Prudential Regulation Authority Rulebook

5.1

This chapter does not apply to firms’ investments in assets covering TPs for linked long-term contracts of insurance, except where the assets are held to cover the additional TPs in respect of policyholder liabilities, including those for any guarantee of investment performance or other guaranteed benefit provided under those contracts.

5.2

Investments in non-traded assets can be an appropriate match for insurance liabilities, particularly annuities or Periodic Payment Order liabilities (PPOs), but they can also give rise to additional risks. For example, they can be difficult to value in the absence of regular market pricing and to sell in a timely manner, particularly under stressed market conditions.

5.3

 In addition to the factors set out in paragraph 3.14 of this SS, the PRA also expects that, prior to investing in a non-traded asset, when determining any internal investment limit, and as part of ongoing practice, firms will also consider and assess matters including the following:

• the appropriateness and robustness of the valuation methodology under a suitable range of operating conditions;
• in the case of internally-rated assets, the robustness, capability and maturity of the internal rating framework;
• if using an internal model, the ability to justify and reconcile any material differences between how investment risk is assessed for capital purposes and when applying the standards of the PPP; and
• the materiality of any embedded optionality, how this may change over time and under stress, and how any change will affect the risk profile of the asset.

5.4

Non-traded assets will often be more complex than those traded on a regulated exchange and as a result often expose firms to additional risk. The PRA expects that for the purpose of identifying the risks arising from these investments (in line with Investments 2.1(1)), firms will take particular care to consider both the systemic and idiosyncratic risks arising from the features of each investment.

5.5

Non-traded assets are often bought and sold both less frequently and in less deep, liquid and transparent markets than traded assets. Therefore, there is often relatively little credible historical pricing data that can be used to measure the risks they introduce as required under Investments 2.1(1). Firms with historical records for their own non-traded assets are unlikely to have access to historical data relating to the market as a whole. It is therefore important for firms to undertake a fundamental analysis of the underlying risks on their non-traded assets.

5.6

The PRA expects that the level of expertise of key persons (including investment managers) and the robustness of risk management systems and controls would increase commensurate with any increases in the scale, complexity or concentration of investments in non-traded assets.

5.7

The PRA reminds firms of its expectations relating to liquidity risk arising from investment in non-traded assets, as set out in SS5/19.

5.8

Conditions Governing Business 3.4 requires firms to demonstrate compliance with the Investments Part of the PRA Rulebook. For this purpose, firms investing in non-traded assets should at a minimum be able to demonstrate that:

• key persons have sufficient experience and expertise to be able to understand and manage the risks involved in the assets held and challenge decisions;
• the suitability of an investment to match the firm’s liabilities has been assessed in the light of suitably severe stress scenarios projected over suitably long horizons. The PRA would not expect an investment to be suitable if under such stress scenarios it resulted in a material deterioration in the firm’s solvency or liquidity position;
• investments in ‘assets not admitted to trading on a regulated financial market’ are kept at ‘prudent levels’ in accordance with Investments 5.2(2), on an objective basis from the standpoint of the hypothetical prudent person in similar circumstances; and
• the firm’s internal investment limits (in accordance with the guidance set out in Chapter 3 of this SS) are adequate to ensure that such investments are kept to such prudent levels.