Clifford Chance

The PRA has responded to calls to make improvements to the UK's regulation of Insurance Special Purpose Vehicles ("ISPVs") to make the UK more competitive as an international ILS destination.

The PRA made two significant announcements in July last year:

(i) a "green channel" to fast-track certain 1 SPV applications; and

(ii) the planned introduction of a standardised Scope of Permission ("SOP")

On 16 December last year, the PRA published its updated Policy Statement: PS12/22 – Insurance special purpose vehicles: Further updates to authorisation and supervision, which updates Supervisory Statement SS8/17.

The effect of the proposed changes is that they should increase the speed of authorisation for the most common "standard" ILS structures and lighten the burden on applicants.

What is changing?

"Standard" applications

In CP10/22, the PRA stated that they will aim to provide a decision on authorisation of "standard" applications within 4 to 6 weeks of the application being made, with the PRA also developing a standardised SOP for such "standard" applications. This has not explicitly been included in SS8/17 where "relatively straightforward" applications are still to be reached "within 6-8 weeks".

"Standard" applications will generally be those that are "short-tail, wholesale, general insurance risks". In its ISPV FAQ guidance, the PRA explained that they are likely to consider "applications with no bespoke issues or non-standard clauses, e.g. a straightforward rule 144A cat bond" to be assessed "as standard". However, it remains unclear which characteristics would cause an application to be deemed "complex". In practice, this should be able to be addressed by early engagement with the PRA prior to making an application.

In our response to the consultation, we encouraged the PRA to extend its concept of transactions that it considers standard, for example, focusing on "standard" terms required for compliance with the key requirements of the Commission Delegated Regulations 2015/35 (as transposed) which would allow greater flexibility for non-cat bond risks to be written through the UK and therefore allow the UK to compete more effectively. In its response to CP10/22, the PRA noted that this was outside the scope of the CP10/22 but interestingly the PRA have acknowledged that it may be considered in the future as part of its further policy making process.

Regulatory approval timing is one of the most critical features in sponsors choosing where to carry out a transaction. Whilst the PRA's commitment in CP10/22 to a 4-to-6-week timeframe to approve "standard" applications is encouraging, the ISPV FAQ further provides that "the PRA will endeavour to let the applicant know within 2 weeks of beginning the pre app process that the application has been identified as a standard application". This suggests that there is at least the possibility of a 6-to-8-week timetable even for "standard" applications. As such, early engagement remains important notwithstanding that the formal approval timeline is potentially much shorter.

The availability of a standardised SOP for PCCs would potentially shorten the timeframe for transactions and allow greater flexibility to investors. Although we await further details of the PRA's promised "standardised" SOP, it potentially opens the pathway for greater use of "platform" applications similar to the innovative Lloyd's ILS "London Bridge" platforms on which we advised. The London Bridge 2 precedent demonstrates that there are opportunities to bring transactions to market through a UK PCC with an appropriately crafted SOP without the need to seek approval for new cells once the initial "platform" has been approved.

This appears to offer the swiftest route to market, once the PCC has been authorised. This could be achieved through a SOP that provides that the terms of the transaction documents can be flexible provided that they include certain mandatory terms agreed with the PRA (e.g. defining the aggregate limit and limited recourse funds for fully funded purposes). Each cell could then also transact without the need for additional authorisation and only where a transaction deviates from the SOP would additional PRA approval be required. This would remove the need to authorise new cells in the ordinary course, for each new potential transaction of that PCC.

Multiple cedants ceding risk to a single cell via a single contract

The PRA have also confirmed that they will allow more than one insurance entity from a group to cede risks within a single contract to an ISPV (or a cell of an MISPV) as long as "the intention is to cede as a group" and the multiple cedants are "part of the same insurance group (as per Solvency II or FSMA) or are Lloyd's syndicates managed by the same managing agent with a shared economic interest".

Whether multiple cedants can cede to a single cell will be at the PRA's discretion and will be subject to a number of criteria, including the risks being short-tail, wholesale, and general insurance; and ensuring that requirements related to effective risk transfer, fully funded, and subordination of investor rights to ceding parties were met.

"Group" will be defined in accordance with the Financial Services and Markets Act 2000 definition of "group" which is slightly broader than the Companies Act 2006. This is a welcome change as it would provide flexibility for insurance groups. However, multiple cedants who are not part of the same group but with aligned interests, such as co-insurers, would not be able to cede risks to the same cell.

Single SMF

The PRA will now permit one individual to hold more than one Senior Management Function ("SMF") role for "standard" applications. The PRA clarifies in PS12/22 that in appointing the SMF, the firm should consider any potential conflicts of interest and how they shall be addressed. As such, whenever all three SMF roles are held by the same individual, the ISPV should have contingency plans in the event that the individual is not able to continue the role.

Historically, outsourced service providers, such as the insurance manager, have taken the CEO or CFO function, leaving the chair with the oversight role. Potential conflicts should be considered as the SMF would need to have oversight of the performance of the ISPV, including of its insurance manager. If an outsourced insurance manager is used, we would recommend that the insurance manager is not the single SMF. If ISPVs would like to appoint an outsourced insurance manager as an SMF, it may be preferable to appoint another SMF for the other SMF functions.

Quantifiable risk

The PRA's assessment of the solvency of the ISPV requires it to take into consideration the quantifiable risks of the special purpose vehicle. The PRA have clarified its interpretation on the definition of "quantifiable risk" in relation to "standard" applications. The concept of "quantifiable risks" is understood under Solvency II to mean all risks that can be quantified, and firms will need to consider the quantifiable risks relevant to their proposed arrangements. However, in relation to "standard" applications, the PRA would generally expect quantifiable risks to capture, at the least, insurance risk, market risk, operational risk, and asset risk which may exist in the ISPV. The PRA considers that this will make it easier for ISPVs to assess their quantifiable risks relevant to their arrangements, and consider that a better understanding of their risks is likely to allow them to make more informed risk management decisions, which in turn is likely to improve their safety and soundness.

Legal opinions and written policies

The PRA will no longer expect a legal opinion for non-English law governed contracts, nor require the full suite of written policies in relation to the system of governance, especially for "standard" applications. In PS12/22, the PRA clarified that the PRA would expect to see a summary description of the written policies in place that are proportionate to the uses and systems of governance requirements of the ISPV.
However, it would remain at the PRA's discretion to request a legal opinion, or request to see the written policies (or a sample) and this would be assessed on a case-by-case basis.

Conclusions

In our view, these are extremely encouraging steps on the path to create a UK regime which is flexible, pragmatic and user-friendly within the prudent and substantive regulatory supervision that the PRA offers.

The changes might not be enough to compete in the well-established international cat bond market, but the UK could offer a real point of difference if the "standard" regime can be extended in the future to a variety of non-cat risks that leverage the local London Market expertise (e.g. cyber, pandemic, life).

The PRA's proposals to use a standardised SOP for PCCs and their appetite to approve platforms based on the "London Bridge" precedent, are particularly exciting and present a real opportunity for applicants who are interested in multiple issuances.