The UK government is working with the insurance industry to turn London into a global hub for insurance-linked securities (ILS), but much work remains to be done.
The UK government is working with the insurance industry to turn London into a global hub for insurance-linked securities (ILS), but much work remains to be done.
A report, published in 2014 by the London Market Group, an insurance trade body, said that London would need to adapt because alternative risk transfer was unlikely to be a “temporary phenomenon”.
Currently, special purpose vehicles (SPVs) and protected cell companies (PCCs), two structures that are key components to an ILS marketplace, are not feasible in the UK, requiring the enactment of primary legislation.
UK chancellor George Osborne confirmed in 2015 that the government is working with the insurance industry and regulators to develop competitive tax and corporate structures to allow ILS deals to be conducted in the UK.
On 1 March of this year, a consultation on a new regulatory framework was issued. It outlined the benefits that ILS business would bring to the UK as well as what the framework would look like once implemented. In the consultation, the government suggested that, with the right framework, “London can make a major contribution to the … growth and development of ILS business”.
Any proposed framework would need to meet the requirements of the Solvency II directive and recognise ILS cover provided by SPVs as a risk mitigation technique available to insurance reinsurance firms, the consultation added.
The government consultation explained: “[The Solvency II SPV framework] is designed to ensure the prudent authorisation and supervision of SPVs used for insurance purposes and we believe that this framework can be applied in a way which meets the needs of market participants and delivers a trusted framework within which the market can operate.”
The new legislation, if it gets the go-ahead, has the potential to benefit all participants in the insurance market, including those with captives overseas.
According to Andrew Holderness, a partner at the law firm Clyde & Co the UK ILS marketplace will provide easier access to the capital markets. He says: “It will allow [the industry] to operate within a jurisdiction with tried and tested and robust legal and regulatory regimes, and which has a very deep talent pool of expertise.”
To some captive insurance companies, however, it may be suitable and attractive to diversify their risk cover to some of their natural catastrophe risks by means of an ILS option. Ilka McHugh, director insurance solutions at Eurobase International, explains: “In this case it could be an advantage to be able to set up the SPV in the London market and let the captive benefit from the capital provided.”
If the proposed changes to the UK legislation are accepted, what would London need to offer to be a successful ILS hub? Paul Traynor, pensions and insurance segments leader at BNY Mellon, suggests a favourable tax treatment would be the one of the necessary ingredients to make London successful.
Traynor says: “Tax incentives for SPVs to locate in London to match those that are offered by offshore centres such as Bermuda and Guernsey.”
He also believes that the city would need a highly proactive regulator, have a close relationship with market players, understand the structures and approve new vehicles quickly.
One way to achieve this, according to Traynor, would be for the Prudential Regulation Authority (PRA) to set up a dedicated unit focused on making London a successful ILS hub.
He says: “The PRA should be as proactive as the other European ILS regulators if it wants to be successful; a slow and costly approval process can make execution dramatically less efficient.”
With jurisdictions such as Bermuda, Dublin and Guernsey already offering attractive ILS business, is there a market need for London to become an ILS hub? McHugh predicts that as global investment in ILS gradually increases, the additional insurance and reinsurance capacity opened up will allow companies to broaden what they are able to offer to the market.
McHugh says: “Becoming an ILS hub will provide London with continued recognition and credibility as a financial centre. As the market currently stands, only around 10 percent of the ILS transactions globally are done through London, which obviously means a loss of income with associated impacts to the financial hub of London.”
She adds that it would increase the attractiveness of London to local and global investors, while having the potential to lead to more jobs, increased tax income and improved credibility for London as a financial hub.
London must also leverage its expertise within specialty markets and position itself within Europe to offer the ILS market something different, says Traynor.
While London becoming an ILS hub could be positive for the UK economy, the government needs to decide what the UK can offer to make it stand out from the other global leaders in the marketplace.
Holderness explains that the consultation revealed key features that will be needed to attract ILS business to the UK, in three crucial areas. The first of the three areas, Holderness explains, is the ability to set up a new ILS vehicle in a timescale that will make the UK competitive with other domiciles.
Secondly, proposals to amend UK company and insolvency laws to allow for the creation of protected cell companies for use in an ILS deal. The final hurdle, he believes, is making the UK tax regime more attractive to international ILS investors. He stresses it will be necessary to design a tax treatment similar to that provided in other competing jurisdictions.
A report by BNY Mellon, released in April, suggested that if London were to turn itself into an ILS market, it would be “perfectly positioned” to become the global centre for cyber risk insurance. The report explained that the new data protection rules being implemented in the EU are expected to further drive up demand for cyber liability cover, which ILS could be used to fund.
Traynor explains, however, that the UK could see some obstacles along the way that would prevent London from being able to cater for cyber risk insurance.
He believes that further innovation within the market is needed so that new risks, such as cyber terrorism, can be accurately measured, modelled and securitised in the future.
Issuing costs are a major impediment to developing London as an ILS market, says Traynor. He says that if London can go down the PCC route, meaning allowing the creation of a single master company, ILS issuers will be able to segregate issuance, which would be a huge advantage for all issuers and sponsors.
He also recommends an ecosystem within the ILS market to support the transactions and stresses that knowledge and expertise are “essential”, in addition to PCC legislation.
If the new proposed legislation and low taxes are attractive enough, compared to the leading jurisdictions, McHugh believes that increased talent and experience will follow, creating a more attractive environment for further ILS business to come to London.
Aside from cyber, Traynor believes that London has the potential to also attract emerging risks such as pandemic, natural catastrophe, pension fund longevity, motor, aviation, and energy and marine liability.
He explains: “Although further work is needed in aggregating and modelling the risk, the capital markets are the logical place for catastrophic emerging risks. London as an ILS hub should be a catalyst for this innovation.”
