01/02/2012 Author: Tony Griffiths

EU miscalculates Solvency II hedge fund risk, research says 

EU policy makers have massively overestimated the inherent risk of hedge funds as an asset class in its Solvency II insurance legislation, new research suggests.

An update of the EU’s capital solvency rules, the Solvency II Directive, due to come into force in 2014, requires European insurance companies with gross premiums exceeding €5bn to, among other stipulations, increase their capital holdings for certain asset classes.

Hedge fund investments are classed as among the most risky, with the directive imposing a capital charge equivalent to 49% of a firm’s total hedge fund holdings.

However, a study released this week, Solvency II: A unique opportunity for hedge fund strategies, from France’s EDHEC Business School, argues that “a solvency requirement of 49% does not reflect the risks inherent in hedge fund strategies.”

According to report author Mathieu Vaissie, a research associate with the EDHEC-Risk Institute and a senior portfolio manager at Lyxor Asset Management, realised risk for almost all strategies “is on average as much as 60% lower than the aforementioned 49% capital charge.” 

“Applying a pragmatic – though robust – internal model approach to a series of investable hedge fund indices over an observation period covering the recent crisis, we find that a stress test of no more than 25% is appropriate for a well-diversified hedge fund allocation,” Vaissie wrote.