In our excitement about the 25 October 2018 update from the Bank 1, we missed this wonderful speech by Sam Woods (deputy head of Hogwarts)
Sam says
In the area of equity-release mortgages (ERMs) we have consulted on measures to ensure that investments in that asset class, which is growing by more than 10% a year, are appropriately and consistently reflected in the regulatory balance sheet. We want to do this both for prudential reasons and to facilitate competition by establishing a level playing field. Our proposition is a simple one: house price growth above the risk-free rate is a risk to which ERM providers are exposed; it should not therefore be assumed and banked up-front as capital in the form of the Matching Adjustment, even if a reasonable person could expect house prices to increase in that way – instead, that benefit should be earned if and when the house price growth actually materialises. We have received many strong views in response to this suggestion, and are considering them now before reaching a final view.
This is quite a mouthful, so let’s take it apart.
First point, Sam felt that this issue is sufficiently important that he included it alongside the other important subjects in his speech. Wise move. Our guess is that he has had a belly full with all the lobbying from the firms on the one hand and Eumaeus and Leasehold Knowledge Partnership on the other.
Second point. ‘are appropriately and consistently reflected in the regulatory balance sheet’? Ah right, we want to treat assets and liabilities in a consistent manner. Yes! The implication is that there should be no Matching Adjustment.
But then he loses the plot. Point 3: ‘house price growth above the risk-free rate is a risk to which ERM providers are exposed’. How does he work that one out? Actually, ERM providers benefit if there is strong HPI and especially so if HPI exceeds risk-free. The correct statement is that ERM providers are exposed to house prices, but it is a fall in house prices that they should be worried about.
Fourth point. ‘…it [house price growth over risk free?] should not therefore be assumed and banked up-front as capital in the form of the Matching Adjustment’. Quite so, and if we take this statement to mean what the natural reading suggests, then Sam is condemning MA, or at least some of it. But why then does his colleague David Rule suggest in his July 2 letter to the industry that insurance firms with a pile of junk on their books are ‘not therefore exposed to changes in the market price of credit risk in the same way as other investors’? And why, as that letter also says, does the Bank of England support the Matching Adjustment framework?
So Sam says yay and Dave says nay.
Final point ‘We have received many strong views in response to this suggestion, and are considering them now before reaching a final view’. Real meaning: We have been lobbied in all different directions and wish we knew what to do.
It’s simple, Sam: just scrap the Matching Adjustment.