Asia Risk Congress: LCR drives expanding regional liquidity swap market

Insurers providing liquidity swaps to banks is a growing trend in Asia

The increasing need by banks for liquid assets to meet the requirements of Basel III is driving a burgeoning liquidity swap market in Asia, according to two insurers from the region.

The liquidity coverage ratio (LCR) is due to be implemented in 2015 according to the timetable outlined by the Basel Committee on Banking Supervision and will require banks to hold an increasing amount of liquid assets.

According to insurers speaking at the Asia Risk Congress 2012 in Hong Kong yesterday, the need to meet the LCR has seen the creation of a liquidity swap market in region, whereby insurers lend out long-dated assets on a collateralised basis to banks for a fee.

Stephan van Vliet, head of investment strategy at ING in Hong Kong, said ING has transacted such swaps in countries across the region including Japan.

"We can do this with loan books where we get an extra return over the equivalent publics and also using private placements but regulators require onerous restrictions on insurers to do the loans themselves. I think that should change," he said. "Especially with the large amount of infrastructure that still needs to be built in Asia, taking on loan books is one way of co-investing with banks."

Chandresh Shah, chief risk officer at Aviva in Singapore, didn't say whether his firm has engaged in this activity but he did point out that insurers have ample liquidity and that the risk of "cash surrenders" – where insurance companies' liquidity would be impaired by paying out on a policy – is relatively low.

"My view is that liquidity is not an issue for most insurers that have standard assets. Even in the worst stress scenario an insurance company will not face anything more than 20% of its balance sheet value as 'surrenders', and liquid assets such as government bonds are [around] 75%," he said.

"This contrasts with banks where banking assets can't be liquidated in the long term and behavioural assets such as saving and current accounts can translate into a huge outflow for the [Basel III] LCR if there was a run on a bank," Shah added.

The liquidity swap market emerged in the UK following the financial crisis and the UK's Financial Services Authority has issued warnings about the potential risk of this type of collateralised lending between insurers and banks, even intervening to prevent some transactions taking place.

Van Vliet said regulators in Asia were similarly cautious: "Generally regulators are not that comfortable yet with these transactions so there is a whole teaching and lobbying effort but it makes a lot of sense."

However, there is also the challenge of persuading insurance company boards about this approach, Van Vliet said. "Even our own boards need to be taught about these transactions so there is a whole organisational effort to get everybody to the same level of expertise. But this is a great area of opportunity and it's very capital efficient."

While Hong Kong is one of the jurisdictions where banks face a shortage of liquid assets, van Vliet said further engagement with the regulator is required before such transactions can take off.

"With liquidity swaps, an insurer needs to be well measured as these are long-term commitments so from a legal and regulatory perspective you need to be sure that these are allowed. There is a lack of clarity about what the Hong Kong regulator will support but if they were open to engagement on this that would be helpful," van Vliet said.