UK ILS regulations approved by Committee, but not without questions

A UK government cross-party parliamentary committee has just completed a meeting in which it approved the Risk Transformation Regulations 2017 and the Risk Transformation (Tax) Regulations 2017, which will make up the UK ILS regulatory regime, but not without pertinent questions from those attending.

In fact, listening in to the meeting of today’s Fifth Delegated Legislation Committee, it seems clear that the technical specifics of some of the laws surrounding ILS business are perhaps not fully understood by all those asked to approve them. But the committee had enough attending to get the regulations passed despite questions raised.

Questions were asked regarding the fact these regulations have been prioritised by the UK government at a time when it is facing an exit from the European Union, which many feel may become a so-called hard Brexit.

Ministers attending the committee meeting asked whether the enactment of the UK ILS regulations would actually provide significant benefit to the local insurance and reinsurance market, at a time when it faces issues of passporting and continuity of access to trade in Europe.

Other questions were asked regarding the tax treatment of these ILS vehicles and whether they could be used to aid in avoiding tax.

But committee members were told that the fact UK ILS vehicles will have to be approved before use by both the Financial Conduct Authority (FCA) and the Prudential Regulatory Authority (PRA) means that the rules cannot be used for the wrong reasons.

Also the fact ILS structures are fully collateralized, sufficiently to always pay their insurance or reinsurance obligations, means that the structures have to be used for their stated purpose only.

But the overarching mood among those assembled did seem to be that the ILS regulations position the UK and London insurance and reinsurance market to catch up on a segment of business that so far it has missed out on.

City Minister Steve Barclay explained that despite the importance of London as a reinsurance hub, the rapid growth of ILS has happened elsewhere, largely offshore.

So the process of developing a “fit for purpose” regulatory framework has been undertaken, with the goal of ensuring London can play a role as the ILS market grows, Barclay explained.

He said that the rules have been developed to ensure protection of both issuer and investors, while also ensuring transactions are ring-fenced within protected cell vehicles to ensure security and segregation of risks or assets from one transaction to another.

When Barclay explained that ILS investments should be for institutional investors, saying that it is “Wrong for retail investors to purchase them,” he received acknowledgement and agreement from the rest of the committee, signaling that this is clearly an issue that the law makers had been looking for comfort on and which the draft regulations have addressed.

It is “the right time for the UK to improve its offering to this market,” Barclay said, having explained that the ILS market has experienced impressive growth and that the UK now no longer has to miss out.

Jonathan Reynolds, the Shadow City Minister, said that he found it odd that the government is “taking this step to ensure the London market can compete globally, given the prospect of a hard Brexit.”

It was clear from some comments that certain committee members are sceptical that the ILS regulations will make the difference to the London reinsurance market’s success and importantly the countries tax take, at a time when it faces losing more business if a hard Brexit becomes a reality.

But ILS is not linked to Brexit and the development of the ILS market and issuance of insurance-linked securities (ILS) will continue apace, no matter what happens regarding the UK’s exit from the EU. So the committee appeared to see the benefits that could be gained by having the ILS regulations enacted as law.

Conservative Party MP Nigel Mills said that he “Welcomed the fact we’re trying to reform our regulatory and tax rules so this work can be done onshore in the UK,” adding that it “Has to be the right answer for our economy that this is done onshore.”

However he asked for assurance that the tax treatment of ILS vehicles will be tightly defined enough so that the structure cannot be used for tax evasion purposes.

Other MP’s questions how many jobs the ILS regulations would generate, or whether it will add to the countries tax take, both important issues to parliamentarians in the current climate. They also sought assurances that the regulatory regime would be strict enough to ensure that ILS in the UK can only be used to transact in insurance risk and not as a tax-free (or light) structure.

Barclay responded to the questions, saying that “Brexit makes it even more important to bring ILS onshore to bolster the UK’s re/insurance market.”

“This is the kind of global business that the UK should be dealing in,” Barclay explained, before going on to explain the safeguards that are naturally in place in ILS transactions and the regulatory oversight that will prevent the PCC vehicles use for tax avoidance.

At the end of the short committee meeting the attendees voted positively for the UK’s ILS regulations to be approved, paving the way for them to become law in the coming days.

So that seems to be it, the long road towards approval now completed for the UK’s ILS regulations. It’s going to be fascinating to watch them being put to work and we hope to see ILS style transactions taking place in the UK before long.

We still stand by our initial statement on this though, that the ILS regulations should be a catalyst for innovation for the UK reinsurance market.

While the chance to think bigger, and come up with regulations that offered something entirely new to ILS practitioners sadly did not happen. It’s still going to be a benefit to the sector to have more choice and it will be interesting to see what London market participants can do using the new regulatory framework.

Join us in New York in February 2018 for our next ILS conference