UK embraces ILS structures

HM Treasury has now published a formal consultation in relation a new regulatory, corporate, insolvency and tax framework for insurance linked securities (“ILS”) business in the UK. The Government’s aim is to reinforce London’s standing as the world’s leading insurance market by creating the necessary legal environment to allow the domicile of ILS issuers in the UK. Part of the proposal is to create protected cell companies (“PCCs”), which would be one of the more radical changes to UK corporate law in recent times.

The plans are focused on the two leading forms of alternative risk transfer, cat bond ILS transactions and collateralised reinsurance.

The consultation is split into three parts. It closes on 29 April 2016; we are proposing to respond to it.

Authorisation and supervisory framework

The first section outlines the Government’s view on the authorisation and supervisory framework for ISPVs. The Government intends to apply the authorisation and supervisory framework applicable to SPVs under Solvency II to insurance SPVs (“ISPVs”) in the UK.

A core requirement of the applicable authorisation and ongoing supervision of ISPVs will be compliance by ISPVs with the “fully funded requirement”, a matter of growing relevance in an era of negative returns on “safe” investments.

An industry concern has been that ISPVs will not achieve PRA authorisation in a timeframe which is commercially viable given the pace of ILS deals. The latest consultation document demonstrates that the Government is looking to address these concerns by moving towards a more streamlined approvals regime, especially for multi-issuance ISPV vehicles. However, questions remain over whether even the timeframes now envisaged will be sufficiently fast to put the UK on a level playing field with more established ILS jurisdictions, such as Bermuda, Cayman Islands, Ireland, Guernsey and Jersey.

New PCC regime applicable to ISPVs

The consultation document also proposes amending companies and insolvency law in the UK to allow for the creation of protected cell companies (or PCCs). PCCs allow pools of assets and liabilities to be segregated within a company, such that the assets of one cell cannot be used to meet the liabilities of another cell (and vice versa). PCCs would, amongst other things, make establishing multi-issuance ISPVs more feasible. Such vehicles are now common in the established ILS jurisdictions, as well as in jurisdictions such as Luxembourg where they are also frequently used for repackaging and securitisation transactions. However, PCCs would be novel under UK company and insolvency law and their introduction would be a major development in UK company law.

The consultation asks for inputs in relation to this regime on a wide number of issues (including whether the abbreviation “PCC” could be too easily confused with “PLC”).

The new PCC regime is only envisaged to be available for ISPV purposes in the UK. It will be interesting though to see in the long run whether the Government would be prepared to see them used more widely.

Taxation of ISPVs

For tax purposes, the focus of the consultation is on ensuring that there is no tax leakage at the level of the ILS, while at the same time making sure that ultimately any investors pay tax at the profit they make. Imposing a withholding tax on returns would be one solution but the competitive disadvantage of this is acknowledged. The Government will introduce enabling legislation in the 2016 Finance Bill, so that the tax changes can be made later.

Overall, these proposals are a welcome step forward in making London an ILS “hub”, and creating the tax and corporate and the regulatory environment necessary to enable the UK and London to be an attractive alternative to investors and issuers in this increasingly competitive market.