Risk Transformation Regulations 2017 — House of Lords, 2017-11-07
Topic: Domestic Commerce
Denis Tunnicliffe (Labour, Centre-left): My Lords, I thank the Minister for introducing the order so thoroughly. As he outlined, the Risk Transformation (Tax) Regulations 2017 create the regulatory and supervisory framework for insurance-linked securities. ILSs allow companies to obtain reinsurance protection from a new pool of capital separate from traditional reinsurance, meaning the direct transfer of reinsurance risk to the capital market. The proposed framework is composed of three elements: the corporate structure for insurance special purpose vehicles or ISPVs, called protected cell companies or PCCs; an authorisation procedure for the PRA and the FCA; and the specific tax arrangements for ILSs Before I turn to some specific questions which arose from my reading of the regulations, impact assessment and consultations, I will say something about ILSs in general. The assumption—I use that word deliberately—is that they ought to have little or no correlation with the wider financial markets as their value is linked to non-financial risks such as natural disasters, and therein lies my concern. The Government have made no attempt to conceal the fact that the UK will be venturing into the unknown. Indeed, on the first page of the impact assessment the Treasury states: "London would be the first major financial centre to offer ILS solutions and we think that a major and well trusted financial centre can help grow the global ILS market" This is not a statement of certainty. Given the admission that the UK is breaking new ground, I would have expected the Government to have been keen to assess the impact that the introduction of more risk to the market could have on the financial sector as a whole. An IMF working paper puts it well, stating: "The growth in recent years of Insurance-Linked Securities has widened the exposure of investors (mostly hedge funds and specialist investment vehicles) to insurance risks originated and managed by insurance companies ... But the effect is that catastrophic insurance losses can now be transmitted directly to investors without the cushion of the insurance company's balance sheet" There seems to be an untested assumption, throughout the Government’s proceedings, that there is no correlation between ILSs and economic stability. Am I wrong? Have the Government carried out such risk assessments? If they have, I would be grateful if the Minister could publish them. If not, will he go back to his department and urge it to produce them? It is this lack of inquiry which makes me doubly concerned about the lack of a requirement for a formal review to take place The Government have stated that there are a number of issues they intend to review periodically, including whether protected cell companies could be used for other purposes and the untested authorisation and supervision of ISPVs and MISPVs. How did they arrive at the view that a formal review, perhaps within a year of these regulations coming into force, was not necessary? I suggest that there are plenty of measures which would merit review: the extent to which ILS shares are traded on a secondary market, the usage and impact of PCC gateways and the tax treatment. The noble Lord knows that conventions dictate that we do not test the opinion of the House on such matters, but let that not undermine the importance that I place on these questions I have a few specific points. The first relates to the tax measures. This third component is in separate regulations —the Risk Transformation (Tax) Regulations 2017 — which are not being debated today. Surely it would have made more sense for the two instruments to be debated alongside each other? Can the framework come into force without the tax elements in place? When does the Minister expect this House to debate the tax treatment for ILSs Moving to the insurance mechanisms, a PCC will comprise a core— which is the legal entity—and a number of cells. Will there be a limit to the number of cells each ISPV will be authorised to have? Has the department carried out any analysis on the estimated number of cells each company will run? I ask with particular concerns that an unlimited number of cells would increase the risk of instability in the market, especially if cells are grouped. I understand that this grouping of cells will be allowed in limited circumstances. The Government consulted on how the PRA may impose limitations on how PCCs use these gateways, so as to ensure that cells are used with care and are consistent with the EU Solvency II directive. Will the Minister outline the circumstances in which the PRA would enforce such restrictions My final point is about the Government’s decision, as a result of listening to consultation feedback, to change from a pre to a post-transaction notification period to the PRA for new multi-arrangement insurance special purpose vehicle cells, or any assumption of new risk. Why the change? What objections were raised to what sounds like a perfectly reasonable suggestion? As a result of this shift in approach, the Government have stated that the necessary safeguards are in place. Will the Minister outline what these are? The consultation response goes on to say that, "it will be proportionate for the PRA to give permission to mISPVs to enter into specified kinds of risk transfer deals in the future without the need for further authorisation, provided that those future deals are in accordance with the limitations as set out in the mISPVs permission". Is it the PRA’s responsibility to monitor whether deals are in line with expectations or is the onus on the company to report it As I have made clear, although we will not vote against this order, I am deeply concerned that the Government are inviting further risk into an already unstable and uncertain market without fully considering the consequences. I hope that the noble Lord can relieve some of my worries in his response.