Solvency Assessment and Management:
Steering Committee
Errata to Position Paper 1051 (v 3)
Market Risk SCR – Structure and Correlations
ERRATA
Currently, Final Position Paper 105 (FPP105) recommends that where an instrument such as
preference shares predominantly behaves similar to an equity it should be treated as "Other Equity".
The following is quoted from section 7 (the recommendation to be used in secondary legislation):
"The characteristics of investment instruments need to be considered when deciding on which market
risk charges apply. For instance, commodities could be considered as similar to equities and therefore
treated as “Other Equity”, while many preference shares exhibit properties more akin to interest rate
risky assets in which case they should be treated within the interest rate and spread risk modules.
Both of the above instruments should also form part of the concentration risk calculation. They should
also form part of the currency risk calculation where relevant. Where instruments exhibit both the
traits of equity and interest-rate risky assets, they should be treated as “ Other Equity” ."
This treatment can potentially lead to, for example, a preference share on a local equity attracting a
higher stress than the local equity itself, which is counterintuitive.
In the most recent Solvency II specifications the following text was used:
“Where it is not possible to consider the asset as the composite of separate components then the
determination of which of the standard formula risk sub-modules apply should be based on whichever
of the fixed income or equity characteristics is predominant in an economic sense"
This definition, if it replaces the sentence above in bold, would enable a more appropriate treatment of
hybrid instruments such as preference shares.
Without being prescriptive, and leaving the treatment of such instruments up to judgement, an
example of an appropriate treatment could then be:





if the instrument cannot be split in an interest rate and equity component, and
the equity characteristics are predominant in an economic sense
then the equity module should be applied instead of the interest rate module, where
the equity sub-module (global / SA / Other) should be determined based on the economic equity
exposure of the instrument
E.g. if a preference share will convert
o into a listed share on the JSE, then the SA Equity sub-module should apply
o into an unlisted SA share, then the Other Equity sub-module should apply
1
Errata to Position Paper 105 (v 3) was approved as a FINAL Position Paper by the SAM
Steering Committee on 30 June 2015.
Solvency Assessment and Management: Steering Committee
Errata to Position Paper 105 (v 3) – Market Risk SCR – Structure and Correlations
The capital requirements task group believe, taking into consideration industry feedback received that
the following principles need to be considered/adhered to:
1. The best approach is to consider assets as the composite of separate components
2. Only if this is not possible and there is a single market risk that is clearly and by far the most
predominant risk can the asset be allocated to a particular single risk module
3. Where the asset contains a mixture of market risks and if it cannot be considered as separate
components, then should be allocated to the “Other Equity” category
Therefore, it is recommended that the sentence
"Where instruments exhibit both the traits of equity and interest-rate risky assets, they should
be treated as “ Other Equity”."
be replaced by:
“Where it is not possible to consider the asset as the composite of separate components and
where the asset predominantly exhibits a single market risk characteristic, then the
determination of which of the standard formula risk sub-modules apply should be based on
that predominant market risk in an economic sense. Any leverage within such an asset should
be treated appropriately, by stressing the underlying risk factor in the valuation and not simply
the market value of the asset. Where it is not possible to consider the asset as the composite
of separate components and the asset exhibits a number of different market risks without a
single risk being the predominant trait, the asset should be included in the “Other Equity” submodule.
"
in the “Recommendation” section 7 of FPP105.
Page 2 of 2