explore “a dedicated prudential treatment of exposures” related to investments with environmental and/or social objectives, which it has also been asked to report on by 2023.
“We are – again – moving towards the implementation of a green supporting factor, probably coupled with a ‘brown’ penalty,” Dorothee Atwell, Partner and Head of Investment Funds and Asset Management Germany at Pinsent Masons, told RI.
As a consequence of the European Commission’s proposals, “it thus appears to only be a small step to incentivise ‘green’ investments by allocating a lower equity capital charge due to – for example – a reduction in climate and sustainability-related risks whilst at the same time allocating a higher equity capital charge to investments that are considered ‘brown’, she continued.
CRRII, the EU regulation covering capital regulations for banks, is usually relatively aligned with Solvency II developments for insurers. The European Banking Authority (EBA) was mandated in 2019 to present a report on “whether a dedicated prudential treatment of exposures related to assets or activities associated substantially with environmental and/or social objectives would be justified” by 2025. However, the EBA mandate does not specifically mention harmful activities.
The Commission proposed in the Renewed Sustainable Finance Strategy in July to bring the EBA report mandate forward to 2023.
Insurance industry bodies reacted negatively to the proposal that assets could be subject to different rules based on sustainability. Olav Jones, Deputy Director General at Insurance Europe, said: “We agree with the EC’s comments in its proposals that there is no evidence to justify different capital treatment for assets on the basis of sustainability-related issues. Capital charges in Solvency II should remain based on evidence and the real underlying risk.”
Jörg Asmussen, CEO of German insurance association GDV, said that the “preferential treatment for green investments is not productive from a financial stability standpoint. Solvency II has to be risk oriented [but] green investments are not without risk per se”.
In contrast, Caroline Metz, EU Policy Officer at NGO ShareAction, said these proposals do not go far enough, and indicated that the Commission “has decided to kick the issue[of capital requirements] into the long grass”. “The Commission rightly recognises that sustainability risks should be better reflected in Solvency II,” she said. But “at this stage, Solvency II does not reflect the full risk of investments in environmentally or socially damaging activities.”
“At the very least, the Commission could have shortened the timeline for EIOPA to look into this,” she told RI.
As part of other proposed amendments, insurers will be required to identify exposure to climate change risks and carry out scenario analysis. The proposed changes – which were first floated in the Commission’s Renewed Sustainable Finance Strategy in July – are the first step towards bringing sustainability and climate considerations into the Solvency II framework.
EIOPA has also been mandated to conduct climate stress tests for the insurance and reinsurance sectors and will begin to track trends in the frequency and severity of natural disasters as well as insurer and reinsurer exposure, with a view to potentially changing the formulas for catastrophe risk.
Meanwhile, Metz also said that she was “disappointed” that the Commission had failed to make any proposals on double materiality. “If one is to be serious about tackling the challenges of our time, insurers should be required to assess not only the impact of climate and sustainability issues on their business, but also the impact that their own business activities have on our planet and societies,” she said.
Green Party MEP Sven Giegold said that the proposed rules “continue to have more holes than Swiss cheese […] it is not enough to let EIOPA now prepare the umpteenth expert report and postpone the issue again for years. Anyone who takes the European Green Deal seriously must also act in 2021”.
“The lack of ambition in addressing sustainability risks falls short of the EU’s own announcements in the Sustainable Finance Strategy, he continued. “The consideration of climate risks only in the internal risk management of insurers is not sufficient.”
The next step for the review pacakge is for the European Parliament and the Member States in the Council to negotiate the final legislative texts on the basis of the Commission’s proposals.