VOSTF Updates from February 18 Meeting

The Valuation of Securities Task Force (VOSTF) of the NAIC held a conference call February 18, 2021. The following updates are from that meeting.

Exposed Items with comment period ended March 20, 2021

Receive a Proposed Amendment to the Purposes and Procedures Manual of the NAIC Investment Analysis Office (P&P Manual) to Update the Financial Modeling Instructions for RMBS/CMBS Securities and Direct IAO Staff to Produce NAIC Designation and NAIC Designations Categories for Non-Legacy Securities

The IAO recommended that the NAIC move to a single NAIC designation and designation category for all non-Legacy Securities that are financially modeled residential mortgage-backed securities (RMBS)/commercial mortgage-backed securities (CMBS) closed on or after January 1, 2013.  This is in response to feedback from the American Council of Life Insurers (ACLI), which noted that “the mechanics of the price break points was causing insurer owned securities with otherwise strong credit to be reported as NAIC 2, NAIC 3 or NAIC 4 under the financial modeling price breakpoints process purely because they are owned at a premium and not because of their credit risk.”

It proposes to stop zero loss securities from automatically getting NAIC Designation Category 1.D.  Eric Kolchinsky, Structured Securities Group (SSG) Director, said zero-loss was supposed to be a temporary solution.  The 2020 year-end financial modeling identified some securities that no longer qualified as being zero-loss because more conservative scenarios were applied to reflect the economic impact of the pandemic.  It proposes to modify the existing SVO administrative symbol “FM” will be used to identify legacy security that will use breakpoint price to determine a NAIC Designation Category and add a new SVO administrative symbol “FS” to indicate a non-legacy security will get assigned a single Designation Category by the SSG.

As there is potential impact to SSAP No. 43R, SVO staff recommends a referral to the Statutory Accounting Principles (E) Working Group (SAPWG).

The recommendation included proposed revisions to the P&P Manual to incorporate the change.

Discuss Comments Received and Consider for Adoption a Proposed Amendment to the Purposes and Procedures Manual of the NAIC Investment Analysis Office (P&P Manual) to Require the Filing of Private Rating Letter Rationale Report

In February 2020, the VOSTF asked the SVO to make incremental recommendations to address bespoke securities and their overreliance on CRP ratings to assess investment risk and for regulatory purposes.

Subsequently, on October 23, 2020, the Financial Condition (E) Committee asked VOSTF to “implement policies to oversee the NAIC’s staff administration of rating agency ratings used in NAIC processes, including, staff’s discretion over the applicability of their use in its administration of Filing Exemption.”

In response, the SVO took initial steps toward the implementation of some of its recommendations. The first has to do with oversight of PL securities.

The SVO proposed changes to Parts One and Three of the P&P Manual to “permit the SVO to review all PL securities whether processed through a feed or submitted directly to the SVO and would require insurance company filers to provide private rating letter rationale reports for each private rating letter.”

The proposed effective date is January 1, 2022.

It is re-exposed for 30 days with comment period ended March 20, 2021.

Receive a Proposed Amendment to the Purposes and Procedures Manual of the NAIC Investment Analysis Office (P&P Manual) to Update the List of NAIC Credit Rating Providers to Reflect NRSRO Changes

In July 2019, Morningstar acquired DBRS, and together became the fourth-largest credit ratings agency, now called DBRS Morningstar.

In response, the SVO recommended a non-substantive amendment to remove references to the old entity, remove the rating symbols from the mapping tables, and add new references to DBRS Morningstar.

Discussed Items

Receive Referral from the Statutory Accounting Principles (E) Working Group on Non-Conforming Credit Tenant Loans

On November 12, 2020, the SAPWG discussed 2020-24: Accounting and Reporting of Credit Tenant Loans, deciding that CTLs will remain within the scope of SSAP No. 43R—Loan-Backed and Structured Securities and reported on Schedule D-1. On December 28, the SAPWG provided a limited-time provision to permit non-conforming CTLs for D-1 reporting if they are filed with the SVO by February 15, 2021. It is required to disclose in Note 1 as a permitted practice if the reporting entities have not received an SVO assigned designation.

The SAPWG requested VOSTF to provide comments:

• If it is appropriate to revisit the 5% residual asset risk threshold as a requirement for conforming CTLs;
• The recommended residual risk threshold if applicable;
• A list of mitigating factors for CTLs that exceed the 5% residual risk threshold;
• Provide the outstanding principal of nonconforming CTLs that were filed with the SVO in accordance with the direction of SAPWG Interpretation INT 20-10 and NAIC designation category assigned by the SVO;
• Provide number of CTLs that originally exceeded the residual risk threshold but were later considered as “conforming” due to mitigating factors; and the nature of those factors (i.e. a residual risk insurance policy).

Discuss U.S. Securities Exchange Commission (SEC) Rule 18f-4 Under the Investment Company Act of 1940 Related to the Use of Derivatives by Registered Investment Companies

Marc Perlman, NAIC Investment Counsel, provided an update on the SEC-proposed change on derivatives use by Exchange Traded Fund (ETF) in July 2020. The SEC adopted the final version of rule 18f in October 2020. This rule provides an exception from the derivatives risk management program requirement and the VaR-based limit on fund leverage risk for a fund that either limits its derivatives exposure to 10% of its net assets or uses derivatives transactions solely to hedge certain currency risks. This program will be administered by a derivative risk manager, and a new position will be approved by the board of directors.

The SVO will determine if the ETF’s cash flows are fixed income-like or not.  As most of the ETFs on SVO Identified Bond or Preferred Stock ETF should predominantly hold bonds or preferred stock respectively pursuant to the P&P Manual, they likely fall under the exception for limited uses of derivatives and may not need to comply with all requirements of this rule.

The SVO will draft an exposed item prior to the next VOSTF meeting on March 22, 2021