This piece is by Wenzhe Sheng, Senior Product Manager of Regulatory Tech at Clearwater Analytics.
Liquidity risk presented to the global financial system by non-bank financial institutions (NBFIs) has been a key theme in recent years, with regulators and international bodies across the globe beginning to dig under the surface to discover the resiliency of NBFIs, both operationally and financially. The latest proposals from the Bank of England’s Prudential Regulation Authority (PRA) reveal there is work still to be done in the insurance industry, leaving many uneasy that they are not prepared to meet the new liquidity requirements.
According to proposals released last month, the PRA wants large UK life insurers to face more stringent liquidity reporting rules, a response to the recent market stress events that we have seen become more commonplace over the last five years. The regulator specifically referenced the LDI-shock that rattled gilts markets after Liz Truss’s notorious mini-budget in September 2022. It identified key weaknesses in its current data collection practices, including the frequency of data collection, quality of data collected, and the responsiveness and comprehensiveness of the liquidity monitoring. The view of the PRA is that relying on months-old information on liquidity positions is simply not good enough.
The rational of these proposals cannot be denied. Insurers’ investment strategies have materially changed, which indicates that a shift in the regulation overseeing those strategies would make sense. Over the last decade, life insurers have been engaging in far more complex financial instruments than has ever been the case before. The days of filling portfolios with listed equities and high-grade fixed income have moved on, with more and more insurers investing in both private credit and illiquid assets coupled with large hedging positions against the underlying market risk exposure.
On the other side, we are in a high-for-longer market where volatility can rapidly take shape. These fundamental shifts in market dynamics and investment strategies pose a systemic risk to financial stability, and supervisors like the PRA are not surprisingly keen to plug the gaps that exist in their realm.
When regulatory changes start filtering through into individual insurance firms, the question is always – “How do I implement this?”. Traditionally, insurers’ operating models and infrastructure have not kept pace. The process adopted by many is often evolutional rather than transformational, as evidenced through the fact that you have to deal with different data across different legacy systems and spreadsheets.
There is often a bridge that must be crossed between business and technology, and having the capability to rapidly obtain a transparent view of all of your holdings isn’t as easy as it sounds. Nonetheless, having a transparent view of liquidity levels and risk exposures is a critical task, one that can be achieved through a strong and flexible data infrastructure, ideally built on modern cloud-based technology.
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