Question ID: 2323
Regulation Reference: (EU) No 2015/35 - supplementing Dir 2009/138/EC - taking up & pursuit of the business of Insurance and Reinsurance (SII)
Topic: Solvency Capital Requirement (SCR)
Article: 179(1)
Status: Final
Date of submission: 05 Aug 2021
Question
Our question concerns the calculation of spread risk on credit derivatives, especially CDS. Article 179 (1) states, that the capital requirement equals the loss in the BOF resulting from an increase/decrease in absolute terms of the credit spread of the insruments underlying the credit derivatives. Looking at CDS, pricing is not always directly linked to the spreads of underlying instruments. Although there might be one or several "reference entity obligations" which indicate the pricing of the CDS, the spread of the CDS and the spreads of the reference entity obligations may develop in different ways. When there is no specific single underlying, is it okay to apply the spread widining/tightening to the Spread of the CDS itself or do you propose a different approach?
EIOPA answer
The starting point are the debt instruments which the CDS references (i.e. the “instruments underlying the credit derivative").
In order to determine the spread risk SCRcd, the effect of the instantaneous increase/decrease of the credit spread for the underlying instruments on the value of the CDS determined in accordance with Article 75 Solvency II has to be calculated.
If it can be shown to give the same result as applying the spread widening/tightening to the underlying instruments the described approach to apply the spread widening/tightening to the Spread of the CDS is in line with the requirement of Article 179(1).