Turning to direct investments, let me be clear that the PRA supports sensible diversification of portfolios backing annuities into assets such as infrastructure finance, commercial real estate lending and equity release. However, we expect insurers to do this properly. That includes:  6  https://www.bankofengland.co.uk/prudential-regulation/letter/2018/solvency-2-risk-margin  6  All speeches are available online at www.bankofengland.co.uk/publications/Pages/speeches/default.aspx  6  1. Having a strategy and risk appetite. Insurers need a disciplined approach. To put it flippantly, they should not be buying whatever is on the market this week or simply because they see their competitors buying those assets. The risks from direct investments are different to bonds. This is especially true if insurers originate their own Matching Adjustment assets: for example, by financing property development. Boards need to set clear risk appetites that capture all material risks at a suitable level of granularity, translating into a set of limits. 2. Building the right capabilities. Some insurers do investment in-house and others outsource. All insurers need people with sufficient market knowledge in all three lines of defence. That includes underwriting, risk management and potentially work out. 3. Developing appropriate management information, including for the board. 4. Appropriate valuations, internal ratings, and Matching Adjustment and Solvency Capital Requirement calculations. On this final point, we have provided considerable guidance on our expectations in Supervisory Statement 3/17 (SS3/17), particularly in relation to restructured equity release mortgage portfolios. One thing that has become clear to me is the importance of internal ratings.

For example, in the securitisation market, originators need a two-layer structure to create pan-European transactions backed by well diversified multi-jurisdictional asset portfolios: first, assets must be securitised at the domestic level, and then, a pan-European vehicle backed by several domestic securitisation transactions must be set up. This is a complex procedure and incurs costs. I now turn to an important retail market, namely the mortgage credit market which represents in the EU an outstanding volume of around EUR 4 trillion. The lack of integration manifests itself here in numerous ways. In no national market can borrowers access the full range of mortgage products. Moreover, only a negligible portion of European mortgage credit is granted across borders, and the techniques for loan origination and servicing differ substantially from country to country. More than half of mortgage lending is still financed by retail deposits, although in recent years capital market instruments, such as covered bonds and residential mortgage backed securities, have gained in importance. These are important asset categories that can also be used as collateral in the Eurosystem’s monetary policy operations. Nevertheless, they still exhibit a high degree of heterogeneity across countries due to differences in their legal, tax and regulatory framework. BIS Review 18/2005  3  Given the size of the mortgage credit market, the costs incurred through the lack of integration cannot be ignored.