Risk Transformation Regulations 2017 — House of Lords, 2017-11-07
Topic: Domestic Commerce
George Young (Conservative, Centre-right): My Lords, I am very grateful to the noble Earl, Lord Kinnoull, and the noble Lord, Tunnicliffe, for their comments on these regulations, the light they have shed on them and the perceptive questions they have raised. I am grateful to the noble Earl for identifying that his company—clearly in the forefront of developing this market—has been dealing with these securities for some time. He made the point that the infrastructure needs improving if we are to capitalise on our strengths, and that developing these vehicles in London means that they can then utilise some of the other strengths of the London capital market, such as fund management. He raised issues about the costs. I understand that the PRA and FCA have both set out the costs of authorising ILS vehicles. The proposed costs are already known to the market and so far the industry has not expressed any concern about them. Indeed, the fact that we are developing a fit-for-purpose regulatory structure has been welcomed The PRA is aware of the concerns about timing and has said that it aims to improve straightforward ILSs within a six to eight-week timeframe. Given that this is a new activity for it, I expect there will be a learning curve. As time progresses, this may be less steep and it may be able to turn applications round more quickly. However, once the initial authorisation of a vehicle has taken place—this is the protected cell company—each ILS deal can then be added, without having to be approved by the PRA, so long as it complies, as the noble Lord, Lord Tunnicliffe, has just said, with the vehicle’s overall business plan. This will allow ILS deals to be conducted at speed within an authorised vehicle On the question of these instruments being listed on the stock exchange, the regulations do not prevent the trading of these instruments on a secondary market. However, as I said when I introduced the regulations, if trading of these instruments is to occur, the secondary marketplace should be accessible only to sophisticated or institutional investors, and this will be regulated by the FCA. We do not want retail investors to be able to purchase these securities as they are clearly unsuitable for retail investment On the important issue raised by the noble Lord, Lord Tunnicliffe, the Government’s view is not that we are entering into the unknown by seeking to attract this business to the UK because, as we heard from the noble Earl, ILS is now a well-established and well-understood industry that has been part of the global reinsurance market for some 25 years. Therefore, the ILS business model and the contribution it makes to increasing capacity is well understood and it is clear that ILS has made a positive contribution to global reinsurance capacity. The ability to conduct ILS business in the UK, or indeed across the EU, is not new. Indeed, under the EU’s Solvency II Directive, the UK is obligated to permit and regulate this business. What is new is the regulatory fit-for-purpose framework we are introducing through these regulations, which will ensure not only that we remain a competitive market but that ILS business is conducted to high prudential standards The noble Lord referred to impact assessments. As he will know, government departments are required to produce impact assessments for any new regulations they seek to introduce. One such assessment was submitted for the Risk Transformation Regulations and cleared by the Regulatory Policy Committee. As ILS is already possible in the UK, the purpose of that impact assessment was to determine whether the new framework would increase costs for business or the regulators. The conclusion, consistent with the objective to make the UK a competitive environment, is that it would not. What is difficult to estimate is how much ILS might be attracted to the UK The noble Lord also raised the important issue of the impact that developing this market might have on overall financial stability. This will not be the case. Unlike conventional reinsurers, ILS transactions do not pool risk, as I explained. Deals must be fully collateralised—the transformer vehicle must raise and hold collateral which is sufficient to meet its reinsurance obligations. These deals are not a way for insurance companies to leverage or hedge their risk or avoid the proper capitalisation of risk that is required under the Solvency II directive, so each risk is in a sense insulated within its own cell. Indeed, I would argue that if these transactions are arranged prudently, they can contribute to financial stability because of the way they are composed. The noble Lord may be interested to know that Hiscox carried out an insurance sector stress test in January of this year which underlined the importance of ILS in providing an alternative source of capital for insurers to draw on in times of crisis The noble Lord addressed the point that I made that this market was not correlated with general financial markets. A range of publicly available studies has looked at this issue, so again, we are not dealing with the unknown. For example, one report published in 2016 by the Chartered Financial Analysts Institute concluded that: "ILS products allocate capital efficiently while providing positive returns for investors—returns that offer true diversification because they are not correlated with returns of the traditional asset classes" The clearest evidence of this view being reliable is the performance of ILS investments during the financial crisis. While financial markets in general were hit by the crisis, ILS instruments continued to perform well The noble Lord asked about the tax regulations. The Risk Transformation (Tax) Regulations, which set out the tax treatment for these vehicles, are made under the Finance Act 2016 and will be considered in another place. I will write to the noble Lord on the question he raised about the timing and why they are not being introduced simultaneously The noble Lord asked about the number of cells that a protected cell company will be able to use. This is not limited by legislation but will be a matter of interest to the PRA, the regulatory body. The PRA will judge what scale of business, including the number of deals, is prudent if individual transformer vehicle applications go down this route. Protected cell companies are designed so that the number of deals should have no impact on the stability of the market as a whole because each cell, as I said, is self-financed The noble Lord may have raised other issues and I apologise if I have not addressed them. He asked if we would keep the regulations under review: I think he put that in a slightly more direct way. The Government will, of course, keep these regulations under review to ensure that they are working for both the consumer and the industry In conclusion, I am grateful to the noble Earl and the noble Lord for their contributions. I will write to pick up the points that I have not dealt with. I commend these regulations to the House.