As the UK government continues to develop and advance its ambition of turning London into a global hub for insurance-linked securities (ILS) business, international law firms have highlighted some uncertainties and potential shortcomings of the new guidelines.
The establishment of an ILS hub in the United Kingdom has the potential to expand the reach and influence of the ILS marketplace, while increasing the relevance and position of London as a global hub for insurance and reinsurance business.
Fist discussed in March 2015, the UK Treasury has now published its draft proposals for the framework, with the UK’s financial regulators, the Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA), also consulting on the authorisation and supervision of insurance special purpose vehicles (ISPVs), in relation to ILS business.
Shortly after the announcement from the UK government, which was part of its Autumn 2016 statement, Artemis discussed how law firm Simmons & Simmons had said that the UK regulator would need to ensure speed to market that is comparable with other ILS domiciles, if it’s going to compete with such jurisdictions.
But it seems that speed to market isn’t the only potential shortcoming of the new draft regulations and, while it’s certainly a step in the right direction there is likely more fine-tuning to be done to ensure the UK’s ILS targets are successful.
Simmons & Simmons describes the current proposal that ISPVs be disqualified from UK tax exemption should there be a corporation tax compliance failure, such as delays or errors in filing tax returns, as “particularly draconian.” And stressed that it hopes “this measure is dropped or watered down following consultation responses.”
During its announcement the UK government also explained that for the time being at least, the introduction of UK protected cell companies (PCC) will be exclusively for ISPVs and not utilised more generally, which Simmons & Simmons feels is an unfortunate outcome.
Simmons & Simmons also highlights the proposal that any ISPV meets Solvency II requirements, and is fully funded; a topic also discussed by global law firm Clifford Chance in a recent briefing on the UK ILS draft regulations.
“Some of the concepts in the Solvency II Delegated Act (including at ‘all times’, ‘fully paid in’ and eligible assets) are ill defined and could create uncertainty which would be unhelpful to the development of the ILS market in the UK,” said Clifford Chance.
The firm continues to explain that it had hoped that discussion between the UK Treasury and the London Market Group (LMG) combined with the PRA Supervisory Statement would provide clarity on the interpretation of certain Solvency II requirements.
“However, the PRA’s Supervisory Statement still leaves room for uncertainty in respect of assets that can be counted towards ‘fully funded’ – particularly around the way in which contingent assets are treated. In addition, the draft Statement says that, for the purposes of authorisation, limited recourse clauses will be “irrelevant to their initial assessment of whether the ISPV is fully funded.” The PRA’s final position on this may be critical to the success (or not) of the UK ILS offering,” explained Clifford Chance.
Further discussing potential challenges with Solvency II requirements and ISPVs, Simmons & Simmons explains that “proposals surrounding the senior insurance managers regime and the directors duties may be unnecessarily cumbersome for these single transaction vehicles, and applying Solvency II may simply be overkill.”
Another potential shortcoming highlighted by Simmons & Simmons relates to the proposed transformer vehicles failing to live up to their billing, “whereas it is possible for a transformer vehicle to undertake a single ILS transaction, without needing to be a PCC, there is no proposal in the legislation as currently drafted which might enable that original transformer vehicle to be itself “transformed” into a PCC.”
This, says Simmons & Simmons, would encourage early adoption of the draft proposals and support the facilitation of successful initial vehicles to become PCCs, making multiple issuances of ILS solutions.
A number of other law firms have commented on the proposal from the UK government and the ongoing consultations between the regulators, with the majority stressing a need for innovation and changes to both legal aspects and regulatory issues.
This was highlighted by Nick Bradley of law firm Pinsent Masons, in a recent article on Out-Law.com. “The ILS market has grown over the last decade or so such that it has now become an important part of the established reinsurance market, for catastrophe risks and, on the life side, mortality and morbidity risk. For London to retain its place as a global hub for reinsurance it is vital that it has the elbow room within the regulatory and tax regime to innovate.
“It will be exciting to see the UK, and London in particular, take its place in this market. The Treasury, the Bank of England and the regulators deserve credit for recognizing the opportunity, and hopefully this exciting initiative will enable UK PLC to put in place an effective regime which is both attractive to investors and reinsurers,” said Bradley.
Of course, the fact there are some potential shortcomings in the draft ILS regulations is not surprising, but it does highlight the importance that the ILS market provides feedback to help make the regulations as robust and innovative as possible by the time they pass, which as we wrote is expected to be in the first-half of 2017.