Risk Transformation Regulations 2017

Debate between Earl of Kinnoull and Lord Young of Cookham

Tuesday 7th November 2017 Lords Chamber

[Lord Young of Cookham (Con)]

My Lords, I hope that the noble Lord, Lord Tunnicliffe, will be in an equally benign mood when he addresses the regulations in my name.

The Risk Transformation Regulations 2017 introduce a bespoke regulatory framework for insurance-linked securities business in the UK, announced at Budget 2015. The regulations comprise three main elements. First, they provide for UK regulators to apply a new authorisation and supervisory regime for insurance-linked securities vehicles in the UK. Secondly, they introduce a new type of company to enable multiple insurance-linked securities deals to be managed in a single company. Finally, they set out the rules for the issuance of insurance-linked securities investments so that the interests of protection buyers and investors are protected.

In an insurance-linked securities transaction, risk is transferred from an insurer or reinsurer to the capital markets. An insurer contracts with an entity specifically established to take on insurance risk. These entities are often known as insurance special purpose vehicles, and are called “transformer vehicles” in the regulations. The insurer transfers a specified risk to the transformer vehicle, paying reinsurance premiums for the risk transferred, and the vehicle then raises collateral to cover that risk by issuing securities to capital market investors. Investors earn income on their securities from the premiums paid by the insurer. Should the insured event take place, the collateral is released to the insurer to compensate them for their loss. If the insured event does not take place, the collateral is returned to investors. Investors are attracted to insurance-linked securities transactions as they offer a return that is uncorrelated to the performance of traditional financial markets.

Insurance-linked securities are now an important and growing part of the global specialist reinsurance market. As of 2017, more than $90 billion-worth of insurance-linked securities have been issued. By enabling insurers to access alternative sources of capital from the capital markets, this business has brought much-needed additional capacity to parts of the reinsurance market. However, despite the importance of London as a global insurance hub, the rapid growth of the insurance-linked securities market has taken place elsewhere.

The March 2015 Budget therefore announced that the Treasury, PRA and FCA would work closely with the London market to develop a more effective framework for insurance-linked securities business. The London market established an industry group, the insurance-linked securities task force, and over the past three years, the Treasury, PRA, FCA and insurance-linked securities task force have worked together to design the fit-for-purpose regulations that are before the House today. At its heart, therefore, the insurance-linked securities project aims to ensure that London and the UK maintain their position as a global insurance hub—and I am sure that noble Lords will agree that any attempt to increase the competitiveness of the UK’s financial services offer is welcome.

The regulations are split into four parts, and they achieve three broad aims. Part 2 implements a new authorisation and supervision regime for insurance-linked securities vehicles, which will be overseen by both the Prudential Regulation Authority and the Financial Conduct Authority. The PRA will be the lead regulator. By providing a robust and efficient framework for the supervision of insurance-linked securities, consistent with requirements set out in EU law, investors and protection buyers that use UK vehicles will benefit from the world-class financial regulation that the UK provides.

Part 3 ensures that only sophisticated or institutional investors can be offered insurance-linked securities in the UK. As I explained a moment ago, in an insurance-linked securities deal, when an insured event occurs, investors are liable to lose some or all of their capital. These are complicated financial instruments, and it would be wrong for public retail investors to be able to purchase these investments. That is why the regulations restrict the types of investors who can purchase insurance-linked securities; these investors will often hold investments in a number of different insurance-linked securities vehicles to both diversify their holdings and minimise the risk of losses.

Part 4 introduces a new form of corporate body called a protected cell company. A protected cell company allows multiple insurance-linked securities deals to be managed in a single company. Each new deal is held in a cell, and the structure of a protected cell company ensures that each deal’s assets and liabilities are ring-fenced from one another. This type of structure is already common in the insurance-linked securities market and allows for a more efficient management of risk than a new vehicle being set up for each individual deal. Protected cell companies will be carefully regulated by the PRA and FCA, with the PRA ensuring that each cell is fully capitalised.

Unlike conventional reinsurance, insurance-linked securities transactions do not pool risk. Indeed, the regulations require risk to be segregated: the transferred risk of one insurance or reinsurance entity cannot be combined with the risk of any other entity. Nor do these transactions lead to the leveraging or undercapitalisation of risk. They are not a way for insurers or reinsurers to avoid their responsibility of carefully ensuring that their risk is suitably capitalised.

In insurance-linked securities transactions, the transformer vehicle takes on a specific risk and must hold collateral that is at least equal to the risk that has been transferred to that vehicle. The Bank of England and Financial Services Act 2016, which amended the Financial Services and Markets Act 2000 to provide the enabling powers for the risk transformation regulations, defines risk transformation as the activity of assuming risk from an entity and fully funding exposure to that risk by issuing investments.

Regulations therefore ensure that each and every insurance-linked securities deal in the UK will hold capital that is at least equal to the risk that it has assumed. There can be no leveraging, pooling or undercapitalisation of risk in these transactions. This will ensure that insurers can rely on the protection they arrange through insurance-linked securities deals. That is an important point to bear in mind, considering the terrible impact of Hurricanes Harvey, Maria and Irma in the US and the Caribbean recently. These hurricanes represent some of the largest loss events that the insurance industry has seen and have tested the insurance-linked securities market’s capacity to respond and pay out on claims.

To summarise, the regulations before the House today are aimed at improving the competitive position of the UK insurance market by giving insurers and reinsurers a fit-for-purpose regulatory regime for insurance-linked securities.

We have heard that insurance-linked securities are a growing market—indeed, 2017 has seen a record issuance of insurance-linked securities, with more than $11 billion issued this year alone. EY has estimated that the market could grow to $224 billion by 2021, and the CEO of Securis, a UK-based insurance-linked securities fund has said that,

“the opportunity set for ILS has never been better”.

It is therefore the right time for the UK to improve its offer in this market. These regulations will be accompanied by new tax regulations that provide for a more competitive and straightforward tax treatment for authorised insurance-linked securities vehicles in the UK. The moves have been welcomed by the industry. I am pleased to say that the London Market Group, which represents London’s insurers and reinsurers, has welcomed this new framework for insurance-linked securities business. I beg to move.

[The Earl of Kinnoull (CB)]

My Lords, I thank the Minister very much for his clear explanation of something which I suspect was not his home ground. It is, however, my home ground in some ways. This is an important statutory instrument, and I declare my interests as set out in the register of the House, in particular those in respect of the non-life insurance industry. I very much welcome the instrument, as it will allow London to take a full part in this extremely interesting new reinsurance market. I say a full part because London has been part of issuing and buying insurance-linked securities for some time, we just have not had the apparatus of protected cell companies, an apparatus which exists conveniently in Guernsey and very conveniently, in a market-leading sense, in Bermuda. I should also say that the first issuer in London of such a thing was my company in 2002, so since then, from a standing start, the market has got to the size that the Minister mentioned.

I very much congratulate the Treasury, which has slaved away for two years with a whole team of people, but I know that the London Market Group has been a particular part of that, and has shown considerable flexibility in changing a mindset, because protected cell companies are a very different structure to those we are used to in this country. It is a big market. I found some notes from when I was sitting on a panel discussing insurance-linked securities in New York in 2011. Then, the worldwide issuance was US$30 billion, and the London Market Group tells me that it is $89 billion—I am pleased to hear that it has grown by $1 billion overnight to $90 billion. The average maturity of the securities is under three years, which means that market issuance is about $30 billion a year, so it is a very big market for those who are going to run PCCs to have a go at.

There are one or two other benefits for London which were not mentioned in the introduction. First, these securities are listed—obviously, we have two very convenient stock exchanges here, which I hope are hungry for business. Secondly, the money in these structures has to be managed, and we have plenty of fund managers who are happy to do that. Also, being here in the London market will be of benefit because one is very close to innovation. There is a lot of innovation in London. The Caribbean wind storms that have gone through recently need a lot of innovation, because those islands do not have the wherewithal to buy traditional reinsurance—it is too expensive—and this may provide a route. I know that people are working on that. I know that a number of people who are working are assuming that we will approve the regulations, and their great hope is that the first transaction will be done before year end.

If I had any concerns, and purely to ask the Minister something—I do not really, because I think that we have taken the best of breed from all the PCC structural developments around the world—it would be that I note that the PRA is left with a couple of powers which if incorrectly exercised could lead it to deal damage to the market. The first is the cost of each cell and the costs of regulation. Of course, when you are deciding on the jurisdiction of your special purpose vehicle, cost is key. I hope that the PRA will think about that. Secondly, paragraph 63 enables the PRA to ask for information about each new cell when it arrives. Obviously, it could ask for a tremendous laundry list of stuff. I hope that it will be proportionate in what it does. Can the Minister confirm that the PRA intends to be pragmatic and proportionate in its approach to this new market in the UK?

Financial Guidance and Claims Bill [HL]

Debate between Earl of Kinnoull and Lord Young of Cookham

Report: 2nd sitting (Hansard): House of Lords
Tuesday 31st October 2017 Lords Chamber

[The Earl of Kinnoull]

My Lords, we are on the home leg. In moving Amendment 43, I shall speak also to Amendment 46. I am reporting back the same two amendments that we discussed in Committee, and your Lordships will be delighted to hear that my remarks will be very short. Before I make them, I should say that the Minister is now a great hero of mine. I remarked that he was sending me emails at 7.21 am during Committee stage, but he takes a bit of a lie-in these days: his first email to me this morning was at 8.20 am. He has worked with terrific courtesy, particularly on this issue, which is a very difficult one given the poor state of relations between our Parliament and Holyrood. It will be very helpful, because working on this is greatly to the benefit of people both sides of the border.

Your Lordships will recall that I had two beefs with the law as it is. The first is my beef about arbitrage: companies can set up in unregulated Scotland and aim their activities at England. I felt that any form of arbitrage within the United Kingdom was against the general principle of having a single market in the United Kingdom and was wrong. The second beef I had was that as one looked at the statistics—we have drowned in really depressing statistics in this area—one saw that Scotland had it worse than England in terms of the activities of these very unpleasant companies. So I thought it was time for Scotland to do something about it. The Justice Committee at Holyrood has been studying the problem and feels the same—we had various quotes from various Scottish Ministers feeling that.

I should also say that this is another piece of Meccano, because the trigger in my mechanism would actually be held by Scottish Ministers. Tantalisingly, the good news is that last night a letter surfaced that was being sent by Annabelle Ewing, the relevant Scottish Minister, to the Justice Committee at Holyrood, saying that the Scottish Government were now keen to regulate CMCs in Scotland and that officials were in active discussions with equivalent officials down south to do that. Accordingly, I am hoping that in a minute we will hear some very good news from the Minister. I do not know what happened next, but he does. I beg to move Amendment 43.

[Lord Young of Cookham]

My Lords, the end is in sight. I am very grateful to the noble Earl, Lord Kinnoull, for his amendment and for the kind words he said about me. It has been a very constructive dialogue to seek to get this bit of the Bill right.

The amendments in his name seek to extend Part 2 of the Bill to Scotland. As noble Lords will be aware, the Government worked closely with the Scottish Government during the development of this policy to ensure that the FCA’s regulatory regime not only achieves the aim of strengthening claims management regulation but is proportionate to the needs of the sector and its consumers. Having sufficient evidence of malpractice by CMCs in Scotland is essential to justify extending regulation across the border. Our initial discussions with the Scottish Government revealed that they did not want regulation of CMCs to be extended to Scotland. Their view was that there was limited evidence of malpractice. We had powerful contributions in our debate in Committee which put forward a contrary view.

Because CMCs in Scotland have tended to be solicitor led, they are often regulated by the Law Society of Scotland. The decision was therefore made to replicate the current scope of claims management regulation to England and Wales only. However, following the very useful debate which we had on this issue in Committee, we have continued discussions with the Scottish Government, and their views are evolving.

The Scottish Government have not yet requested that claims management regulation is extended to Scotland, but I say to the noble Earl that, should we receive ministerial confirmation that the Scottish Government wish to extend claims management regulation to Scotland, we would be ready and willing to table a government amendment to that effect. So we will continue to engage with the Scottish Government and we will keep our position on claims management regulation in Scotland under review.

Financial Guidance and Claims Bill [HL]

Debate between Earl of Kinnoull and Lord Young of Cookham

Committee: 4th sitting (Hansard): House of Lords
Wednesday 13th September 2017 Lords Chamber

[Lord Young of Cookham]

My Lords, Amendments 74 and 76, tabled by the noble Earl, Lord Kinnoull, seek to extend Part 2 to Scotland. I am grateful to him for the way he set out the case for this extension. The Government carefully considered the scope of claims management regulation during the development of this policy. The current framework for claims management regulation, set out in the Compensation Act 2006, limits the extent of claims management regulation to England and Wales only and this will remain the case as we transfer regulation to the FCA. The matter is currently reserved, so we cannot simply make regulations to devolve the matter to the Scottish Government.

In reaching this decision, the Government had a dialogue with the Scottish Government to establish their view. Their view, as outlined in correspondence from the Scottish Business Minister, was that there is limited evidence of malpractice by CMCs in Scotland, and they concluded that extending the scope of claims management regulation would be unnecessary and disproportionate. That view is clearly challenged, and is about to be challenged again.

[The Earl of Kinnoull]

The Scottish Government have come out with a long paper—it is a dozen pages or so—in which they publicly state completely the opposite. We have been citing these terrific statistics from Which?. I do not know at what point in time their views are dated, but events have moved on and the old views are clearly wanting.

[Lord Young of Cookham]

I am very grateful to the noble Earl, who has been very influential, as I will explain in a moment, in persuading the Government to think about this again. I will not quote it again, but what I just quoted was the view at the time we consulted. The Scottish Government concluded that regulation would be unnecessary and disproportionate. It may well be that, from the evidence the noble Earl referred to, since then they have changed their view.

As for regulatory arbitrage, it should not mean that a firm can evade regulation by moving across the border. The Bill gives the Treasury a power to define when a person should be treated as carrying on claims management activity in England and Wales, which gives government the flexibility to adapt the definition should the market change. When exercising this power, the Government intend to capture CMCs approaching consumers in England and Wales, and CMCs taking forward their claims should be subject to FCA regulation. This mirrors the current regulatory framework, in which the requirement to be authorised is not dependent on where the CMC is located but based on where it carries out the regulated service.

With regard to nuisance calls in Scotland, the Government continue to build on a package of measures to tackle this problem across the UK. We have already delivered a number of actions, including: a measure in the Digital Economy Act 2017 making it a requirement for the Information Commissioner to issue a statutory code of practice on direct marketing; requiring all direct marketing callers to provide caller line identification; and increasing the maximum level of monetary penalty the ICO can issue to £500,000 for serious breaches of the regulations. In the light of what the noble Earl has said, we will re-engage with the Scottish Government on this issue and keep our position on claims management regulation under review.

Amendment 75, tabled by the noble Lords, Lord McKenzie and Lord Stevenson, seeks to establish a timescale within which the Government will commence the legislation relating to the single financial guidance body. I am not sure the amendment would do what the noble Lord wants: these regulations would have to be made within 18 months of Royal Assent, but the regulations could then provide for these sections to come into effect after 18 months have passed. I am sure that was not the intention, but that is the reading of the amendment as I have interpreted it. As indicated in our response to the consultation on the single financial guidance body, the new body will come into existence no earlier than autumn 2018. We want to ensure that we provide for the best possible transition from the existing services to the new body. We are conscious, though, that the process has already created some uncertainty for existing services and for consumers. For that reason, as well as those given by the noble Lord, we would like to move as quickly as is practicable.

We also want to provide time for the chair and chief executive to assess and contribute to the key set-up arrangements. In line with Managing Public Money principles, the Bill must have passed Second Reading in the House of Commons before a recruitment exercise for the chair and chief executive can commence. We anticipate starting this recruitment exercise as soon as possible after that point. We are working with existing services and other key stakeholders to ensure that we remain on track to establish the new body. Although I sympathise with what the noble Lord is seeking to achieve with this amendment, I assure him we have every intention of establishing the new body as soon as is practically possible and ensuring that the body is able to deliver an improved, joined-up service to meet the needs of the public.

Against the background of the undertaking I have given to the noble Earl, and the assurances I have just given to the noble Lord, Lord Stevenson, I hope this amendment might be withdrawn and the others not pressed.

[The Earl of Kinnoull]

I am very grateful to the Minister for his typically courteous response and the courteous way in which he dealt with my rather not-so-courteous interruption, for which I apologise. What he said about my point on arbitrage sounded very good, although I want to read it again in Hansard, as did the undertaking. I would like to see how things progress from here, to see if there is anything left on these issues to discuss on Report. But it sounds as if progress is being made, for which I thank the Government very much indeed. On that basis, I beg leave to withdraw the amendment.