As part of the Government's plans to assist the insurance market enhance its position as a leader in the global insurance market, a consultation paper was published in March 2016 setting out the Government's initial thinking on a new corporate, regulatory and tax framework for insurance-linked securities (ILS) vehicles in the UK.
ILS are financial instruments which offer insurance and reinsurance firms another avenue for risk mitigation, by instead transferring their risk to the capital markets. The majority of the global ILS market is currently based offshore in places like Bermuda and Guernsey and the ILS capital currently stands at around $70 billion, which accounts for around 12% of the overall reinsurance capital.
The rise in the use of alternative risk transfer has prompted an interest to expand London's presence into the ILS market, and with the right framework the Government believes that London can make a major contribution to the continued growth and development of ILS business.
In its consultation paper, the Government sets out its initial views on the authorisation and supervision, corporate structure and tax framework for ILS.
Chapter 2 of the consultation paper sets out the Government's suggestions on the authorisation and supervision of ILS. The initial approach set out in the consultation paper is based on the most common forms of ILS deals – collateralised bonds and CAT bonds (although the Government acknowledged that the approach may need to be further tailored to other forms of ILS).
The Government believes that the Solvency 2 framework establishing a separate authorisation and supervisory framework for insurance special purpose vehicles (ISPVs) can be applied to ILS in a way which meets the needs of market participants.
An issue highlighted in the consultation paper is the time for authorisation. The Government proposes that an accelerated assessment for relatively standard ISPVs of 6-8 weeks may be possible. However, this may prove to be a challenge as this seems to be a significantly shorter period than the current requirement that authorisation decisions are to be made within 6 months of the application.
Another interesting issue discussed in the consultation paper is the possibility that the UK framework for ISL business would benefit from a protected cell companies (PCC) regime. This would allow for pools of assets and liabilities (known as cells) to be segregated within the company and each ILS deal would be allocated to its own cell. As this concept is unfamiliar in English law, the Government will need to amend companies and insolvency law in the UK to allow for the creation of PCCs.
In order to attract genuine interest to the London market and as ISPVs are primarily located in offshore jurisdictions, the UK will need to design a tax treatment similar to those exhibited offshore which maximise value for investors. In doing so, the Government will need to ensure that any proposed tax changes are robust against aggressive tax planning or tax avoidance.
Currently under the Taxation of Insurance Securitisation Companies Regulations 2007 (SI2007/3402), ISPVs are taxed on a similar basis to a securitisation company within the main securitisation tax regulations. However the Government does not believe that updating these regulations will deliver a competitive tax outcome for ILS vehicles that issue equity to investors. Instead the Government has asked market participants for their views on a possible tax exemption approach whereby equity-backed UK ISPVs would be exempt from corporation tax on profits arising and instead their investors would be subject to tax on the distributions they receive. The Government suggests that this approach could also be suitable for debt-backed deals.
The consultation closed on 29 April 2016 and the approach set out in the consultation document will be developed and refined once the Government has taken into account responses received from stakeholders.
Since the consultation, the Economic Secretary has issued a letter to the London Market Group regarding the ILS project. The letter provides that the next stage of the project will be to finalise the regulations in order to implement the new framework in early 2017. We understand from this letter that it had been the Treasury's intention to issue draft regulations for consultation this Autumn.
It is worth noting that as this consultation paper was published prior to the UK's decision to leave the EU, it is unclear whether the Government still believes that elements of the Solvency 2 framework can be applied to ILS in relation to authorisation and supervision.