UK Gov launches ISPV reform consultation including accelerated cat bond pathway

The UK’s Prudential Regulation Authority (PRA) has now officially launched its consultation on reforms for the insurance special purpose vehicle (ISPV) regulatory regime, which includes the accelerated pathway for certain catastrophe bond applications and a 10-day target for approvals of certain ILS arrangements.

The consultation was teased back in September, when we first reported that the UK government has an ambition to enhance the regulatory environment for use of ISPV’s for insurance-linked securities (ILS), so as to encourage more ILS and catastrophe bond issuance in the UK.

The PRA said today that, “The proposed reforms are intended to enhance the safety and soundness of the insurance sector by making more diversified reinsurance capital available to cedants while also furthering the PRA’s secondary competitiveness and growth objective by making authorisation of UK ISPVs faster and easier.”

As well as the accelerated pathway for certain catastrophe bond applications and a 10-day approval timeframe for certain arrangements, the proposals also aim to make it easier for more activities with the capital markets to be undertaken in the UK.

The PRA explained, “The proposals introduce a new accelerated pathway for certain UK ISPV applications (e.g. some types of catastrophe bonds) which meet the criteria set out in the PRA’s proposed new statement of policy – Approach to authorising and supervising UK insurance special purpose vehicles. Under the accelerated pathway, in collaboration with the Financial Conduct Authority (FCA), the PRA proposes to consider applications and, where satisfied, issue approvals within 10 working days (rather than the current 4–6-week process) of an application being submitted to the PRA and deemed complete.

“In addition, the proposed reforms will make it easier for a wider range of current market practices to be undertaken in the UK, while also streamlining and speeding up the standard application and approval processes.

“The reforms will also clarify the PRA’s expectations of UK insurers who cede risks to Special Purpose Vehicles, wherever they are established.”

Sam Woods the Deputy Governor of the Bank of England for prudential regulation said, “These reforms will deliver a much faster turn-around time for approval of new Insurance Special Purpose Vehicles in the UK, supporting growth and competitiveness while maintaining safety and soundness.”

The proposed changes are:

a. Structural changes to:

• make clear that UK ISPVs can count realised investment returns that are retained by the vehicle to cover the aggregate maximum risk exposure (AMRE) and that the AMRE may increase over time commensurate with the realisation of investment returns that are retained in the vehicle;
• amend PRA rules to disapply the requirement that UK multi arrangement ISPVs (UK MISPVs) must be formed as Protected Cell Companies (PCCs) in cases where they assume risks under more than one separate risk transformation transaction and where those separate transactions constitute a single contractual arrangement;
• allow UK ISPVs to make use of grace periods in relation to the fully funded at all times (FFAAT) requirement in some scenarios; and
• clarify the use of Limited Recourse Clauses (LRCs) by UK ISPVs.

b. Process changes to:

• authorise, via an ‘accelerated pathway’, certain UK ISPV applications which meet criteria set out in the proposed new statement of policy (SoP, see paragraph 1.8) (eg some types of catastrophe bonds (cat bonds) are likely to meet the criteria); and
• simplify the authorisation of all other UK ISPVs.

The PRA has included indicative draft application forms at Appendix 6 to demonstrate what applicants would be asked to submit following these changes.

c. Updates to PRA expectations of (re)insurers ceding to SPVs:

• introduce general expectations for UK (re)insurers using SPVs as risk mitigation; and
• clarify expectations with reference to the use of SPVs to transfer long term insurance business risks that are subject to material market and credit risk.

d. Changes to the Senior Managers and Certification Regime (SM&CR):

• Creation of a new Senior Management Function (SMF) specifically for UK ISPVs, leading to fewer SMF applications being required for UK ISPVs.

e. Consequential changes:

The PRA proposes to make other minor or consequential changes including to improve clarity and to reflect feedback received in CP5/24 that was beyond the scope of that consultation (as noted in Chapter 11 of PS 15/24).

Feedback on the proposals is now being sought and the full consultation document, with details on all the consultation proposal points above, can be found here.

The simplification of application and approval processes are key and could help to drive more interest in catastrophe bond and ILS issuance in the UK.

But so too are the items focused on fully-funded grace periods, which have been a real sticking-point and held back insurance-linked securities (ILS) activity in the country.

The question will be, whether the UK can ever become as efficient, fast, or cost-effective as established ILS domiciles. But, equivalence with them is likely not necessary to stimulate some more activity in the country, as these improvements should serve to make the UK’s ILS regulatory regime a lot more attractive to sponsors of catastrophe bonds and other third-party capital backed reinsurance arrangements than it is today.