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London outrun by Bermuda on catastrophe bonds

Ambitions to turn London into a hub for the $70bn insurance-linked security market, one of its fastest growing sectors, face being scuppered by a slow moving regulatory approach.

The government wants to introduce new rules that would make it possible to issue these ILS securities in the UK, but industry insiders say that the proposed timetable for approving them would make the new regime uncompetitive against established rivals such as Bermuda.

The securities, which include catastrophe bonds and more bespoke collateralised vehicles, allow insurers and reinsurers to pass risks — often related to US windstorms — on to investors such as pension funds. They have been growing rapidly as investors are attracted by their annual returns of mid- to high-single digits that are not correlated with financial markets.

Some also see scope for ILS vehicles to expand beyond weather-related risks. Terror attacks and cyber risks are among those that could be covered, says Des Potter of insurance broker Guy Carpenter. Others see the potential for life insurance related ILS, for example covering longevity risks.

According to Guy Carpenter, the amount of capital employed in ILS vehicles has doubled since 2012, and is growing at a rate of 19 per cent a year.

However, London has lagged behind rival insurance centres such as Bermuda and Dublin as it lacks a suitable legal structure for ILS vehicles. The UK government has been working on plans to legalise them since 2014 and the project has been given added impetus since the Brexit vote in June.

With London-based insurers eyeing alternative domiciles in other parts of the EU, ILS is seen as a way to ensure that the city remains a hub for the industry.

“What London did not have was the legal structure for ILS vehicles nor, then, for the tax and regulatory framework to domicile vehicles in the UK,” says Michael Wade, a senior adviser to the Cabinet Office. “It is so important for London to re-establish its lead position in this area of risk transfer. ILS is a game changer if we can get it right.”

Draft ILS rules were issued alongside the Autumn Statement last month, and the Prudential Regulation Authority, the UK’s insurance regulator, also put out details of its proposed approval process. Once it has approved the company that issues the securities, it wants ten days to approve each new vehicle. That, say people in the ILS market, is too long.

“It is not as fast as Bermuda,” says Katherine Coates, a partner at law firm Clifford Chance. “Bermuda . . . allows post transaction notification. If the London market could get that it would be fantastic. We want to demonstrate that we have a rigorous regulatory system, but need flexibility to get the market up and running.”

Malcolm Newman of the London Market Group, an industry association, agrees. “You can’t tell a client in this market that a deal is subject to regulatory approval. Some clients would go to other jurisdictions.”

Mr Newman is hopeful that the PRA will refine its approach when the consultation period on its rules finishes next February.

The PRA declined to comment.

A legal framework for ILS vehicles would, its backers believe, attract a host of other activities and jobs from administration to fund management to London, and so provide a boost to the economy. They also hope that the regime would help to expand the market size by encouraging more investors to put money into ILS.

“Investors in continental Europe are not comfortable transacting with some jurisdictions,” says Luca Albertini, chief executive of specialist ILS fund manager Leadenhall Capital Partners. “Continental Europeans prefer having onshore jurisdictions.”

For its part, Bermuda is relaxed about the potential threat from London. Greg Wojciechowski, chief executive of the Bermuda Stock Exchange where $19bn of cat bonds are listed, says: “I don’t see it as a competitive play at all. We see their ability to expand into other areas than we do . . . if the pie expands, there’s more of the pie to go around.”

However, he adds that any new ILS regime will face challenges. “We have areas of strength in Bermuda that aren’t going to be easily replicated elsewhere.”

Timing, he says, is crucial. “Speed to market is critically important for this industry. Financial markets get totally unnerved by uncertainty. It can be a deal killer.”

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