ILS: London can find its feet

London is prepared to take on Bermuda by looking to become a global hub for insurance-linked securities (ILS) issuance. Many believe the potential is there: brand new legislation is setting the legal framework for ILS products, London as a regulatory jurisdiction is well recognised worldwide, and it can provide the necessary talent pool as a major re/insurance and financial centre.

The expectations are high and so is the ambition of some market participants, who believe London can offer more than the nat cat ILS products which are Bermuda’s specialty. ILS has the potential to transcend many other types of risks and the capabilities to make that happen within the London Market are certainly available.

“London contains the intellectual talent pool and access to capital markets in a small geographic area in the City of London,” says Malcolm Newman, CEO of SCOR’s Paris-London hub and chairman of the London Market Group’s ILS taskforce.

“This is linked to the UK’s reputation for sound regulation, a well developed and globally recognised legal system and an onshore approach that will open up ILS to new clients,” Newman adds.

A valuable proposition

ILS allow insurance and reinsurance firms to transfer risk to the capital markets, which can make the management risks more effective for businesses and consumers. So far, Bermuda is the leading jurisdiction for the issuance of the securities. ILS issued from Bermuda represented 76.1 percent ($22.5 billion of $29.5 billion) of total outstanding capacity at the end of the second quarter of 2017, according to data from the Bermuda Monetary Authority.

Since 2010, 185 Bermuda-based special purpose insurers (SPIs) have been registered and have issued 187 ILS deals. But this happened before London passed new legislation which should enable the first ILS deals to be issued from the market later this year.

“London’s new ILS framework can make the City the global hub for innovative ILS solutions,” says Des Potter, head of GC Securities, EMEA, Guy Carpenter, who also sits on the London ILS taskforce.

“The UK’s success has to be based on innovation. The goal is not to stem the flow of business going to Bermuda or to grow London’s market share of cat bonds, but to take ILS to its next stage of evolution using the unique skillset we have in London,” Potter explains.

London is entering the business at a time when the market is thriving. Issuance volume in the second quarter of 2017 was the highest for any quarter since 2009: $7 billion of new risk capital was issued via 28 deals. Furthermore, total issuance of $9.8 billion for the first half of 2017 exceeded the total annual volume since 2009. There might be space for more.

“The majority of ILS issues to date have been for North American perils and these have been issued primarily in Bermuda,” Newman notes. “The development of solutions for non-US risks is an opportunity for London to use its global reach and its significant talent pool to open up new markets and pioneer new solutions,” he adds.

Regulation being put in place by the British government sets out how to establish special vehicles to issue ILS, the legal framework for ILS, and the associated tax treatment.

Paul Schultz, CEO of Aon Securities, notes that there are a number of important aspects of the regulatory framework including, but not limited to, favourable tax treatments, establishment of a process for creating protected cell companies (PCCs), and a focus of the framework’s compliance being in alliance with securities regulation.

Schultz adds that London has a deep history with the insurance industry and that the new framework proposed offers an opportunity for that local insurance industry to continue to evolve alongside the broader market.

“The implementation of the London ILS strategy is a progressive step which serves to continue to entrench London as a hub for the insurance industry by recognising the growing influence capital markets-type risk transfers are playing in the current industry environment.

“There exists a great deal of opportunity in the London ILS space not only in the catastrophe bond issuance space but further in fronting, collateralised reinsurance, and insurance asset management,” Schultz says.

The last leg

While Bermuda has an established market for ILS, the new framework in London still needs to be approved by market participants, but experts are confident that London will pass the test.

Paresh Thakrar, chief operating officer of Hiscox Re, believes that “a combination of engaged and pragmatic regulators, a few pioneers willing to road test the rules, and a bit of innovative spark from the industry will make London attractive as an ILS issuance jurisdiction”.

“If you put those elements together, the capital will come. London has a longstanding, trusted and respected capital market framework which is very attractive for investors and money managers worldwide, and we now have the opportunity to build on this with ILS.

“The City’s heritage, particularly Lloyd’s which is naturally synonymous with risk, is another significant draw for cedants wishing to place business and for investors willing to take risk,” Thakrar says.

ILS, aka catastrophe bonds, are normally used to insure against extreme risks such as earthquakes and hurricanes, but the London ILS market may want to offer more than nat cat cover.

“We would expect collateralised reinsurance to be placed via the PCC framework as well,” says Schultz.

“We expect specialist investment funds to be established to underwrite reinsurance or invest in bonds via the newly established framework, similar to that seen in other jurisdictions.”

While cat bonds and simple collateralised reinsurance structures are the obvious places to start, Newman believes there is potential for more.

“London will, of course, be competing with established products, but bringing these to new global clients. Alongside this I expect new solutions to be developed, taking ILS beyond its property cat origins.

“I cannot give details but I know that some organisations are exploring new types of risk to be covered. There is also interest from the government sector in bringing insurance solutions to some state-covered risks. The impact on underdeveloped parts of the world when catastrophe strikes is leading people to question the effectiveness of the current post-event aid system,” Newman says.

In June 2017, the World Bank launched its first-ever pandemic bonds to support a $500 million pandemic emergency financing facility in collaboration with Swiss Re and Munich Re.

Such securities may become more common in future as governments aim to reduce the insurance gap in developing as well as in developed countries.

London wants to be prepared to offer the appropriate regulatory environment for new products. “The framework aims to be as flexible as possible in allowing investors to access insurance and reinsurance risk in different ways, which is something we welcome,” says Thakrar.

“If we can leverage London’s broking, underwriting, and actuarial talent to provide innovative solutions to big challenges such as the protection gap in both mature and emerging markets, London can become the global centre for reinsurance risk transfer,” Potter adds.

“The UK’s success has to be based on innovation. The goal is not to stem the flow of business going to Bermuda or to grow London’s market share of cat bonds, but to take ILS to its next stage of evolution using the unique skillset we have in London,” he explains.

If the expectations for London as an ILS hub are met will depend not least on the behaviour of London’s regulator, Newman notes.

In order to be successful, London’s regulator will need to be fast and agile in applying the legislation, authorising new issues and responding to sudden opportunities that may arise, he says.

“There needs to be a partnership between the market players and the regulators to establish London as an ILS centre of choice.”

Protecting the market

It is also important to see that the concept is being embraced and supported by Lloyd’s, which is keen to ensure the market makes the most of what could become a competitive advantage.

Inga Beale, chief executive of Lloyd’s, has even indicated that Lloyd’s is exploring the possibility of using ILS to protect the market.

Beale says that once the new regulations allowing ILS issuance from the UK come into force—expected in the fourth quarter of this year—she is keen to help kick-start a London ILS market, ideally by helping pave the way for some early deals.

As well as potentially using an ILS structure itself, another tactic to achieve this is by working with the London Market Group’s ILS taskforce led by Newman, which is exploring a possible deal designed to cover emerging market risks.

“My guess, watching how quickly the capital markets can work, is that we will see some quick issuance using the new facility,” Beale says. “The London Market Group is collectively looking at this with a view to getting something going around uninsured risks in emerging markets. It would be good to see something like that launched quickly.

“It is early days and nothing concrete exists yet but we will explore the possibility of Lloyd’s using this form of risk transfer centrally, on the behalf of the entire market. There could be an opportunity around that. The main focus for now is how members could benefit individually, but there is a way we can use it to benefit the entire market.”

Beale says she has had good feedback from investors interested in ILS deals issued from London. She believes it represents a very positive move for London at a time of uncertainty in other areas.

“Once this comes into force, it is really good news for the London Market—it fills a gap in our financial services offering. We recently hosted a gathering of the Geneva Association’s chief investment officers and their reaction to this was very positive.

“There is capital around and this gives us and our members access to that capital to pass off some of our risks. Certainly, in the context of some of the other uncertainties the UK is facing such as Brexit, this is very good news,” she concludes.