The Pfandbrief 2011 | 2012

Quo vadis? The regulatory treatment of Pfandbriefe under Solvency II
In contrast, Pfandbriefe with a rating of AA or worse are treated in the same way as unsecured
debt. The capital requirement for 10-year Pfandbriefe increases to around 11% with a AA-rating,
to about 14% with an A-rating and to as high as ca. 25% with just a BBB-rating. The capital
requirement for Pfandbriefe without a recognised rating is approximately 29% (cf. figure 2).
For privileged risk weightings it can be assumed that investors will prefer Pfandbriefe and
other covered products to uncovered bonds.
As the approach for calculating the spread risk depends on the rating and on the modified
duration of a security, the capital requirement for fixed-income securities generally increases
for poorer ratings and longer maturities (see Illustration 2). Ignoring the diversification effects
resulting from the correlation assumptions made in the standard model, the capital requirement
for a AAA Pfandbrief designed as a zero-coupon bond increases from around 3% for
a five-year bond to more than 6% for 10-year bonds and finally to around 11% for 20-year
bonds. While the interest rate risk encourages life insurers in particular, with high durations
on the liabilities side, to increase the level of duration on their asset side, the spread risk offers
the opposite incentive.
Fig. 2:
Spread risk II
AAA AA A BBB BB B or lower unrated
40
Spread risk: Capital requirement as percentage of Pfandbrief on
market value basis
70%
60%
50%
40%
30%
20%
10%
0%
1 2 3 4 5 6 7 8 9 10 15 20 30 40 50
Maturity (years)
In contrast, government bonds from the European Economic Area (EEA) have thus far been
free from spread risk, regardless of their creditworthiness. There was no capital requirement
in QIS5 even for Greek and Portuguese government bonds, although both of these countries
have been hit by multiple ratings downgrades. In contrast to issuers of Public Pfandbriefe, this
regulation grants the countries of the EEA a privilege that is largely politically motivated. But
in view of the recent discussions regarding creditor participation (bail-in), credit and default
risks in highly-indebted Euro countries can no longer be basically disregarded. The proposed
introduction of collective action clauses underscores this argument.