The Securities and Exchange Commission of Pakistan (SECP) has proposed the issuance of subordinated debt by insurance companies to significantly support the development of the corporate debt market of Pakistan.
According to a document of the SECP on “subordinated debt securities,” the subordinated debt as a new instrument would attract a broader range of investors.
The SECP said that investing in insurance subordinated debt is an interesting opportunity because it allows the possibility to invest in a sector that has some external supervision, which is not the case for most non-financial corporates. Additionally, subordinated debt’s distinct risk profile offers investors more options, contributing to a more mature market. This also encourages conservative investors to participate, providing a crucial risk buffer. Moreover, the pricing of subordinated debt sets a benchmark for riskier assets, establishing clearer pricing standards for various debt instruments.
It is important to note that the specific investors in subordinated debt can vary depending on the issuer, the terms of the security, the prevailing interest rates, and market conditions. Additionally, regulatory requirements and investor preferences can influence the composition of investors in subordinated debt of banks and insurers
At present, insurance companies in Pakistan are not involved in the issuance of debt securities, especially subordinated debt securities, one potential reason is the lack of benefits in the existing solvency regime. The proposed subordinated debt framework has been thoughtfully designed to offer insurance companies several advantages, including the ability to maintain solvency margins, engage in cost-effective capital raising, enhance creditworthiness, and provide the capacity to absorb risks during financial stress.
Moreover, the issuance of subordinated debt by insurance companies has the potential to play a pivotal role in the growth of the corporate debt market in Pakistan, with insurance companies emerging as new players in the domain of debt instrument issuance, SECP said.
The SECP stated that the issuance of subordinated debt securities represents a strategic financial move that empowers insurance companies to enhance their financial standing and actively pursue growth opportunities while adeptly managing risks as well as the applicable solvency requirements. Issuance of subordinated debt can play a pivotal role in elevating the overall stability and competitiveness of insurance entities in the market.
Under the current solvency requirements applicable to insurers in Pakistan, no allowance and/or benefit is available against any subordinated debt issued by an insurer. This may be one reason why insurance companies have not ventured into the issuance of subordinated debt, since it would be considered as a normal debt liability and no benefit is allowed, in respect of its subordination and loss-absorbing capacity, in maintaining required solvency margins.
The issuance of subordinated debt by insurance companies can bring about financial stability, enhance their risk management capabilities, and provide insurance companies with an alternative source of capital, whilst focusing on meeting solvency requirements effectively. Further, the SECP aims to propose a regulatory way forward to allow insurance companies to leverage the subordinated debt to meet their solvency requirements effectively.
The universe of international subordinated financial debt is growing and now has a market cap in excess of $1 trillion split between banks ($700 billion), insurance ($250 billion), and corporates ($120 billion). As of March 31, 2022, insurance companies operating in India had raised a total of INR 9,345 crores (life insurers: INR 4,194 crores; Non-Life and Health: INR 5,151 crores) as other forms of capital i.e. including subordinated debt and preference shares.
The SECP is of the view that in line with the prevalent practices in international jurisdictions as well as the guidance available in the ICPs of IAIS, the insurance industry in Pakistan should also reap the benefits of having subordinated debt in the computation of solvency.
Source: Pro Pakistani