New rules to curb Taiwan insurer bond ETF investing

Taiwan insurers have had a growing appetite for bond exchange-traded funds (ETFs), courtesy of a quirk in local rules, but the island’s financial regulator has imposed a higher risk charge on the assets to reduce this hunger.

Taiwanese insurers investing into bond ETFs that track an overseas index will  find their allocations subject to a 6.61% foreign currency risk charge, the Financial Supervisory Commission (FSC) said last week. 

That comes on top of risk charges of 6.33% and 8.35% apiece for bond ETFs that track overseas developed markets and emerging markets, meaning insurers would face total risk charges of 12.94% and 14.96%, respectively. In comparison, bond ETFs that are denominated in Taiwanese dollars with domestic underlying assets would have a risk charge of 8.1%.

The change in capital charges are part of an effort to close an effective loophole in Taiwan’s asset rules. Insurers can invest up to 62.25% of their assets in foreign instruments, but Taiwanese dollar-denominated ETFs with foreign bonds as their underlying are currently considered to be domestic assets, even though most invest in US dollar debt.  

In substance, however, these ETFs are subject to foreign currency risks, Serene Hsieh, director for financial services ratings at S&P Global Ratings, told AsianInvestor.

The change to capital rules is part of the FSC’s efforts to discourage insurers from making unlimited foreign currency investments. Insurers have invested heavily into bond ETFs since 2018, and they did so even more aggressively after the regulator lumped Formosa bonds (foreign currency bonds issued by Taiwanese divisions of international companies) into insurers' overseas investments under new rules in November 2018. 

Cathay Life, the largest life in Taiwan, now invests about 5% of its investable assets in bond ETFs. That allocation is a fivefold increase on the start of the year, when the insurer said fixed-income ETFs accounted for 1% of assets. The scale of outstanding bond ETFs has grown rapidly to reach NT$1.1 trillion ($35.9 billion) as of September, and insurers are believed to be the main investors in the debt.

The FSC revises the risk factors applied to bond ETFs to curb excessive exposure to these assets. The foreign exchange risks of the instruments are not fully reflected under insurers’ current risk-base capital (RBC) regime, Chang Chuang-chang, vice chairman of the FSC said in an interview with AsianInvestor last month. 

OTHER RULES

Besides stipulating the new 6.61% foreign currency risk charge for bond ETFs, the FSC also provided more granular details about the risk charges for exchange traded notes (ETNs) and other types of ETFs, such as those that track a futures index and real estate index, in the same announcement (see table below).

The foreign currency risk charge will also apply to any of these instruments that have underlying overseas assets.

Moreover, the FSC intends to limit insurers’ investments in other domestic insurers by revising the calculation method for capital adequacy ratio, in order to reduce the systemic risks in the insurance industry.

When an insurer invests in the subordinated debentures or preferred shares of another insurer or financial holding companies, the investments should be removed from the insurer’s own capital, which will in turn lower its capital adequacy ratio, Hsieh explained.

The local regulator has made consistent efforts to ensure insurers have adequate capital buffer to face the changing conditions in the capital market and other challenges like the adoption of International Financial Reporting Standards 17 in 2025. Hsieh said the FSC’s first priority with the changes has been to ensure the stability of Taiwan’s financial system.