nterest in insurance-linked securities (ILS) has been ramping up for some time and a quick look at the size of the market explains why. billion, putting the market on course for a record year.
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It was therefore unsurprising that in the Budget back in March, UK Chancellor George Osborne noted that the ILS market represents an important growth opportunity for the country and that the government would work with the industry and regulators to develop a new competitive corporate and tax structure for allowing ILS to be domiciled in the UK, thereby making greater use of so-called alternative capital.
ENCOURAGING DEVELOPMENTS Subsequent developments have been encouraging. In April, Osborne indicated that the government was altering its tone on regulation in the City, focusing its efforts on making it more attractive for business. After the election in May, Osborne retained his post, making the prospect of government support for ILS as strong as it ever was likely to be—no other political party had much interest in creating the type of structure that would make London competitive in this respect, particularly from a taxation perspective.
Then, in June, the London Market Group’s ILS taskforce was set up, tasked with producing a series of recommendations that could be included in the Chancellor’s autumn statement later this year. The taskforce will consider potential changes to the tax, regulatory and company law regimes that could make the UK a more attractive domicile for ILS business and managers.
However, the delivery of the summer Budget in July could be seen as raising some questions about the government’s commitment, since there was no mention of the changes needed for ILS to be issued. This could simply be a question of timing—the logic of creating a rule that allows people to be paying less tax, which is one of the fundamental points that the UK has to deal with if it is to attract ILS investors—doesn’t necessarily cuts. The structural changes required are also neither simple nor quick.
Looking forward, it will be interesting to see whether the political will
remains and progress on this issue is sustained or whether it is quietly dropped. It may be that the challenges that need to be overcome in order to make London a centre for ILS are simply deemed to be too big.
SIGNIFICANT CHALLENGES As well as the need to make the tax regime more attractive to ILS investors, the UK regulators—in particular the Prudential Regulation Authority (PRA)—are likely to have a number of concerns which they will want to see addressed. These will include ensuring that the collateral
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adequate know-how, including access to modelling capability, to assess these risks properly.
The PRA will also want to know that the ceding company appreciates
the extent to which risk is actually being transferred by it pursuant to the ILS arrangement, and that it understands the wider impact on traditional re/insurers as a result of participating in an ILS arrangement (such as with regard to concentration of risk, impact on returns on capital, and possible changes in business model, etc).
setting up insurance special purpose vehicles (SPVs), which will form a pivotal part of the ILS arrangement. For example, legislation to create a framework for protected cell companies, which effectively reduce the capital requirements on ILS deals and cut administrative costs, will likely take some time for both the
However, the key aspect of regulation of the ILS market is speed of
response. The UK regime is used to taking months to authorise vehicles whereas in Bermuda, for example, regulators can do so in a matter of days. The UK needs a regulatory process which can set up a new insurance vehicle in a time scale that makes the UK competitive with other domiciles.
AN EVOLVING ROLE Against this challenging backdrop, we may see an interim role for London as an advisory or legal hub to nearby offshore domiciles, such as Malta and Gibraltar. There is a precedent: although Bermuda is the world’s largest issuer of ILS, a lot of the documentation is done under New York law. London offers the necessary expertise, both in the investment banking sector and in the legal sector, to take on a similar role, one that would be more cost-effective for European issuers requiring support services.
opportunity. The real prize is not so much ensuring that an ILS vehicle is domiciled in the UK but that there is an active ILS market in the UK and that ILS deals are transacted in the UK. This will provide easier access to the capital markets for European based re/insurers, and it will allow them 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. needed to deliver them—are less so.
“The UK currently lacks the corporate insurance special purpose vehicles, which will form a pivotal part of the ILS arrangement.”
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