My Lords, Amendment 29 introduces a power into the Financial Services and Markets Act 2000 for the Treasury to make regulations relating to transformer vehicles. Transformer vehicles
are used for risk-mitigation purposes, particularly in the insurance and reinsurance industry. The Government plan to use this power to implement a new framework for insurance-linked securities business.
In an insurance-linked securities transaction, an insurer contracts with an entity specifically established to take on insurance risk. These entities come within the definition of “transformer vehicles” in the amendment. The insurer transfers risk to the transformer vehicle and the vehicle raises collateral to cover that risk by issuing securities to capital market investors. The vehicles exist solely to transform risk into capital market instruments and to compensate the insurer should the insured event take place. Investors receive a return from the premiums paid by the insurer and the collateral is returned to investors if the insured event does not take place. Unlike conventional reinsurers, ILS transactions do not pool risk. The transformer vehicle takes on a specific risk and typically holds collateral that is at least equal to the risk transferred. This key safeguard will be a firm requirement in the UK framework. The framework will ensure that insurers can rely on the protection they arrange through ILS deals.
Insurance-linked securities are now an important and growing part of the global specialist reinsurance market. By enabling insurers to access the capital markets as an alternative way of reinsuring risk, this business has brought additional capacity to parts of the reinsurance market. But despite the importance of London as a global insurance hub, that growth has taken place elsewhere. In London Matters, a report by the London Market Group on the competitiveness of the London insurance market, the UK’s out-of-date regulatory framework for insurance-linked securities was highlighted as inhibiting London’s ability to compete as a reinsurance hub.
Therefore, the March 2015 Budget announced that the Treasury, the PRA and the FCA would work closely with the London market to develop a more effective framework for insurance-linked securities business. The London market established the insurance-linked securities task force, which is working with the Treasury and the financial regulators to design a fit-for-purpose regime. Work is ongoing, but it is clear that the Financial Services and Markets Act needs to be amended to provide for the introduction of detailed regulations which will implement the new framework. In particular, the Government intend to use the power to create a bespoke corporate structure for transformer vehicles which assume risk from insurers and reinsurers. This will ensure that these vehicles are robust and managed in a way so that they can meet their obligations to insurers and investors. Given that this is a rapidly evolving market, the power will enable the Treasury and financial regulators to keep the regulatory framework up to date.
The clause enables the regulatory arrangements of Lloyd’s of London to be updated, should that be needed to facilitate the Lloyd’s market adapting to ILS business or the use of transformer vehicles. If this requires amendments to the Lloyd’s Acts then the regulations concerned will be dehybridised, so that the amendments are not delayed in Parliament by the hybrid procedure. I am grateful to the Delegated Powers Committee for its report on this clause, which recommends
that the clause be amended to ensure that the consent of the council of Lloyd’s is needed before the FCA or PRA can be enabled to require the council to carry out functions on their behalf. I fully understand that the committee would want to be reassured that those affected by the use of a dehybridising provision are afforded an alternative protection. The Government will therefore give careful consideration to the committee’s report.
Although the Government’s current plan is to introduce a framework focused on the insurance industry, it is possible that the use of transformer vehicles by non-insurance entities, for example a company seeking to mitigate the longevity risk associated with an employee pension scheme, may become more common in the future. The power provides the flexibility for regulation to keep pace with such market developments, should that be required.
Finally, I am pleased to say that the London Market Group, which represents London’s insurers and reinsurers, has welcomed this first step in implementing a new framework for ILS business. I beg to move.