Solvency II reform could free up billions for investment, says EPRA

Expected changes to how insurance companies can spend their equity could potentially unleash billions worth of investments in the European listed real estate sector, according to Dominique Moerenhout, the head of the European Public Real Estate Association (EPRA).

Moerenhout, who has been leading the organisation for the past five years, says that the expected upcoming easing of restrictions to investment in listed real estate under the Solvency II regime is potentially a 'game changer' for the industry. Changes are likely to include the relaxation of a five-year minimum holding period for listed real estate to fully benefit from a reduced 22% capital requirement rate as well as the cancellation of a requirement to hold listed real estate investments in separate entities.

'European insurers are the largest institutional investors in Europe's financial markets. A minor change to the allocation of equity by the insurance industry could easily double the size of the European listed real estate sector,' Moerenhout told PropertyEU in an interview.  

Contrary to the US, where pension funds account for the bulk of institutional equity, in Europe the insurance sector represents €10.4 trn worth of assets compared to just about €4 trn for the pension fund industry. Hence, the preferential treatment of certain assets compared to others can have ‘phenomenal consequences’ in the equity markets, Moerenhout added. 'We have been lobbying to make investing into listed real estate on the part of European insurers easier since the start.’  
When Moerenhout took the helm at EPRA in 2017, European insurers operating under the Solvency II regime, were forced to hold cash equal to 39% of the value of their listed real estate investment. The regulation - designed to guarantee that insurers can meet their obligations to policyholders in the event of extreme market downturns - treated listed real estate as an equity investment. Unlisted real estate, on the other hand, required a capital charge of just 25%, in what at the time was seen as an 'unfair treatment' of the listed real estate sector. The different Solvency Capital Requirement (SCR) treatment potentially skewed allocations away from the listed asset class, to the benefit of unlisted property companies and funds.

As such, EPRA lobbied for an SCR reduction, arguing that the impact of stock volatility on the performance of listed real estate was ironed out over time and that over the long term it offered a similar risk and reward profile to unlisted property. The organisation advocated its views to both members of the European Commission as well as advisors to the European Insurance and Occupational Pensions Authority (EIOPA), asking to have the asset class treated equally across its main two forms, listed and unlisted. 'We proved that investing in listed real estate holds the same risks as investing in unlisted real estate. We also provided research confirming that listed real estate is essentially a bricks and mortar investment and not an equity investment,' Moerenhout explained.

In 2019 the EU Commission with EIOPA's recommendations created a new risk-submodule under which listed real estate would fall, i.e. long-term investments in equity. The regulation, which came into force in July 2019, applied a 22% capital charge for these types of equity portfolios - a major achievement for EPRA, one of the main organisations behind the changes. However, the equity portfolios that would in fact be eligible for the reduced capital charge were quite rare as the revisions also introduced a number of difficult criteria that should be met by insurers in order to benefit from the reduced SCR rate. The biggest constraint was a requirement to intend to keep the investment for at least five years.

Moerenhout: 'While this was a massive improvement compared to the past, it did not result in major changes to insurers' allocations to listed real estate. The main reason is that these technical constraints were still preventing massive investment into the sector.'  

Over the past two years, EPRA has been advocating a softening of the minimum holding period for listed real estate. Its efforts are expected to pay back over the course of this year. As of today, EPRA is expecting the restrictions to be removed through a delegated act by the end of the summer. Moerenhout: 'Once these restrictions are eliminated, we are expecting to see tremendous appetite for European listed real estate from insurance companies in Europe.' 


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