Earlier this month, the European Commission announced a change to the capital weightings that will apply to EU-regulated insurers holding long-term investments in European companies – including holdings in certain European private equity and venture capital funds.  This is a very welcome step, and an important victory for the European private equity industry associations after a lengthy campaign.  The change should herald a boost to private equity and venture capital funding.

By proposing to amend the Solvency II rules, which have provided the prudential and supervisory framework for EU-regulated insurers since 2016, the Commission has accepted that a risk weighting of 22% is more aligned with the risk profile of longer-term equity investments.  That is significantly lower than the 39% that has applied to many European private equity and venture capital funds in the past, and the 49% weighting that can apply to other holdings in private equity by default.  The hope is that insurers – who traditionally contribute less to private equity funds than pension funds and other long-term asset managers – will recognise that an allocation to diversified portfolios of equity holdings is an attractive way for them to deliver returns, whilst matching their liquidity requirements.

But the change is, of course, also driven by a policy objective to persuade more asset managers to make longer-term investments in Europe, and that policy objective means that the new capital weighting comes with some conditions.  As well as a requirement for a five-year holding period, there is also a need for a connection to the European Economic Area (EEA).  If an insurer adopts a “look through” approach, the holding period must be met at the level of the underlying company and the underlying unlisted equity holdings must relate to companies whose head office is in the EEA in order to qualify.  That would pose challenges.  If the insurer applies the criteria at the fund level (as it is specifically permitted to do), the conditions must be met at the level of the fund.  In that case, the holding period threshold will be easier to achieve, but it means that the fund itself must be an EEA-domiciled closed-ended fund, or qualify as a venture capital fund (EuVECA), a social entrepreneurship fund (EuSEF) or a long-term fund (ELTIF) under EU rules.  The only circumstances in which a non-EU fund could qualify would be if it had been marketed under the AIFMD’s third country passport – which does not yet exist.  (The fund also needs to be “unleveraged” in order to qualify, although short-term subscription line financing is not counted as leverage for this purpose.)

Any incentive to make EEA investments or to use EEA structures has particular significance in view of the UK’s (potentially) imminent departure from the EU.  From the date of departure (or, if there is a transitional period, from the end of any such period), it would seem likely that UK companies or structures will not qualify (unless, for example, the UK pivots towards a Norway-style long-term relationship with the EU).  That could be a particular issue for any UK funds which have traditionally sought capital from EU-based insurers.

On the other hand, if the UK proceeds to “onshore” European law in the way it currently intends, it is quite possible that UK-based insurance companies will only get a 22% preferential capital weighting if they invest in UK funds, or those with a UK-investment focus.  It hardly seems sensible for policy-makers to fight over capital in this way, given that funds which are more diversified are likely to be more attractive to all investors. But the obvious win-win solution may be a casualty of Brexit politics.