ISLAMABAD: The Securities and Exchange Commission of Pakistan (SECP) has proposed the issuance of subordinated debt by insurance companies to significantly support the development of the corporate debt market of Pakistan.
The SECP Wednesday issued a concept paper on the issuance of subordinated debt by insurance companies and its treatment for solvency purposes, as well as, a draft of proposed amendments to the Insurance Rules 2017 to elicit public comments.
The main objective of the concept paper is to examine how the issuance of subordinated debt can strengthen financial stability and enhance the risk management capabilities of insurance companies, offering them an alternative capital source.
The paper also explores the characteristics and regulatory framework for subordinated debt securities, aiming to enable insurance companies to efficiently utilize eligible subordinated debt in their solvency requirements.
The issuance of subordinated debt under the proposed framework has the potential to bring several advantages to the insurance companies including the ability to maintain solvency margins, engage in alternate capital rise, enhance creditworthiness, and provide the capacity to absorb risks during financial stress.
As new debt instrument issuers, insurance companies' subordinated debt issuing can significantly contribute to Pakistan's corporate debt market growth.
The concept paper and proposed revisions are part of the Insurance Division's efforts to support a five-year insurance sector development plan for sustainable growth and insurance for all in Pakistan.
According to a document of the SECP on "subordinated debt securities", the subordinated debt as a new instrument would attract a broader range of investors.
The SECP said that investing in insurance subordinated debt is an interesting opportunity because it allows the possibility to invest in a sector that has some external supervision, which is not the case for most non-financial corporates.
Additionally, subordinated debt's distinct risk profile offers investors more options, contributing to a more mature market. This also encourages conservative investors to participate, providing a crucial risk buffer. Moreover, the pricing of subordinated debt sets a benchmark for riskier assets, establishing clearer pricing standards for various debt instruments.
It is important to note that the specific investors in subordinated debt can vary depending on the issuer, the terms of the security, the prevailing interest rates, and market conditions. Additionally, regulatory requirements and investor preferences can influence the composition of investors in subordinated debt of banks and insurers
At present, insurance companies in Pakistan are not involved in the issuance of debt securities, especially subordinated debt securities; one potential reason is lack of benefits in the existing solvency regime.
The proposed subordinated debt framework has been thoughtfully designed to offer insurance companies several advantages, including the ability to maintain solvency margins, engage in cost-effective capital raising, enhance creditworthiness, and provide capacity to absorb risks during financial stress.
Moreover, the issuance of subordinated debt by insurance companies has the potential to play a pivotal role in the growth of the corporate debt market in Pakistan, with insurance companies emerging as new players in the domain of debt instrument issuance, SECP said.
Under the current solvency requirements applicable to insurers in Pakistan, no allowance and/ or benefit is available against any subordinated debt issued by an insurer.
This may be one reason why insurance companies have not ventured into the issuance of subordinated debt, since it would be considered as a normal debt liability and no benefit is allowed, in respect of its subordination and loss absorbing capacity, in maintaining required solvency margins.
The issuance of subordinated debt by insurance companies can bring about financial stability, enhance their risk management capabilities and provide insurance companies with an alternative source of capital, whilst focusing on meeting solvency requirements effectively. Further, the SECP aims to propose a regulatory way forward to allow insurance companies to leverage the subordinated debt to meet their solvency requirements effectively.
The universe of international subordinated financial debt is growing and now has a market cap in excess of USD 1 trillion split between banks (USD 700 billion), insurances (USD 250 billion) and corporates (120 billion).
As of March 31, 2022, insurance companies operating in India had raised a total of INR 9,345 crores (life insurers: INR 4,194 crores; Non-Life & Health: INR 5,151 crores) as other forms of capital, i.e., including subordinated debt and preference shares.
Copyright Business Recorder, 2023
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