UK drafts beginnings of ILS framework, starts with transformers

The UK government has begun to put in place the legal framework for facilitating insurance-linked securities (ILS) and collateralised reinsurance business, beginning with amendments to a financial services bill to allow a transformer vehicle to be established.

The amendments to the Bank of England and Financial Services Bill, which would allow an addition to the Financial Services and Markets Act 2000 giving the government and the HM Treasury the ability to enact legislation to create this framework for transformer companies.

The proposed transformer company would feature a protected cell type structure, with different parts of the transformer vehicle allowed to be legally segregated and to be separate from the overall vehicle.

The amendments explain:

Transformer vehicles

(1) In this section “transformer vehicle” means an undertaking (“A”) which—

(a) is established for the purposes of carrying on the activities mentioned in subsection (2), or

(b) carries on those activities.

(2) The activities referred to in subsection (1) are—

(a) assuming risk from another undertaking (“B”), and

(b) fully funding A’s exposure to that risk by issuing investments where the repayment rights of the investors are subordinated to A’s obligations to B in respect of the risk.

The powers the government would give through the amendments would allow the HM Treasury to “make provision for facilitating, and provision for regulating” the establishment and operations of transformer vehicles, the activities (mentioned above in 2) and enable the trading of investments issued by transformers to be undertaken and regulated.

Transformers would be able to consist of multiple parts under the legislation if adopted, the segregated or protected cell type concept, with each part able to have a distinct legal personality from the transformer.

The amendment also includes a mention of Lloyd’s of London and implies that Lloyd’s would have a role in oversight, of some kind, to these transformers. That perhaps suggests that these vehicles would be possible to establish specifically to access risks from the Lloyd’s market and transform them to ILS investors.

The amendment explains that the regulation, if passed would:

Authorise the FCA or the PRA to require the Council of Lloyd’s to exercise functions on its behalf (including functions conferred otherwise than by the regulations)

That is interesting, as for Lloyd’s to have some form of oversight certainly implies that these transformers would be able to access risks from within that marketplace, or help ILS managers and investors to transform the risks out to their funds, an intriguing prospect we’re sure.

The Lloyd’s insurance and reinsurance market has been part of the process to look into what London would need to become a hub for ILS business, through the London Market Group (LMG) and this transformer and the amendments mention of Lloyd’s aligns with information released to date.

By providing the UK government with the means to regulate ILS activity and by starting with a specific transformer vehicle, with legal separation within and between entities and a clear role for Lloyd’s suggesting potential for investors to access risk via that marketplace using the transformer, the UK has followed up on its goals to target collateralised reinsurance, over catastrophe bonds.

No doubt SPI type legislation will follow in good time, but this first draft amendment appears focused on efficient marshaling of risk to capital, leveraging the benefits of a cell type structure legal separation, with transformation of risk to investment assets and (maybe) access to Lloyd’s.

Of course this draft amendment, which will go back in front of a House of Lord’s committee on the 11th November this week, is necessarily broad and would allow the government plenty of leeway to adjust the final legal structures.

It’s another interesting step on the road towards welcoming ILS and collateralised reinsurance business to London, and maybe to Lloyd’s, although it should be noted that hurdles remain around the tax issue and other regulatory details.

While bringing the ability to transact and invest in ILS business to London is no easy task, this does suggest that the work being undertaken is being performed with innovation in mind which is key.

Also read:

– London LMG looks to innovate on equal reinsurance credit for ILS.

– Attracting ILS & cat bonds will be challenging for London: Report.

– London re/insurance market needs true innovation: DAC Beachcroft.

– Collateralised reinsurance focus for London (LMG) ILS task force.

– London has to fight its corner on ILS: Michael Wade, Cabinet Office.

– London ILS task force participants revealed, holds first meeting.