Bank of England plans tougher liquidity rules for insurers following ‘critical gaps’

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Large UK life insurers using complex financial instruments to manage business risks are to face more stringent liquidity reporting rules under proposals from the Bank of England.

The BoE’s Prudential Regulation Authority, which supervises UK insurers, wants to see the biggest firms using derivatives contracts report their liquidity positions more frequently and consistently, according to proposals published on Wednesday.

The move is a response to recent market stresses, such as the “dash for cash” during the Covid-19 pandemic in March 2020, and the so-called LDI shock following the UK’s mini-Budget in September 2022. The BoE said both events exposed “critical gaps” in insurers’ existing liquidity reporting requirements. During both events, insurers were exposed to significant net outflows to meet margin calls on derivative contracts.

The PRA said that during the LDI episode of 2022 — which triggered an emergency £65bn intervention by the Bank of England to stabilise the bond market — the regulator relied on quarterly data from insurers that was nearly three months out of date at the time of the shock. 

“Current regulatory returns do not give the PRA sufficiently detailed or regular information on the granular cash flows that form the basis of liquidity risk for large insurance firms,” said the PRA.

The rules the BoE is consulting on will see large insurers required to report monthly cash flows, liquid assets and the impact of changes in credit or market conditions. They will have to report some data daily in stressed conditions, under the proposals.

The new reporting requirements will only apply to insurers with assets of more than £20bn and holding derivatives contracts of £10bn or more.

Huw Evans, head of UK insurance at KPMG, said nine insurers would be impacted by the proposals, adding they were “a step change in the volume and frequency of liquidity reporting and these firms may need significant investment in systems, collateral and treasury management”.

The new rules come against the backdrop of greater scrutiny by global regulators of the use of complex financial instruments, such as derivatives, by financial groups beyond the banking sector.

The PRA’s proposals are part of a wider effort by global regulators to tackle the risk that widespread use of derivatives in many parts of the non-bank financial sector that could increase vulnerability to periods of market turbulence.

UK insurers are increasingly using derivatives and other financial instruments to manage various risks to their businesses. The gross notional derivatives exposure of UK life firms had more than doubled to £1.4tn since 2018, said the PRA.

“These instruments can be a significant source of liquidity risk because they can require firms to increase margin or collateral payments when market conditions change, resulting in rapid and substantial outflows,” said the PRA. “The impact on individual insurers can be material.”

The Financial Stability Board, which coordinates global regulation of the financial system, this week recommended several ways national authorities could tackle liquidity concerns, including requiring market participants to do stress tests of their derivative exposures.

The PRA said several other regulators already collect “additional and more granular information than the UK” on liquidity risks at insurers, including the US, France and Belgium. In 2022, the IMF suggested the UK could enhance its “supervisory reporting on liquidity, including flow data” in its oversight of insurers.

The extra disclosure requirements outlined on Wednesday would have an upfront cost of £11mn and £3.6mn of ongoing costs for the industry, the PRA said, but it added they would be worth it as UK life insurers currently disclose “no information on liquidity risk exposures”.

The PRA proposes the new rules to come into effect at the end of December 2025.

The Association of British Insurers, the sector trade body, said it recognised the importance of the PRA having up to date liquidity data.

“The ABI will make a detailed assessment of these [reporting] templates and provide our feedback to the PRA in due course.”