5  https://www.bankofengland.co.uk/-/media/boe/files/prudential-regulation/supervisory-statement/2020/ss120.pdf https://www.bankofengland.co.uk/-/media/boe/files/prudential-regulation/supervisory-statement/2018/ss818.pdf https://www.bankofengland.co.uk/speech/2021/march/sam-woods-association-of-british-insurers-executives-neds-and-chairs-networkwebinar 6 7  5  All speeches are available online at www.bankofengland.co.uk/news/speeches and @BoE_PressOffice  5  The current calibration of the FS has three components for investment grade assets: the probability of default, the cost of downgrades, and a floor based on long term average spreads (the LTAS floor). For sub-investment grade assets a fourth component limits the MA on such assets to that of an investment grade corporate bond. The components of the FS are based on historic averages to varying degrees, notably the LTAS floor which is 35% of the average spread over the previous 30 years. What often surprises is the extent to which the LTAS floor actually bites, for example in Chart 8 we show the components of the FS for non-financial BBB corporate bonds, which highlights that the LTAS floor is often biting. The LTAS floor is, as the name says, a long term average. Accordingly it is relatively unresponsive to changes in market spreads, and this is a key reason for the FS being slow to respond to market signals. Implementation issues Moving from FS components to firms’ implementation: to know what FS to apply, firms are required to determine two parameters; the credit quality step (CQS) and the fundamental spread sector. Firstly, the CQS. For many assets in MA Portfolios the CQS can be mapped by looking at the rating assigned by an External Credit Assessment Institution (ECAI).

As I said earlier, MA portfolios already include many types of debt instrument, and where assets are not MA eligible firms may consider – if appropriate – holding them outside the MA portfolio to back other liabilities. And the PRA has taken, as far as possible, a pragmatic approach to fixity – for example for floating rate bonds and for assets with inadequate modified Spens clauses. Over 2020, we saw very few applications for asset classes not already held in peer MA portfolios, instead seeing firms applying to invest in less liquid asset classes such as ground rents and ERMs. While the asset classes may not be new to us, firms can expect to be challenged when investing in asset classes that are new to them. We have published supervisory expectations in Supervisory Statement 1/20 “Solvency II: Prudent Person Principle”5 and Supervisory Statement 8/18: “Solvency II: Internal models – modelling of the matching adjustment”6. These cover risk management aspects including the consistency of investments with the prudent person principle, the ability to manage the assets – including in stress or in default – and the ability to model the solvency capital requirement appropriately. Next I would like to touch on the future direction for new asset classes in MA portfolios. As Sam Woods, the Deputy Governor for Prudential Regulation, and PRA’s Chief Executive said in his March speech7 at the ABI, we are wary of calls to encourage specific forms of investment with prudential regulatory incentives.