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China introduces collateral guidelines for offshore reinsurers to lower risk

China's insurance regulator has introduced new guidelines to lower risks posed by offshore reinsurers to the domestic sector with the establishment of a framework to offer collateral within the country.

In a March 13 notice, the China Insurance Regulatory Commission said domestic insurers may ask offshore reinsurance companies to provide collateral, such as bank deposits and standby letters of credit, in China.

"China's management of offshore foreign companies has been slack," Hu Xingdou, an economics professor at Beijing Institute of Technology, told S&P Global Market Intelligence. "It is hard to regulate them. So as a way to prevent risks, it is reasonable to ask for some collateral."

The collateral, especially in the form of bank deposits to be held at domestic Chinese banks, is also a way to prevent the outflow of capital from China, Hu said.

Collateral in the form of bank deposits have to be deposited in the ceding companies' accounts at domestic commercial banks, the CIRC said. The deposits should be fully controlled by the Chinese companies. Additionally, claims and payment under standby letters of credit should also be made in China as well.

Under China Risk Oriented Solvency System, or C-ROSS, which took effect in early 2016, Chinese insurance companies that cede premiums to offshore reinsurers face higher capital charges than when they do so with domestic names, resulting in lower solvency ratios. Additionally, ceding business to offshore reinsurers that have not deposited collateral leads to higher capital charges than doing so to foreign reinsurers with collateral within the country.

There were not too many Chinese insurers that had previously asked offshore reinsurance providers to offer collateral, said a senior manager with an international reinsurer in Hong Kong, who did not want to be named.

Offering collateral remains optional and is not mandatory for offshore reinsurers, the senior manager said, adding that the CIRC's latest notice simply provided more details and emphasized potential risks.

The senior manager at an international reinsurer said the company will wait and see if there are further rules to be unveiled that will impact its business.

Further, some Chinese insurers have solvency ratios that are much higher than regulatory requirements, so ceding premiums to offshore companies without collateral would not dramatically affect their solvency ratios, the Hong Kong-based senior manager said.

Before the most recent notice, reinsurers that had sufficient capital and carried credit ratings that met CIRC requirements were allowed to do business with Chinese insurance companies, said Jonathan Zhao, Hong Kong-based managing partner and Asia-Pacific insurance leader at EY. Now, credit ratings are no longer the sole determinant of whether a Chinese insurer can conduct business with offshore firms.

The Chinese regulator had previously decreed that the primary receiver of Chinese insurers' reinsurance business should have at least an A- rating from S&P Global Ratings, A.M. Best and Fitch Ratings, and an A3 rating from Moody's.

China's reinsurance sector is currently dominated by a single Chinese name, China Reinsurance (Group) Corp., which took up about one-third of the market as of August 2016, according to figures reported by the Securities Times. The rest of the market is split roughly down the middle between foreign reinsurers' Chinese branches, including Taiping Reinsurance (China) Co. Ltd., and approximately 200 offshore reinsurance firms.

Meanwhile, two more domestic reinsurers, Qianhai Reinsurance and PICC Reinsurance, began operations in 2017, following on the heels of the government's call to develop the reinsurance sector.

S&P Global Ratings and S&P Global Market Intelligence are owned by S&P Global Inc.