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Derivatives

U.K. Insurance Guidelines Could Discourage Exotic Trades

Guidelines for insurance companies issued last month by the Financial Services Authority, the U.K. regulator, could make funds reluctant to enter derivatives that would be costly to unwind.

Guidelines for insurance companies issued last month by the Financial Services Authority, the U.K. regulator, could make funds reluctant to enter derivatives that would be costly to unwind. The FSA could ask insurance companies to unwind a trade if the regulator believes the insurance company has not assessed the credit risk, but the FSA has not provided any precise guidance. The FSA requires insurance companies to produce Individual Capital Assessment analysis, which should take into account the expected response of the swap positions to widening of credit spreads.

Although the guidelines for swaps are unclear, this is unlikely to prevent corporates from entering vanilla trades such as interest-rate swaps, said Forough Long, head of fixed income at Allianz Cornhill in London, who manages USD4 billion of funds. "Some of the bigger funds however, may consider unwinding swaps for the ICA," she noted.

Andrew Smith, an actuary in Deloitte Actuarial and Insurance Solutions, said this is unlikely to occur, especially in the case of structured transactions that could be expensive for funds to unwind. "The credit stress test is more of a disincentive to enter exotic and structured solutions," he explained. One banking official said he expected the FSA to iron out this uncertainty, but noted it would likely take a test case to highlight the problem.

 

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