CP15/24 – Proposed changes to the UK Insurance Special Purpose Vehicles (UK ISPV) regulatory framework

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Responses are requested by Friday 14 February 2025.

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1.1 This consultation paper (CP) sets out the Prudential Regulation Authority's (PRA) proposed reforms to the UK Insurance Special Purpose Vehicle (UK ISPV) regulatory framework, through a combination of changes to PRA rules, supervisory statements and statements of policy.

1.2 A Special Purpose Vehicle (SPV) is a vehicle which is authorised to securitise insurance risk. (Re)insurers transfer insurance risk to the SPV, which in turn issues an instrument (an Insurance Linked Security or ILS) which allows investors from the capital markets to fund the risk exposure. SPVs are used by (re)insurers as an alternative to traditional reinsurance methods.

1.3 In this CP and the appendices the term UK ISPV refers to special purpose vehicles (as defined in the PRA Rulebook Glossary) which are authorised and operate in the UK. The term special purpose vehicle (SPV) refers to special purpose vehicles (as defined in the PRA Rulebook Glossary), whether authorised in the UK or outside the UK.

1.4 The UK ISPV regime has seen limited uptake since its introduction in 2017. Feedback from market participants has been that the UK regime does not positively support the establishment of UK ISPVs. The PRA proposes amending its policy framework to allow the UK non life insurance sector to play a bigger role in the global ILS market, while continuing to offer policyholders a level of protection consistent with the PRA's objectives. The PRA considers that such changes will allow the UK ISPV regime to be more in line with global practice and make the regime more competitive.

1.5 This CP should be read in conjunction with policy statement (PS) 15/24 - Solvency II Restatement of assimilated law^{footnote [1]}, published on Friday 15 November 2024. PS15/24 implemented the conclusions of the Solvency II Review and finalised the PRA rules and other policy materials that will replace Solvency II assimilated law (which is being revoked by the Government in line with the approach of regulation under the Financial Services and Markets Act 2000) without substantive change. Accordingly Chapter 11 of PS15/24 sets out details of the PRA's restatement of regulations relating to UK ISPVs from the Commission Delegated Regulation (EU) 2015/35 (CDR) and Commission Implementing Regulation 2015/462 (CIR) into the PRA's policy framework also without substantive change. However, and as provided in CP5/24 - Review of Solvency II: Restatement of assimilated law, the PRA is now proposing substantive changes to the material described in Chapter 11 of PS15/24 in this CP.

1.6 The current requirements on UK ISPVs derive from a combination of the PRA's final policy outlined in PS15/24 and UK legislation. This CP proposes reforms to the UK ISPV regulatory framework in line with the PRA's primary and secondary statutory objectives. The PRA notes that some of the significant changes previously discussed with stakeholders^{footnote [2]} require legislative changes outside the PRA's remit. This is discussed further in paragraphs 1.9 to 1.10.

1.7 This CP sets out the proposed changes to the UK ISPV regime as follows:

a. Structural changes to:

• make clear that UK ISPVs can count realised investment returns that are retained by the vehicle to cover the aggregate maximum risk exposure (AMRE) and that the AMRE may increase over time commensurate with the realisation of investment returns that are retained in the vehicle;
• amend PRA rules to disapply the requirement that UK multi arrangement ISPVs (UK MISPVs) must be formed as Protected Cell Companies (PCCs) in cases where they assume risks under more than one separate risk transformation transaction and where those separate transactions constitute a single contractual arrangement;
• allow UK ISPVs to make use of grace periods in relation to the fully funded at all times (FFAAT) requirement in some scenarios; and
• clarify the use of Limited Recourse Clauses (LRCs) by UK ISPVs.

b. Process changes to:

• authorise, via an 'accelerated pathway', certain UK ISPV applications which meet criteria set out in the proposed new statement of policy (SoP, see paragraph 1.8) (eg some types of catastrophe bonds (cat bonds) are likely to meet the criteria); and
• simplify the authorisation of all other UK ISPVs.

The PRA has included indicative draft application forms at Appendix 6 to demonstrate what applicants would be asked to submit following these changes.

c. Updates to PRA expectations of (re)insurers ceding to SPVs:

• introduce general expectations for UK (re)insurers using SPVs as risk mitigation; and
• clarify expectations with reference to the use of SPVs to transfer long term insurance business risks that are subject to material market and credit risk.

d. Changes to the Senior Managers and Certification Regime (SM&CR):

• Creation of a new Senior Management Function (SMF) specifically for UK ISPVs, leading to fewer SMF applications being required for UK ISPVs.^{footnote [3]}

e. Consequential changes:

The PRA proposes to make other minor or consequential changes including to improve clarity and to reflect feedback received in CP5/24 that was beyond the scope of that consultation (as noted in Chapter 11 of PS 15/24).

1.8 The proposals in this CP would result in:

• changes to the Insurance Special Purpose Vehicles Part of the PRA Rulebook (Appendix 2).
• deletion of SS8/17 - Authorisation and supervision of UK insurance special purpose vehicles, since the substance is predominately in relation to the PRA's policy approach which has now been transferred to a proposed new statement of policy (SoP).
• a proposed new SoP - Approach to authorising and supervising UK insurance special purpose vehicles.(Appendix 4). This proposed new SoP includes material from SS8/17 plus amendments to reflect the proposals in this CP (see mapping table in Appendix 8). The proposed policy changes are discussed within this CP.
• a proposed new supervisory statement (SS) - Prudential considerations for insurance and reinsurance undertakings when transferring risk to Special Purpose Vehicles (Appendix 5). This proposed new SS reflects the proposals in this CP that update PRA's expectations of (re)insurers ceding to SPVs.
• changes to the Solvency II - Insurance - Senior Management Functions Part of the PRA Rulebook (Appendix 3).

1.9 In addition to proposals being consulted on within this CP, the PRA has identified other aspects of the UK ISPV regime that may be suitable for reform which lie outside of the PRA's regulatory framework. These include changes to allow for:

• multiple contractual arrangements via single cells of PCCs, dependent on the Risk Transformation Regulations 2017 (the RTR); and
• limited use of letters of credit as part of the funding of a UK ISPV, dependent on amendments to Article 284A of the Financial Services and Markets Act^{footnote [4]} (FSMA) and the Risk Transformation (Tax) Regulations 2017.

1.10 The PRA is working actively with HMT to assess and enable reform in these areas, if deemed appropriate, in addition to the proposals in this CP.

1.11 The PRA considers that the proposals in this CP will advance the PRA's primary objective of safety and soundness by maintaining a proportionate and robust regime for all UK ISPVs, and will advance the PRA's primary objectives of safety and soundness and policyholder protection by providing guidance for UK cedants transferring risks to SPVs on the prudential implications of such arrangements.

1.12 The PRA considers its proposals would provide clarity on the PRA's expectations of UK ISPVs. The PRA is seeking to support the use of prudent risk mitigation techniques, good governance, systems, and processes in the running of UK ISPVs, which would advance the safety and soundness of such firms. In building on existing requirements and expectations, that apply in respect of cedants' use of SPVs focussed on specific risk management considerations, the PRA seeks to advance cedants' safety and soundness.

1.13 The PRA considers its proposals would help foster a better understanding of its expectations in relation to the authorisation and supervision of UK ISPVs. This will enable market participants to make more informed decisions regarding their participation in the ILS market in the UK. Such participation is also likely to make it easier to raise new capital in the UK insurance market and would further promote the PRA's secondary objective of effective competition.

1.14 The PRA has assessed whether the proposals in this CP will advance the international competitiveness of the economy and the growth of the economy in the medium to long term. The PRA considers its proposals will make the UK ISPV regulatory framework more attractive globally, increasing international competitiveness and growth by making it more desirable to establish UK ISPVs, and providing diversification and additional sources of capital and reinsurance capacity. The PRA notes that measures such as LRCs, allowing retained realised investment returns to count towards covering the AMRE, grace periods and multiple contracts for non-PCC UK ISPVs are not uncommon in the international marketplace. In providing for or setting out more clearly how such mechanisms could be used within the UK's framework; the PRA considers the proposals will enhance the international competitiveness of UK ISPVs globally.

1.15 Additionally, the PRA considers that simplifying and accelerating the authorisation process and clarifying the PRA's expectations in relation to the authorisation and supervision of UK ISPVs will facilitate and promote the establishment of UK ISPVs. It will make it simpler for UK ISPV sponsors to apply for authorisation, thus supporting medium to long-term economic growth through increased transaction volumes. Furthermore, the PRA considers that establishing a more level playing field for UK ISPVs within the international ILS market might help support medium to long term economic growth in the UK.

1.16 This CP is relevant to UK ISPVs and firms wishing to obtain authorisation to be a UK ISPV, UK Solvency II firms, the Society of Lloyd's and its members and managing agents, (re)insurance groups, third country (re)insurance undertakings (including those that have a UK branch, a third country branch undertaking), and UK insurance holding companies. The CP may be of particular importance to:

• firms who wish to apply for, or have obtained authorisation as a UK ISPV; and
• firms seeking to use SPVs as risk mitigation.

1.17 The PRA considers that the benefits of the proposals outweigh the likely costs. The proposed structural changes are expected to be beneficial from a financial and resource cost perspective. One of the proposals is to allow UK ISPVs, which assume risks under multiple contracts comprising a single contractual arrangement, the choice of forming a PCC or not. This will potentially make it much more cost effective for firms to use UK ISPVs to renew risks or issue tranches in their risk mitigation plans. Similarly, the proposed procedural changes are expected to make it easier and quicker for firms to apply for UK ISPV authorisation. Market intelligence suggests that simplifying the documentation required for an application could result in a 20 - 25% reduction in the time and effort required to put together the needed documentation for an application. The CBA is discussed further in Chapter 8 of this CP.

1.18 The PRA has a statutory duty to consult when introducing new rules and changing rules (section 138J of FSMA), or new standards instruments (section 138S of FSMA). When not making rules the PRA has a public law duty to consult widely where it would be fair to do so.

1.19 The Insurance Practitioner's Panel^{footnote [5]} and Cost Benefit Analysis Panel^{footnote [6]} were consulted on the proposals in this CP. Feedback from the Cost Benefit Analysis Panel is included in Chapter 8.

1.20 In carrying out its policymaking functions the PRA is required to comply with several legal obligations. The analysis in this CP explains how the proposals have had regard to the most significant matters including an explanation of the ways in which having regard to these matters has affected the proposals.

1.21 'Have regard' considerations which are significant in the PRA's analysis include using its resources in the most efficient and economic way; imposing a burden in a manner which is proportionate to the benefits expected to result from that burden; exercising its functions transparently; encouraging economic growth in the interests of consumers and businesses; the desirability of the PRA exercising its functions in a way that recognises differences in the nature of, and objectives of, businesses carried on by different persons; and maintaining the competitiveness of the UK. The analysis of 'have regards' is discussed in more detail within Chapter 7.

1.22 The PRA consulted in 2022 via CP10/22 - ISPVs further updates to authorisation and supervision on proposed changes to its approach to authorising and supervising UK ISPVs. This was followed by PS12/22 which implemented these changes. These reforms focused on process changes to the regime which were within the control of the PRA. As part of the process of completing the adaptation of the UK's prudential regime for insurers inherited from the EU into a framework consistent with the UK's approach to financial services regulation, the PRA restated various regulations into the PRA Rulebook, including those related to UK ISPVs, via PS15/24, as outlined in paragraph 1.5 of this CP. The PRA now proposes amending the UK ISPV part of its policy framework to make further changes to the UK ISPV regime.

1.23 The proposals in this CP are structured as follows:

• structural changes to the UK ISPV regime;
• changes to the authorisation process;
• changes to expectations of (re)insurers ceding risks to SPVs;
• changes to the Senior Managers and Certification Regime (SM&CR); and
• consequential changes (in respect of minor policy changes).

1.24 The PRA proposes that the implementation date for the changes resulting from this CP would be mid-2025.

1.25 This consultation closes on Friday 14 February 2025.The PRA invites feedback on the proposals set out in this consultation. Please address any comments or enquiries to [email protected].

1.26 When providing your response, please tell us whether or not you consent to the PRA publishing your name, and/or the name of your organisation, as a respondent to this CP.

1.27 Please also indicate in your response if you believe any of the proposals in this consultation paper are likely to impact persons who share protected characteristics under the Equality Act 2010, and if so, please explain which groups and what the impact on such groups might be.

2.1 The PRA's current policy framework requires the AMRE to be FFAAT. The framework also allows for the AMRE to change over the life of a contractual arrangement if the contractual provisions clearly set out how and when the risk transfer and funding, and consequently the AMRE, may change.

2.2 The PRA recognises that the current framework may limit the ability of firms to use UK ISPVs for multi year risk transfer arrangements due to the upfront investment required to meet FFAAT. The PRA proposes to clarify that it will allow realised investment returns to contribute towards meeting the requirement of UK ISPVs to be FFAAT. The PRA considers that allowing the contractually agreed AMRE of a UK ISPV with a multi year contract to increase over time to reflect the realised returns from investment of the funds in the vehicle may potentially allow for a smaller upfront investment in the UK ISPV. This will also mean that investors may not need to inject further funds into the vehicle to cover an increase in the AMRE. The PRA considers that this will enhance the ability of firms to use UK ISPVs, making the regime more attractive to firms.

2.3 This proposal is subject to certain expectations, as outlined in the proposed new SoP. In particular since there is an increasing risk over time of actual returns being less than those assumed in the contractual arrangements, the PRA would only expect a maximum of 7 years of realised investment return allowance to be provided for in the contractual arrangements and expects that UK ISPVs take into account the requirements on how it invests its assets in Rule 2.6 of the Insurance Special Purpose Vehicles Part of the PRA Rulebook.

2.4 It should be noted that the PRA does not consider that discounting of the AMRE over time is appropriate and hence this should not be undertaken within the structure of a UK ISPV.

2.5 Cedants should be aware that the AMRE of the UK ISPV can be stepped up or down every year in line with the change in value of the assets in the vehicle and claims paid during the year. Consequently, the level of capital relief available to the cedant at any point should be no greater than the UK ISPV's AMRE.

2.6. A UK ISPV that takes on more than one contract for risk transfer from one or more cedants is a UK MISPV. PRA rules currently require all UK MISPVs to be PCCs. This means that a standalone UK ISPV cannot undertake more than one contract. A PCC can be thought of as being a limited company that has been separated into legally distinct portions ie cells. The income, assets and liabilities of each cell are kept separate from all other cells. Regulation 43(5) of the RTR does not permit more than one risk transfer contract per cell of a PCC.^{footnote [7]}

2.7 The PRA recognises that there may be certain circumstances in which a standalone UK ISPV may want to undertake a risk transfer which needs to be structured through multiple risk transfer contracts. This could enable the tranching of risks, which allows a risk to be split in multiple layers in order to cater for the preferences and risk appetites of different sets of investors. Multiple risk transfer contracts also allow firms to renew contracts without setting up an entirely new vehicle.

2.8 Under current PRA rules a UK MISPV must be a PCC. Hence where a standalone UK ISPV (currently a non-PCC) wishes to undertake more than one contract it needs to set up a new vehicle which can be both cost and time inefficient.

2.9 To address the issues outlined in paragraphs 2.7 and 2.8 the PRA proposes to change its rules such that UK MISPVs which undertake more than one risk transformation transaction, but which fall within the definition of contractual arrangement in the PRA rules, are not required to be a PCC. As part of this rule change the PRA also proposes to add a definition of risk transformation transaction to capture individual risk transformation contracts as distinct from a contractual arrangement.

2.10 This will enable UK MISPVs to undertake more than one risk transformation transaction, such as renewal or tranching of risks, within the same vehicle without needing to be formed as PCCs, as long as those transactions are a contractual arrangement as defined in Rule 1.2 of the Insurance Special Purpose Vehicles Part of the PRA Rulebook.

2.11 In the context of SPVs, a grace period is a defined period of time during which the requirement for an SPV to be FFAAT is not applicable. This allows time to ascertain the extent of funds which can be 'rolled over' from one risk transfer arrangement to another at renewal.

2.12 The use of grace periods is not allowed in the current UK ISPV regime. Certain other jurisdictions permit the explicit use of grace periods.

2.13 The PRA is aware that the requirement for UK ISPVs to be FFAAT can result in funding issues for renewals. The PRA considers that the allowance of grace periods will provide UK ISPVs and cedants with improved flexibility during rollover periods, as the use of a grace period allows time for any loss amount under the expiring contract to be determined and for investors to post the collateral needed, thereby avoiding over-collateralising, as would otherwise be needed during the grace period.

2.14 The PRA proposes to modify the rulebook to explicitly allow for a 30 - business day contractual 'grace period' at the start of a risk transformation transaction, subject to certain criteria. During the grace period the requirement for a UK ISPV or cell of a PCC to be FFAAT will not apply.

2.15 This would allow, with the joint consent of the investor(s) and the cedant, a period for the UK ISPV to duly execute the underlying documentation, fully fund a new risk transformation transaction and, where applicable, arrange collateral rollover after the risk period has started.

2.16 It is important to note that grace periods (and collateral rollover) can result in risks to individual cedants, including counterparty credit risk, operational risk and legal risk. The PRA therefore proposes to outline in the proposed new SS (see Proposal 7) that cedants transferring risk to SPVs who use grace periods should understand the risks related to their use and their own responsibilities in ensuring the risks resulting from the grace period are managed effectively.

2.17 A Limited Recourse Clause (LRC) has the effect of limiting an SPV's AMRE to the value of its assets. This means the SPV will never have to pay claims which are greater than the value of its assets. The PRA has neither required nor prohibited the use of such clauses in the past. However, the PRA has received feedback that its policy on the use of limited recourse to meet FFAAT is unclear.

2.18 The PRA proposes to clarify that it recognises that such clauses can be used to comply with the FFAAT requirement on an ongoing basis, subject to certain criteria being met. The PRA would not expect that such a clause would be relied on in order to comply with the FFAAT requirement at the inception of a risk transformation transaction.

2.19 LRCs can act to limit the maximum liabilities of an SPV to the value of the collateral held by it. However, the use of a LRC can increase the risk retained by the cedant, as it can lead to a reduction of expected reinsurance recoveries. In addressing this risk, the PRA states in the proposed new SoP that a LRC should not be used as an alternative to a sound risk management framework and investment strategy. The PRA's proposed new SS (see Proposal 7) also outlines how it expects cedants to manage the risk of LRCs being invoked.

2.20 The assessment of these proposals in terms of the PRA's primary and secondary objectives is described in Chapter 1 of this CP.

3.1 At present the PRA's authorisation commitment for UK ISPVs is 4 to 6 weeks for standard applications. The PRA has received feedback that this timeframe is slow in comparison to other jurisdictions and causes delays in marketing the securities that fund the vehicle.

3.2 Certain types of UK ISPVs tend to use standardised structures and have common contractual terms. This standardisation, both in terms of structures and the risks they pose, makes it possible for the PRA to assess and approve these types of UK ISPVs more quickly than other cases. The PRA proposes an accelerated pathway for vehicles with defined criteria, whereby the PRA would consider applications and, where satisfied, issue approvals within 10 working days of a completed application being submitted to the PRA.

3.3 The criteria for UK ISPVs to qualify for an 'accelerated pathway' are outlined in the proposed new SoP and are listed below:

• The risk transferred is:
  • non life insurance; and
  • has a clearly defined loss trigger^{footnote [8]} as per market standards which makes it clear when a loss has occurred.
• The vehicle is limited to a maximum 15 year life, at which point the vehicle will have to be terminated and all outstanding claims commuted.
• The funding for securities arises from a syndicated placement marketed via one or more investment banks or broker dealers to a range of Qualified Investors^{footnote [9]}, with the investment bank or broker dealer underwriting the issuance on a best efforts basis.
• The funding for the UK ISPV's obligations from assuming insurance risk from a cedant is obtained from debt securities and not equities.
• A legal opinion is prepared for the UK ISPV and other relevant stakeholders to the effect that (a) the transaction documents conform in all material respects to their description in the offering circular; and (b) the transaction documents that are core to the instrument's structure are enforceable; and such legal opinion is shared with the PRA as part of the application documentation.

3.4 The PRA expects that a placement of Rule 144A cat bonds is likely to meet the criteria above given their generally standardised legal structures, and are hence likely to be approved within the proposed 10 working days. However, it would be for an applicant to provide complete and sufficient evidence to the PRA that its application meets the criteria, for it to be approved within 10 working days.

3.5 In PS12/22 the PRA simplified the authorisation process for UK ISPVs. The PRA has since received feedback that the authorisation process could be made simpler still. The PRA proposes to make a number of changes which it hopes will allow for a faster and smoother application process for standard applications.

3.6 The PRA currently requires that certain documentation must be submitted as part of an application. The documentation is used by the PRA to assess that the vehicle can meet the FFAAT and other requirements. The PRA has observed that not all the documentation provides the required evidence in each individual case causing the PRA to review a large volume of documents which may not be relevant to the specific application. The PRA proposes to include a non-exhaustive list of documents in the proposed new SoP which are often relevant to a UK ISPV authorisation. This will be a modified version of the list currently provided in SS8/17- Authorisation and supervision of insurance special purpose vehicles ). Applicants would need to identify what documentation, whether from that list or otherwise, is relevant to their particular application to evidence the PRA's requirements, and submit those as part of the application process. The PRA expects that this will reduce the volume of documentation submitted, and should therefore allow the PRA to conduct the assessment more quickly by only reviewing those documents that the firm has identified as relevant. However, the PRA shall retain the right to ask for any further documentation not submitted by the applicant as part of the application process, but which the PRA deems relevant to the application and authorisation process.

3.7 The PRA proposes to provide further guidance on how it shall approach the authorisation and supervision of UK ISPVs in the proposed new SoP, including further information on supervisory reporting timelines.

3.8 The assessment of these proposals in terms of the PRA's primary and secondary objectives is described in Chapter 1 of this CP.

4.1 As outlined in paragraph 1.2, SPV refers to special purpose vehicles which are authorised in any jurisdiction. The PRA proposes to introduce a new SS setting out the PRA's expectations in respect of the use of SPVs by UK cedants. These expectations build on the PRA's existing requirements and expectations.

4.2 The proposed new SS provides UK cedants with clarity on the PRA's expectations for how firms transferring risks to SPVs should manage risks in relation to LRCs and grace periods.

4.3 To ensure firms appropriately consider the inherent risks of ceding to SPVs this proposed new SS also builds on existing PRA requirements and expectations that apply in respect of cedants' reinsurance arrangements, reinsurance exposure, risk management and solvency capital requirements calculations by setting out additional specific expectations in relation to the use of SPVs, though with no modification of the PRA's existing policy.

4.4 The PRA considers that the transfer of annuities and similar liabilities (such as Periodic Payment Orders (PPOs)) presents specific issues that need to be considered, not least because these types of liabilities will typically have a very long duration. The PRA anticipates that an SPV taking on this type of business would likely invest in assets with significant credit and market risks to be able to offer acceptable pricing to a cedant for the risk transfer. An investment strategy involving material market and credit risks would likely increase the probability of asset value deterioration within the SPV. This could result in the cedant not receiving the full return it may have expected if the vehicle had remained funded to the level of the maximum contract limit. The PRA does not consider the presence of a LRC to be a sufficient mitigant for the risk that these arrangements may not in fact result in effective transfer of risk.

4.5 The PRA also notes that, unlike traditional reinsurers, SPVs do not benefit from diversification across a broader range of risks and portfolios of liabilities. SPVs are also likely to have a more limited range of management actions available to respond to a deterioration in operating conditions. The PRA does not expect that a reduction in the overall level of capital held would be appropriate if risks from annuities or similar business were transferred to an SPV.

4.6 The PRA is therefore concerned that it would be very challenging to meet the requirements of effective risk transfer for annuities or similar business in a way that allows competitive pricing of the risk transfer. The PRA is therefore proposing to set an expectation that UK firms should not use SPVs to transfer risks from annuity or similar business. However, the PRA considers that it may be appropriate for firms to use SPVs to transfer extreme mortality or healthcare risks provided that the risk transfer arrangement meets other relevant requirements and expectations.

4.7 The assessment of these proposals in terms of the PRA's primary and secondary objectives is described in Chapter 1 of this CP.

5.1 The PRA proposes to change the definition of the Chief Executive function (SMF1) for UK ISPVs. At present UK ISPVs require at least three designated SMF roles (a Chair, CEO and CFO), although the PRA currently allows the same person to hold all three SMFs. Under the proposal these three SMFs would no longer be needed. Instead, just a CEO for UK ISPVs (SMF1) would be sufficient for all UK ISPVs.

5.2 The PRA recognises that the role of a CEO for a UK ISPV is of a different nature compared to CEO roles in other types of regulated firms, in view of UK ISPVs' specific and narrow business models. For this reason, the PRA proposes rules and expectations that will define the particular SMF1 responsibilities in UK ISPVs. The PRA is interested in understanding from respondents whether this proposal is sufficient to address the unique nature of UK ISPVs or whether a specific UK ISPV only designation would be preferable.

5.3 The PRA considers that requiring only one SMF for these entities reflects the limited nature of the transactions undertaken by UK ISPVs and will make applications quicker and easier.

5.4 The PRA considers that this UK ISPV SMF1 is important for the ongoing safety and soundness of a UK ISPV. The PRA proposes to amend the PRA Rulebook to reflect the new SMF1 definition for UK ISPVs. The PRA proposes to amend Chapter 12 of the Insurance Senior Management Functions Part of the PRA Rulebook to require a UK ISPV to appoint a person to perform the Chief Executive function, define the responsibilities of chief executive function for a UK ISPV, and clarify that the other PRA senior management functions do not apply to a UK ISPV.

5.5 The PRA also proposes in paragraph 3.28 of the proposed new SoP that generally only one individual would need to hold the SMF1 role for ISPVs. The PRA expects the UK ISPV to propose contingency plans in the event that the individual is not able to continue in the role.

5.6 The PRA recognises that in the case of certain complex structures there may be a need for more than one person to hold the UK ISPV SMF1 role, and expects that firms appoint more than one UK ISPV SMF1 only where appropriate and justified. Where two or more individuals perform the UK ISPV SMF1 each will be deemed fully accountable for all the responsibilities inherent in or allocated to that function. It may also be appropriate in some cases to appoint an SMF 3 (executive director) where it felt it was relevant, such as in a complex structure.

5.7 Firms should consider any potential conflicts of interest and how they shall be addressed while appointing any SMFs. It is also acknowledged that, provided there are no conflicts of interest, an SMF role or individual deemed to be effectively running the UK ISPV could be held by a suitably senior employee or director of a third party such as an outsourced service provider.

5.8 The assessment of these proposals in terms of the PRA's primary and secondary objectives is described in Chapter 1 of this CP.

6.1 The PRA proposes to make the following minor consequential changes to reflect the structural proposals outlined in paragraphs 2.1 to 2.20, to improve clarity and to reflect feedback received that was beyond the scope of CP5/24 (as noted in Chapter 11 of PS 15/24).

6.2 The PRA proposes clarifications to the fully funded requirements for cells within UK MISPVs in rule 2.1 of the Insurance Special Purposes Vehicles Part and the rules for UK MISPVs in Chapter 4 of the Insurance Special Purpose Vehicles Part.

6.3 The PRA proposes other minor changes to the PRA rules to clarify the requirements for UK ISPVs, for consistency with the proposed new SoP or as consequential changes. These include:

• adding a specific requirement to notify the PRA of any change to shareholders or members that have a qualifying holding;
• moving systems of governance and risk management requirements to its own Chapter of the Insurance Special Purpose Vehicles Part; and
• updating cross references to the rules in the Insurance Special Purpose Vehicles Part of the PRA Rulebook.

6.4 The assessment of these proposals in terms of the PRA's primary and secondary objectives is described in Chapter 1 of this CP.

7.1 The PRA considers that the proposals set out in this CP form part of an overall package. The proposed implementation of changes to the structural, authorisation and SM&CR parts of the UK ISPV framework, and the proposed changes to PRA expectations of cedants to SPVs are considered interlinked.

7.2 Consequently, the have regards analysis has been completed as a standalone chapter rather than a consideration in each individual chapter.

7.3 In developing these proposals, the PRA has had regard to its framework of regulatory principles. The regulatory principles that the PRA considers are most material to the proposals include:

1. The need to use the PRA's resources in the most efficient and economic way: the PRA considers that the proposals which clarify its expectations for UK firms that transfer risks to SPVs will help supervisors be more efficient in determining whether a firm meets the PRA's requirements or not. The PRA considers that the proposals to create an accelerated pathway authorisation process are in line with efficient use of PRA authorisation and supervision resources by proposing that clear and coherent documentation is required from firms. The PRA considers that its proposals introduce changes to its expectations for UK ISPV applications to take a more proportionate and risk based approach. The PRA considers the proposals would therefore enable its resources to be used in the most efficient way by focusing on the mandatory authorisation requirements.
2. The principle that a burden which is imposed on a person should be proportionate to the benefits expected to result from that burden: the PRA considers that setting out clear expectations eg for UK ISPV standard applications, would allow both the PRA and the applicant to take a more proportionate and risk based approach to these types of applications. The PRA also expects the costs for both the PRA and the applicant to be proportionate to the benefits.
3. The desirability of sustainable growth in the economy of the UK in the medium or long term: the proposals would likely aid the UK ISPV market to attract more applicants in the medium to long term as an alternative to other jurisdictions, contributing to sustainable growth in the UK economy.
4. The principle that the PRA should exercise its functions as transparently as possible: the PRA considers that making the proposed changes to the PRA Rulebook in addition to expectations on UK ISPVs and cedants to SPVs would make it clearer what the PRA's rules are around the UK ISPV regime, and hence make the execution of the PRA's functions more transparent.
5. Supporting the government's objective to promote the international competitiveness of the UK: the PRA considers that financial services are international in their nature. In developing the proposals the PRA has considered the commercial considerations necessary for the establishment and operation of UK ISPVs. The PRA considers that implementing the proposed changes to the UK ISPV regime will make the UK more attractive for firms establishing UK ISPVs and cedants globally. Additionally, the accelerated pathway authorisations process may make it more attractive for firms to issue such vehicles in the UK.
6. Supporting the government's objective to promote medium to long term economic growth in the interests of consumers and businesses: the PRA considers that the UK financial services sector is an important contributor to sustainable economic growth. The proposals would encourage trade in the type of financial services UK ISPVs provide and aid growth in the sector.
7. Responsibility of senior management: the purpose of the SM&CR is to strengthen individual accountability in order to achieve better prudential outcomes. None of the proposals seek to reduce individual accountability under the SM&CR.
8. Recognition of differences in business:as the proposals make different recommendations for UK ISPVs and cedants, and for annuity or similar business exposed to material market and credit risk, the PRA considers that the proposals recognise the differences in the nature of firms' businesses.

7.4 The PRA has had regard to other factors as required. Where analysis has not been provided against a 'have regard' for these proposals, it is because the PRA considers that 'have regard' to not be a significant factor for these proposals.

7.5 The PRA considers that the impact of the proposals in this CP on mutuals is expected to be no different from the impact on other firms. This is because the rules and expectations used as a basis for the proposals do not apply differently to mutuals from other firms.

7.6 In developing its proposals, the PRA has had due regard to the equality objectives under s.149 of the Equality Act 2010. The PRA considers that the proposals do not give rise to equality and diversity implications. The PRA is available to answer any questions that any impacted readers may have from these proposals.

8.1 The benefits and costs of the proposals are outlined below. Unless otherwise indicated the baseline is the PRA's current policy framework for UK ISPVs which is based on the restatement of Solvency II assimilated law as outlined in PS15/24.

8.2 Overall the PRA expects the benefits of the proposals to exceed the costs. The UK, in particular the London Market, is a centre for global insurance and the PRA considers that as a package the benefits outweigh the costs because the proposals bring the UK ISPV regime more in line with global practice and make the regime more competitive. The proposals would facilitate more ILS deals through the UK, increasing diversification of available capital for PRA regulated (re)insurers (supporting the PRA's primary objective of safety and soundness), and increasing capital availability for the (re)insurance market (advancing both the PRA's secondary competition objective and its competitiveness and growth objective). Even though the proposal on grace periods could have introduced some marginal additional risk to the PRA's primary objectives, the PRA believes it has mitigated this potential risk through expectations outlined in the PRA's proposed new SS on the use of SPVs for risk mitigation.

8.3 The current framework may limit the ability of firms to use UK ISPVs for multi year risk transfer arrangements due to the upfront investment required to meet FFAAT. The PRA proposes to clarify that the AMRE of the vehicle can change over the duration of a multi year risk transfer and that it will allow realised investment returns to contribute towards meeting the requirement of a UK ISPV to be FFAAT.

8.4 By using investment returns to meet the AMRE, UK ISPVs could match the likely loss profile over a longer term and allow a smaller upfront investment in the vehicle. The actual quantum of benefit would depend on how the actual investment returns compare to those expected and the length of the investment (up to a limit of 7 years). Allowing for a smaller upfront investment could be a benefit for investors if they will be able to invest the remaining funds elsewhere at greater returns. Since the amount of investment required upfront is reduced it could also potentially make the investment more attractive to a broader range of investors, aiding dispersion of risk.

8.5 There is a risk of the returns on the investment not matching the increase in risk exposure over time. This would mean a cost to cedants if lower returns mean the vehicle does not have sufficient funds to meet the increased risk exposure. However, the PRA expects these costs to be limited given that the PRA limits the investment allowance to 7 years. There is also a risk that UK ISPVs implement investment strategies with higher risk in order to seek higher investment returns. However, this is mitigated by the investment expectations for UK ISPVs that PRA has outlined in the proposed new SoP. A firm ceding to a UK ISPV which was allowing an increase in AMRE for investment returns would need to monitor what cover is available each year. However, the PRA expects that this could be managed as part of cedants regular risk management.

8.6 The PRA proposes to change its rules such that UK MISPVs which undertake more than one risk transformation transaction, but which fall within the definition of contractual arrangement in the PRA rules are not required to be a PCC. This means that firms will be able to conduct renewals and tranching of risks within the same vehicle and will not need to set up separate UK ISPVs.

8.7 The PRA expects that this has the benefit of reducing costs for firms. Market intelligence indicates that frictional costs such as this one have made UK ISPVs less attractive when other jurisdictions offer more flexibility. Allowing a firm to use the same vehicle to handle renewals will eliminate the costs in setting up a new vehicle. The PRA estimates that while a first time contract can take 4 to 6 weeks, a renewal can be done in as little as a week, with commensurate reductions in cost. This reduction in time is important given that such transactions by the UK ISPV are often time sensitive and may not be agreed till the UK ISPV is authorised. This means a longer authorisation time for a UK ISPV could impact whether an ILS deal is executed or not.

8.8 Similarly, a transaction with for example three tranches being carried out in one vehicle should result in the transaction costs of roughly a half to one third of the current situation (as only one vehicle rather than three; as per current rules, would be required). The exact size of the benefit to a given firm would depend on the difference in cost of setting up a new vehicle versus the cost of adding a tranche to an existing vehicle. However, given setting up a vehicle has fixed costs that are unrelated to the number of tranches, the PRA expects that the cost of a tranche is expected to be much lower than the cost of setting up a new vehicle.

8.9 Assuming that adding a tranche to a transaction is much like a renewal, the PRA's market intelligence indicates it can likely be done in a quarter of the time with commensurate reductions in cost. This is assuming costs such as professional fees are time based and reduce proportionately. As the number of tranches rises, the benefits increase.

8.10 The PRA expects this proposal to result in minimal costs for firms. Firms may need to build in mechanisms to the structure of the UK ISPV to ensure that monies from different contracts do not become co-mingled (such as separate trust arrangements or other market mechanisms). However, as firms could continue to choose to be a PCC if they wish, they would incur this related cost only if the benefits outlined above outweigh the cost.

8.11 The PRA proposes to modify the rulebook to explicitly allow for a 30- business day contractual grace period at the start of a risk transformation transaction subject to certain criteria.

8.12 Grace periods are described in paragraphs 2.11 to 2.16. In a renewal, the grace period gives all parties the time to ensure that the outstanding losses from the expiring contract are appropriately calculated and existing contracts are commuted. This means greater certainty of the estimated losses underlying the contract terms and pricing or all parties involved. A large benefit, though one that is difficult to quantify, is that there would be additional deals occurring. This is because the grace period would also facilitate deals which currently do not take place without a grace period being present.

8.13 Further, there is a liquidity benefit for the ISPV market. In the absence of grace periods, in order to meet the FFAAT, fresh investment will be needed every time a contract is renewed. This is because there would not be enough time to ascertain how much funds could be rolled over from the expiring contract to the renewing contract. This allows the market to handle a greater level of transactions than might otherwise have been possible.

8.14 In addition, there are benefits of capital efficiencies from using a grace period, as the investment will not be needed during the grace period, which can be used in other manners as the investor deems appropriate. Given that the investment returns from a UK ISPV are likely to be low (since the monies are likely to be invested in low risk, liquid assets) and since the cost of capital for investors is much higher, this provides a spread benefit to the investor for the period of the grace period.^{footnote [10]} The exact quantum of the benefit would depend on the actual spread which might be available to the investor.

8.15 During the grace period, the cedant is effectively retaining the risks it was expecting to transfer to the UK ISPV. If the investor does not fund their investment obligations during or at the end of the grace period and a covered event occurred during the grace period, while limited recourse will limit the payments from the UK ISPV, the cedant will be 'out of pocket' as it may not receive the monies it would have expected to recover under the reinsurance agreement with the UK ISPV.

8.16 There could be a risk of the investor defaulting during the grace period, which would mean alternative investment would need to be secured to meet FFAT when the grace period expires, if the investor's assets are tied up elsewhere at the time funding is expected.

8.17 The PRA proposes to clarify that it recognises that Limited Recourse Clauses can be used to comply with the FFAAT requirement on an ongoing basis, subject to certain criteria being met.

8.18 Firms, including those who do not currently use the UK ISPV regime, will have certainty that the PRA will accept limited recourse to satisfy FFAAT subject to certain conditions, such as meeting effective risk transfer.

8.19 Use of limited recourse could mean that cedants have a greater risk of not being paid fully. However, as almost every deal the PRA has seen in UK ISPVs until now has included a limited recourse clause within its contracts. Hence, the PRA considers that this clarification will have no cost for cedants relative to the current baseline.

8.20 The PRA proposes, for vehicles with defined criteria, to consider applications and, where satisfied, issue approvals in 10 working days of a completed application being submitted to the PRA. The baseline is the current authorisation process where all standard UK ISPVs are expected to be authorised within 4 to 6 weeks.

8.21 Due to the importance of speed in this market, a faster authorisation means a quicker time to market for certain UK ISPVs such as cat bonds. A reduction in approval times, from 6 weeks to 10 working days, will result in commensurate cost reductions for the firm. This is assuming costs such as professional fees are time based and reduce proportionately.

8.22 The PRA considers that this proposal has no costs to firms. However, there could be increased resourcing costs to PRA if additional staff are required to enable applications to be processed within the accelerated timeframe. While the accelerated pathway might increase the risk that some ISPVs might be approved when they should not have been, the PRA does not think this risk would be significant as this will only be available for vehicles with defined criteria.

8.23 The PRA proposes to make a number of changes which it hopes will allow for a faster and smoother application process for standard applications. The baseline is the detailed list of documentation required for an application as shown in Appendix B of SS8/17.

8.24 Simplified documentation requirements will make it easier to apply for a UK ISPV. Based on market intelligence, the PRA expects that simplified documentation will result in a 20 - 25% reduction in the time to put together documentation for an application with commensurate reductions in cost.

8.25 If the simplified documentation requirements are not readily understood by firms, this could result in too little information being provided upfront to the PRA. This could result in further delays, extending the time for approvals, ultimately resulting in higher costs.

8.26 There are no restrictions on UK firms ceding annuities and similar risks to SPVs anywhere in the world. However, the PRA's current policy framework (the baseline), it is unclear that the PRA has concerns regarding the long-term management of market and credit risk ceded by UK firms to SPVs. In practice, the PRA has not generally approved UK ISPVs that accept annuities or similar risks.

8.27 Firms will have clarity on the PRA's expectations with regards to the use of SPVs and the transfer of annuities and long duration risks. This will mean that there will be limited need for lengthy discussions between the PRA and firms on each case, particularly while authorising UK ISPVs, thereby reducing both time and costs for firms and the PRA.

8.28 The immediate cost to firms is that they will generally not be able to cede annuities or similar long duration liabilities to SPVs (or as a UK ISPV, accept annuities or long duration risks). Compared to the current baseline the PRA estimates that the current costs are zero based on the negligible number of annuity ILS deals the PRA has observed in the UK. However, this cost may increase if demand for annuity SPV transactions increases in future.

8.29 The PRA notes that this change could impact potential future industry needs. There could also be opportunity cost from an economic perspective if increased future demand results in other jurisdictions benefiting from increased annuity SPV transactions.

8.30 The baseline is the PRA's current policy framework. At present, UK ISPVs, require at least three designated SMF roles (a Chair, CEO and CFO), although the PRA allows the same person to hold all three SMFs. Under the proposal these three SMFs would no longer be needed; instead, just a CEO (SMF1) would be sufficient. The PRA proposes rules and expectations that define the SMF1 responsibilities in UK ISPVs.

8.31 The replacement of the current requirement for one Senior Manager holding three SMFs (chair, CEO and CFO) with a single UK ISPV CEO (SMF1) would benefit firms as it is a modest improvement in efficiency of delivering documentation. Requiring UK ISPVs to only have one SMF would also be more proportionate to reflect the limited nature of the transactions undertaken by UK ISPVs.

8.32 Moreover, requiring only one SMF for these entities will make applications quicker and easier for firms to submit and for the PRA to assess and process.

8.33 While, in the long term, costs to firms should be reduced, there may be transitional costs associated for firms with adjusting to the responsibilities as set out in the rules and requirements for the new UK ISPV SMF1.

8.34 The PRA proposes other minor and consequential changes to the PRA policy materials.

8.35 The PRA considers that its proposed changes would provide clarity to firms and ensure there is greater transparency around the PRA's requirements. These proposals would also reduce the need for the PRA to clarify its approach or provide further explanation on a case-by-case basis, including regarding the interpretation of certain PRA rules.

8.36 The PRA considers that these proposals would improve the consistency of the PRA Rulebook as a whole.

8.37 The PRA considers there would be no costs associated with these proposals.

8.38 The PRA has consulted the CBA Panel ('the Panel') on the preparation of this CBA. The PRA submitted a draft CBA for the Panel to review prior to a meeting to discuss its feedback and advice. The Panel provided feedback on the way the draft CBA addressed: the proposals' positive economic benefits and how these advance the PRA's primary and secondary objectives; cost of capital estimate for the grace period CBA; and potentially additional costs associated with the accelerated pathway and simplification of the approval process. In summary:

• the Panel recommended that the overall economic benefits of the proposals should be further explained to demonstrate how the proposals advance the PRA's primary and secondary objectives and outweighed the costs. Paragraph 8.2 now describes that the proposals would increase diversification of available capital (supporting the PRA's primary objective of safety and soundness), and increase capital availability for the (re)insurance market (advancing both the PRA's secondary competition objective and its competitiveness and growth objective);
• the Panel queried the cost of capital estimate for the grace period CBA. The analysis and estimate in paragraph 8.14 and footnote 10 have been amended to make the calculation and assumptions clearer;
• the Panel commented that a smaller upfront investment (under the AMRE proposal) could lead to a broader range of investors which would be good for dispersion of risk. Paragraphs 8.4 and 8.5 of this CP have been amended to reflect the Panel's feedback;
• the Panel commented that the accelerated pathway could increase the risk that some ISPVs might be approved when they should not have been. Paragraph 8.22 of this CP has been amended to include this potential risk; and
• the Panel commented that there could be an additional cost under the Simplification of Authorisation process proposal, set out in paragraphs 3.5 to 3.7, if requests for additional information, which had been previously provided upfront but would no longer be under the simplification of authorisation process, result in delays. Paragraph 8.25 of this CP has been amended to include this potential cost.

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