EU rule to spur share sell-off Insurance companies will ultimately sell €500bn of equities as a result of the EU's Solvency II directive, with the money being pumped into debt markets many already view as over-heated, according to new analysis. The move will exacerbate worries about long-term demand for equities, given that pension funds are already cutting their holdings, and will contribute to the ongoing "structural shift" towards debt markets, squeezing corporate bond spreads further still. IN Regulation & Governance The rebalancing by insurance companies started in 2009 and is likely to continue until 2017, according to a fund flows model developed by Axa Investment Managers. Axa argued that the reallocation concluded to date may explain up to 25 per cent of the slide in equity prices from pre-crisis levels and caused spreads on corporate bonds to tighten by as much as 80 basis points. However it said the effect on European government bond yields has been negligible. The Solvency II rules stipulate the capital requirements insurers" must meet to hold various asset classes. It is widely seen as pushing them to diversify their portfolios away from equities in order to cut their capital requirements and reduce volatility. Corporate credit is becoming the "defensive asset of choice," thanks to its historically low volatility, and short-duration credit is favoured over longer duration paper, steepening the yield curve for corporate bonds. Sovereign debt is also in favour and interest rate and equity derivatives are increasingly being used to manage risk. Mathieu L'Hoir and Mathilde Sauve of Axa IM forecast that as the rebalancing unfolds over the next five years, Solvency II might reduce equity returns by 2 percentage points a year and squeeze corporate bond spreads by another 60 basis points. European government bonds should remain relatively immune to its effects, however. Axa IM's fund flow modelling suggests that Solvency II will reduce insurers" equity allocations from 15 per cent to 10 per cent, increase holdings of sovereign bonds from 32 to 34 per cent and lead to a jump in credit (primarily corporate) from 30 per cent to 33 per cent. Insurers account for about €9tn of the €20tn of European institutional assets.