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Consultation Paper No. 36 -
Draft CEIOPS Advice for Level 2 Implementing Measures on Solvency
II:
Special Purpose Vehicles
1. Introduction
1.1. Background
1.1. In its letter of 19 July 2007, the European Commission
requested CEIOPS to provide final, fully consulted advice on Level
2
implementing measures by October 2009 and recommended CEIOPS to
develop Level 3 guidance on certain areas to foster
supervisory convergence.
1.2. This Paper aims at providing advice for Level 2 measures with
regard to Special Purpose Vehicles (SPVs), as required in Article
209 of the General approach on the Solvency II Directive proposal
adopted by the ECOFIN Council on 2 December 20081 (“Level 1
text”), addressing the authorisation, regulatory requirements and
scope of supervisory review that relate to the establishment of
SPVs under Solvency II.
It also includes material
that could be considered for Level 3 guidance.
1.3. SPVs are specifically addressed in the Directive because it
is recognised that appropriate rules should be provided for SPVs
as they differ from traditional reinsurance undertakings.
The
purpose of introducing the definition of SPVs in the Directive is
to allow alternatives to reinsurance contracts and reinsurance
undertakings that provide ‘reinsurance like’ services to insurers
and reinsurers.
Supervisors acknowledge that there are risks
inherent in using SPVs and hence an appropriate supervisory regime
needs to be established to protect policyholders and to avoid
systemic risks.
On the other hand,
SPVs can play a role in
facilitating alternative risk transfer and bespoke risk management
solutions that enable undertakings to better align their risk
profile with their risk tolerance and SPVs may provide additional
reinsurance capacity at times in which cover through more
traditional channels is limited.
CEIOPS is therefore looking to develop a regime for SPV that
protects policyholders of undertakings while at the same time not
preventing innovation in the insurance industry.
1.4. The Level 1 text in Article 209, highlights five distinct
areas to be addressed by way of Level 2 implementing measures,
these being:
i. The scope of authorisation;
ii. Mandatory conditions to be included in contracts issued;iii.
Governance requirements (including fit and proper requirements for
shareholders and persons running the SPV and sound administrative
and accounting procedures, adequate internal control mechanisms
and risk management requirements);
iv. Supervisory reporting (accounting, prudential and statistical
information requirements); and
v. Solvency requirements.
1.2. Scope of this paper
1.5. It is important to note the scope of Articles 13(22)
(definition of an SPV for the purposes of the Directive) and 209
(relating to the establishment of SPVs within the territory of
Member States) which determine the scope of this paper.
This paper deals with SPVs as defined in the Directive, that is SPVs that reinsure risks from a (re)insurance undertaking and that
assume risks under an arrangement that has the economic substance
of a reinsurance contract by transferring insurance risk from a (re)insurance
undertaking to third parties (in this case investors).
The paper therefore does
not
deal with the following:
• the requirements on the best estimate liabilities for
undertakings who use SPVs (per Article 80) – to be covered by
Level 2 implementing measures or Level 3 guidance relating to
Article 85(a) and (g)3;
• the calculation of the capital requirements for undertakings who
use SPVs or those who invest in SPVs – to be covered by
Level 2 implementing measures or Level 3 guidance relating to
Article 109(e) 4;
• SPVs that are established outside the European Economic Area
(EEA) by undertakings situated in a Member State – to
be covered by Level 2 implementing measures or Level 3 guidance
relating to Article 805 and 1706;
• SPVs authorised prior to the date referred to in Article 310(1).
• the use of other types of vehicles established where
noninsurance risks are transferred to a vehicle from an
undertaking – to be covered by Level 2 implementing measures or
Level 3 guidance relating to Article 85 (a) and (g) and Article
109 (e) as defined in Article 13(30);
• other forms of risk mitigation which could also provide relief
against capital requirements to the extent that risk is
transferred to a counterparty8 – to be covered by Level 2
implementing measures or Level 3 guidance relating to Article
109(e); and
• risk management and internal control requirements of
undertakings who use SPVs or those who invest in SPVs – to be
covered by Level 2 implementing measures or Level 3 guidance
relating to Article 49.
1.6. Some details on the above exclusions may be included within
the paper for completeness but CEIOPS will ensure that, as far as
it considers practicable, the Level 2 advice and Level 3 material
is within the scope of Article 209.
For SPVs that fall within the remit of both Article 13(22) and
Article 209, this paper only deals with requirements as set out in
Article 209.
2. Extract from Level 1 Text
2.1. Article 209 (Special purpose vehicle) of the Level 1 text
reads:
1. Member States shall allow the establishment within their
territory of special purpose vehicles, subject to prior
supervisory approval.
2. In order to ensure that a harmonised approach is adopted with
respect to special purpose vehicles, the Commission (…) shall
adopt implementing measures laying down the following:
(a) scope of authorisation;
(b) mandatory conditions to be included in all contracts issued;
(c) the fit and proper requirements as referred to in Article 42
of the persons running the special purpose vehicle;
(d) fit and proper requirements for shareholders or members having
a qualifying holding in the special purpose vehicle;
(e) sound administrative and accounting procedures, adequate
internal control mechanisms and risk management
requirements;
(f) accounting, prudential and statistical information
requirements;
(g) the solvency requirements.
Those implementing measures designed to amend non-essential
elements of this Directive inter alia by supplementing it, shall
be adopted in accordance with the regulatory procedure with
scrutiny referred to in Article 304(3).
3. Special purpose vehicles authorised prior to the date referred
to in Article 310(1) shall be subject to the law of the Member
State having authorised the special purpose vehicle.
However any new activity commenced by such a special purpose
vehicle after the date referred to in Article 310(1) shall be
subject to paragraphs 1 and 2.
2.2. Recital 61
Appropriate rules should be provided for special purpose vehicles
which assume risks from insurance and reinsurance undertakings
without being an insurance or reinsurance undertaking.
Recoverable amounts from a special purpose vehicle should be
considered as amounts deductible under reinsurance or retrocession
contracts.
3. Advice
3.1. Background
3.1. Article 13(22) of the Level 1 text defines an SPV as “any
undertaking, whether incorporated or not, other than an existing
insurance or reinsurance undertaking, which assumes risks from
insurance or reinsurance undertakings and which fully funds its
exposure to such risks through the proceeds of a debt issuance or
any other financing mechanism where the repayment rights of the
providers of such debt or financing mechanism are subordinated to
the reinsurance obligations of such an undertaking.”
3.2. The structure of an SPV transaction could take a number of
different forms depending on the nature of the risks transferred
and structure of the arrangement itself.
Life SPVs to date have
reinsured risks such as lapse risk or excess mortality to the
capital markets.
Non-Life SPVs to date have reinsured risks like motor risks, and
natural catastrophe risks such as windstorm risks and earthquake
risks to the capital markets.
SPVs could also be established by more than one undertaking within
the same group, to transfer insurance risk to
outside this group, but an SPV should only be established by one
group and not by a number of undertakings from different groups.
3.3. The Directive will oblige Member States to allow SPVs to be
established in their jurisdiction subject to harmonised
authorisation requirements as set out by Article 209.
To benefit from the regulatory capital relief11 available the SPV
would therefore need to be authorised by the supervisory
authority; otherwise the SPV would fall outside the scope of this
paper.
Failure to gain authorisation would result in no regulatory
capital relief from the establishment of the SPV.
3.4. It will remain a matter for Member States, whether they allow SPVs not falling under Article 13 (22) and Article 209 to be
established in their territory.
Such SPVs (for example, SPVs that transfer non insurance risks) may
be considered by supervisory authorities for regulatory capital
relief under risk mitigation purposes.
The assessment of eligibility of such SPVs for risk mitigation
purposes should be based on the same principles as those for SPVs
falling under Article 13(22) and Article 209 but analysis should
be conducted on a case-by-case basis and the onus should be on the
undertaking to demonstrate that the principles for recognition are
met.
3.5. Supervisory authorisation for the regulatory requirements and
scope of supervisory review of an SPV and its use
should address a
number of specific outcomes, among which:
• What is the structure of the SPV arrangement?
• What risks are to be reinsured to the SPV and what are the
trigger events for payment?
• How has the SPV satisfied the fully funded concept?
• What is the investment policy of the SPV?
• What benefit does an undertaking obtain from transferring risk
to an SPV?
• How does this benefit differ from the treatment of traditional
securitisation?
• How does this benefit reflect retained risk or potential risk by
the undertaking, particularly counterparty and reputation risk?
• What additional complexity does the risk transfer present to the
supervision of the undertaking and its group?
• How does the balance sheet for solvency purposes of the
undertaking differ from its accounting balance sheet after a risk
transfer and why?
3.6. Supervisory authorities should assess that the above
questions are appropriately answered, an appropriate mechanism is
in place to transfer insurance risk and that the appropriate
documentation has been received before approving an SPV.
3.7. The principles below, under the headings of the paragraphs in
Article 209, go some way towards answering these issues but they
will need to be considered on a case-by-case basis due to the
variety of SPV transactions that could be undertaken. It is not
possible to anticipate the specific nature that these risk
transfers may take in future years.
Establishing high-level principles for a supervisory framework
aims not to inhibit the ongoing development and evolution of SPVs,
while also allowing an appropriate supervisory review process in
relation to these transactions.
3.8. The supervisory approach CEIOPS is aiming for is to set some
fundamental requirements that the SPV needs meet to attain
authorisation and then concentrate attention on the undertaking
who established the SPV. This approach is aligned with the fact
that the undertaking benefits in terms of capital relief from the
transfer of insurance risk to the SPV.
3.2. The scope of authorisation
Explanatory text
3.9. The definition of an SPV in Article 13(22) of the Level 1
text sets out the scope of an SPV’s authorisation, including its
permitted range of activities as constrained by the preconditions
of its authorisation.
3.10. The SPV is only permitted to reinsure insurance risks (or
assume insurance risks under ‘reinsurance-like’ arrangements) from
undertakings as set out by Article 13(22). It should be restricted
from engaging in activities other than accepting insurance risks
from undertakings, except for activities directly arising from
that business.
3.11. The SPV authorisation should only be valid for the purpose
it was established for, which may include potential future reuse.
The SPV should not retain any risks once the contract period or
risks that have been transferred to the SPV have expired or
otherwise been transferred or terminated.
3.12. Any potential reuse of an SPV should be clearly explained at
the initial authorisation when the SPV is first established, for
example, the undertaking should explain whether the SPV is a
one-off transaction or part of a programme.
The anticipated reuse of an SPV needs prior approval from the
supervisory authority where the SPV has been established.
Re-entering the approval process with the supervisory authority
needs to occur for any regulatory capital relief to be taken by
the undertaking for the SPV, taking into account any changes since
the original authorisation.
3.13. The SPV may only be reused for a very different purpose than
it was established for if the contract period has expired or all
the risks reinsured have been either settled, transferred or have
terminated and all amounts due to the undertaking or investors
have been paid.
3.14. If during the lifetime of the SPV it has any additional
risks reinsured into it, has any changes made to the contracts involved or has further capital raised from investors and placed
into it after authorisation then these changes need to be subject
to prior supervisory approval.
The approval process, for both the reuse of the SPV or for any
change of its characteristics (e.g. additional risks reinsured or
capital placed into it, or contracts involved) during its lifetime
should be proportionate to the nature, scale and complexity
of the transaction that is taking place and may not require a full
authorisation process as would be needed at the original
establishment of the SPV.
The supervisory authority should consider if these changes
constitute a change in the objectives of the SPV, in
which case a more exhaustive authorisation process will be
required.
3.15. If the reuse of an SPV is not approved, because the SPV does
not continue to meet all of the below mandatory conditions, then
failure to gain authorisation would result in no regulatory
capital relief from the SPV (in the same manner as not receiving
authorisation when the SPV is established results in no regulatory
capital relief), notwithstanding other possible supervisory
measures.
3.16. In accordance with Article 209(3), SPVs authorised prior to
the date referred to in Article 310(1) shall be subject to the law
of the Member State having authorised the SPV.
SPVs that have been
authorised prior to the adoption of this Directive shall therefore
not be subject to the conditions set out below and will continue
to be subject to the law of the Member States in which it was
authorised as previously agreed with their supervisory authority
prior to the implementation of Solvency II.
However, if any new activity is commenced by such an SPV after the
date the Directive becomes effective this would require
supervisory approval subject to the requirements set out here in
accordance with Article 209(3).
3.17. Where an SPV is established by an undertaking in an EEA
jurisdiction other than where the undertaking is located,
authorisation should be given by the supervisory authority in
which the SPV is to be established.
Prior to granting authorisation of the SPV, the supervisory
authority where the SPV is to be established should consult the
supervisory authority of the undertaking in accordance with the
requirements set out in Article 26.
This consultation should be accompanied by an
exchange of relevant documentation provided with the authorisation request.
Any views or reservations of the supervisory authority of the
undertaking shall be taken into account in the authorisation
process.
The supervisory authority where the SPV is to be established shall
keep the supervisory authority of the undertaking informed of the
result of the authorisation process.
The quantitative impact of the SPV on the technical provisions and
capital requirement of the undertaking is in the remit of the
supervisory authority of the undertaking.
CEIOPS’ advice
Scope of authorisation
3.18. The SPV shall only assume, under ‘reinsurance like’
arrangements, insurance risks from insurance and reinsurance
undertakings as required by Article 13(22) and shall therefore be
restricted from engaging in activities other than accepting
insurance risks from undertakings (except for activities directly
arising from that business).
3.19. If the SPV is to be reused or it has any change in its
characteristics after authorisation, (e.g. additional risks
reinsured or capital placed into it, or changes to contracts
involved) the changes shall be subject to prior approval from the
supervisory authority where the SPV has been established to ensure
continued regulatory capital relief.
This approval process shall be proportionate to the nature, scale
and complexity of the transaction that is taking place and
shall assess whether the SPV continues to meet the mandatory conditions.
3.20. Where an SPV is established by an undertaking in an EEA
jurisdiction other than where the undertaking is located,
authorisation shall be given by the
supervisory authority in which the SPV is to be established.
Prior to granting
authorisation of the SPV, the supervisory authority where the SPV
is to be established shall consult the supervisory authority of
the undertaking in accordance with the requirements set out in
Article 26.
This consultation shall be accompanied by an exchange of relevant
documentation provided with the authorisation request.
3.3. Mandatory conditions to be included in all contracts issued
Explanatory text
3.21. Authorisation of the SPV should be contingent on certain
mandatory conditions being present within the contractual
arrangements between the undertaking, investors and the SPV.
3.22. After authorisation, if the SPV breaches any of these
mandatory conditions this should be dealt with by the supervisory
authority where the SPV is established.
The supervisory authority of the undertaking should be consulted
regarding any supervisory actions, prior to those actions being
taken, except where the conditions of Article 254(2) apply.
Such actions could include withdrawing the authorisation of the
SPV, which would mean that no regulatory benefit could be derived
from the undertaking’s arrangement with the SPV14 or requiring it
to transfer its risks to another entity (e.g. back to the
undertaking).
Besides, the supervisory authority where the SPV is established
should take into account concerns raised by
the supervisory authority of the undertaking concerning a possible
breach of mandatory conditions by the SPV, and keep the
supervisory authority of the undertaking informed of its opinion
and decision regarding these concerns.
3.23. After authorisation, it is the responsibility of those
persons running the SPV to ensure that no mandatory conditions are
breached.
The supervisory authority where the SPV is established is
responsible for the on-going supervision of the SPV.
If any mandatory conditions are breached the undertaking and/or
persons responsible for running the SPV need to inform the
supervisory authority immediately on discovery of a breach and
discussions between the undertaking, those persons running the SPV
and the supervisory authority should follow.
Initial conditions of authorisation need to be met at all times.
3.24. The mandatory conditions below are those that need to be
satisfied in order for the supervisory authority to be able to
approve the SPV in accordance with Article 13(22) and Article 209,
which would then result in a reduction in the undertaking’s
capital requirements and technical provisions as appropriate.
If these conditions are not satisfied then the supervisory
authority should not approve the SPV16.
3.25. Below are a number of principles that should be included in
the mandatory conditions of the contracts issued in relation to
the establishment of the SPV for authorisation:
3.3.1. Principle 1 – Fully Funded
3.26. The definition of an SPV in Article 13(22) of the Directive
requires the SPV to be fully funded.
This fully funded principle requires the SPV at all times to have
assets that are equal to or greater than its aggregate limit at
any time including any anticipated fees and expenses.
To assess the fully funded concept, assets and liabilities should
be measured on a Solvency II valuation basis.
3.27. To assess the fully funded concept the undertaking should
run a number of stress and scenario tests, as appropriate, which
should be discussed with the supervisory authority during the
authorisation process.
3.28. The contract between the undertaking and the SPV needs to
have clear aggregate limits. Contracts without aggregate limits
(potential unlimited liability) could not satisfy the condition to
be fully funded.
The SPV must be fully funded up to the clearly defined aggregate
limit in the contract.
3.29. This condition is intended to ensure that the SPV presents
minimal prudential risk to policyholders of the undertaking.
The principal aim of the fully funded requirement is to avoid a
situation in which an undertaking could be subject to an
inappropriately low capital requirement or technical provisions by
using an SPV.
An undertaking can not avoid the prudential requirements of the
Directive simply by using an SPV.
3.30. In a Life SPV situation, claims reserves may run down from a
starting peak.
However, for long-terms blocks which are closed to new business,
it is possible that renewals mean that the reserves have not yet
peaked. In such situations, it is envisaged that the increase in
reserves could be fully funded by contractually due future
receipts.
An SPV has to ensure compliance with Article 13(22) of the Level 1
text.
3.31. It is this fully funded condition that differentiates an SPV
from a traditional (re)insurance undertaking.
Only when the proceeds of debt issuance or other financing are
received by the SPV would the SPV be considered fully funded.
It is envisaged that at no period in time would its assets be
insufficient to meet its liabilities as they fell due.
If the value of the assets falls below the value of the potential
reinsurance recoveries or aggregate liabilities this should be
reported immediately to the undertaking and the supervisory
authority where the SPV is established and the supervisory
authority of the undertaking, if they are not the same.
3.3.2. Principle 2 – Investors have a subordinated claim on SPV
assets
3.32. The assets of the SPV must be available to first meet its
reinsurance (or ‘reinsurance-like’) obligations to the
undertaking.
The definition of the SPV requires that the rights of the finance
providers be fully subordinated to the reinsurance obligations of
the SPV.
The undertaking is therefore free to draw down on the assets of
the SPV in order to meet the pre-defined reinsurance (or
‘reinsurance-like’) liabilities19. Unless agreed at authorisation,
only at the expiration of the SPV’s reinsurance cover and when
there are no further reinsurance (or ‘reinsurance-like’)
liabilities under the contracts, can any surplus outstanding after
the SPV’s reinsurance obligations have been satisfied be returned
to capital providers.
The allowance for repayments prior to this should be explained to
the supervisory authority and agreed at authorisation, along with
an estimation of the expected repayments to be made over the
lifetime of the SPV.
3.3.3. Principle 3 – “Prudent person”
3.33. The SPV should adhere to the “prudent person” investment
principles.
The application of this principle to the investment strategy of
SPVs shall also include the following three points:
a) Assets should reflect the duration of underlying liabilities.
3.34. The SPV is expected to pay due regard to the time horizon of
its underlying liabilities when deciding upon its investment
strategy, meaning that assets and liabilities are cashflow matched
and the liquidity risk of the assets is managed appropriately. In
addition, the term of the contract between the undertaking and the
SPV should not exceed the term of the underlying liabilities of
the undertaking.
b) Assets should be of a high quality and counterparty exposures
should be sufficiently diversified.
3.35. The SPV would be expected to invest in high quality assets.
These assets should be adequately diversified.
Counterparty exposures should also be adequately diversified to
ensure that the SPV is not exposed to undue default or
concentration risk.
3.36. The SPV may need to invest in certain assets to fulfil its
purpose or to minimise the risk to a ceding undertaking, for
example, the SPV may need to invest in certain investment assets
to cover linked insurance liabilities, or assets may be withheld
by the ceding undertaking.
In these circumstances, the SPV has to demonstrate how the
“prudent person” principle is satisfied in relation to the
quality of assets and diversification of counterparties.
3.37. The SPV should not be required to deliver investment returns
in excess of the risk premium required by investors. Given the
application of the “prudent person” investment requirements above,
there should be minimal investment risk in the SPV.
c) Derivatives should be used only for risk reduction / efficient
portfolio management.
3.38. CEIOPS would expect derivatives to play a role in tailoring
the SPV profile (e.g. interest rate swaps where the fixed income
coupons are swapped into variable rate coupons with the
counterparty through a swap).
However, the use of derivatives should be prohibited in those
instances in which the sole use of the instrument is to allow the
fund to further leverage itself or where the derivative is
unhedged and could result in a contingent liability which the SPV
would be unable to meet, or one not offset by a corresponding
increase in assets.
This should be assessed during the authorisation process of the
SPV.
3.3.5. Principle 4 – Effective risk transfer
3.39. The reinsurance arrangements with the SPV should effectively
transfer insurance risk from the undertaking to the SPV and
thereby to the investors.
The amount of risk transfer will determine the amount of credit
that the undertaking can take for the SPV in terms of any
reduction in the undertaking’s capital requirements or technical
provisions.
If no risk transfer occurs then the SPV will not satisfy this
mandatory condition.
3.40. The supervisory authority where the SPV is established
should assess that an effective risk transfer has taken place and
that this has been fully documented by the undertaking.
The contractual arrangements and supporting documentation should,
for example, clearly define the risks reinsured, the nature, scale
and scope of the SPV’s obligation to the undertaking, the life of
the SPV over which the SPV remains fully funded, the principal
repayment schedule and rights to residual returns.
3.41. For an SPV to be authorised the reinsurance (or
‘reinsurance-like’) payment obligations of the SPV to the
undertaking must be dependent upon the undertaking suffering a
pre-defined loss.
Generally supervisory authorities should assess on a case-by-case
basis whether there is effective risk transfer, having regard to
the economic effect of the transaction (the nature of the
triggers, such as a parametric or indemnity trigger, may or may
not be relevant in this decision).
3.42. The risks transferred into the SPV need to be clearly
defined so that they may not be used to back any similar
transactions, i.e. the undertaking can not double count any
regulatory capital relief provided for similar risks.
3.3.5. Principle 5 – Intra-group reinsurance
3.43. An important mandatory condition for authorising an SPV for
intragroup reinsurance is that the undertaking cannot use an
internal SPV (i.e. one where an element of finance is not raised
externally) to achieve a regulatory capital reduction at group
level in the absence of any financing external to the group.
The fact that an SPV is internal is not in itself sufficient
justification for a supervisory authority to disallow it, it would
not however be authorised, and therefore the undertaking would not
obtain any group regulatory capital relief.
Regulatory capital requirements of a group are only permitted to
be reduced therefore if, and to the extent to which,
funding is provided externally, from the capital market, to back
the reinsurance provided by an SPV to an entity within the group.
3.3.6. Principle 6 – Non-recourse
3.44. Payments due to investors under the terms of the SPV
contract are the obligation of the SPV only and in the event of
default investors will not have recourse to the assets of the
undertaking.
3.3.7. Principle 7 – Bankruptcy remote vehicle
3.45. The SPV should be segregated into a bankruptcy remote
vehicle separate from the undertaking.
In the event of the bankruptcy of the undertaking no claim would
arise on the SPV except in the case of a pre-defined event as
defined in the terms of the contract with the SPV.
Full disclosure should be made to the supervisory authority where
the SPV is to be established of how this bankruptcy
remote vehicle has been established (with an accompanying legal
opinion).
Any relationship between the bankruptcy remote vehicle and the
undertaking at any time during the expected life of the SPV
must be disclosed to the supervisory authority.
Full disclosure of what will occur at the end of the expected life
of the SPV must be made to the supervisory authority.
3.3.8. Principle 8 – Documentation
3.46. The authorisation of the SPV by the supervisory authority
where the SPV is planned to be established should be based on
appropriate documentation being submitted to this supervisory
authority.
This documentation should allow the supervisory authority to
understand the details of the proposed SPV transaction and to
determine whether the conditions of authorisation have been
adequately met.
3.47. An external legal opinion, commissioned by the undertaking,
should accompany all documentation to ensure that it complies with
the requirements for approval.
Documentation requirements are set out in the following section.
CEIOPS’ advice
Mandatory conditions to be included in all contracts issued 3.48.
The contracts shall include the following conditions:
a. That the SPV shall be fully funded on a Solvency II valuation
basis at all times which requires the SPV to have assets that
are equal to or greater than its aggregate limit of the SPV
contract, including any other anticipated related expenses
and fees.
b. That the assets of the SPV must first be available to meet its
reinsurance obligations, as investors have a subordinated claim on
the SPV’s assets, unless prior repayments to investors have been
explained to the supervisory authority and agreed at
authorisation.
c. That the SPV shall adhere to the “prudent person” investment
principles of the Directive, and also include the following three
points:
Assets shall reflect the duration of underlying liabilities;
Assets shall be of a high quality and counterparty exposures
should be sufficiently diversified; and
Derivatives shall be used only for risk reduction / efficient
portfolio management.
d. That the SPV transaction shall effectively transfer insurance
risk from the undertaking to the investors and that the risks
reinsured into the SPV need to be clearly defined so that
they may not be used to back any similar transactions.
e. That the SPV raises an element of capital externally to the
group in order to achieve a regulatory capital reduction at
group level.
f. That payments due to investors under the terms of the
contract with the SPV are the obligation of the SPV only and,
in the event of default, investors will not have recourse to
the assets of the undertaking.
g. That the SPV should be segregated into a bankruptcy remote
vehicle separate from the undertaking, and full disclosure
should be made to the supervisory authority where the SPV
is established of how this bankruptcy remote vehicle has
been established.
h. The authorisation of the SPV by the supervisory authority
where the SPV is established should be based on appropriate
documentation being submitted to this supervisory
authority.
This documentation should allow the supervisory
authority to understand the details of the proposed SPV
transaction and to determine whether the conditions of
authorisation have been adequately met.
3.49. After authorisation, if the SPV breaches any of these
mandatory
conditions, this shall be dealt with by the supervisory authority
where the SPV is established.
The supervisory authority of the
undertaking shall be consulted regarding any supervisory actions
prior to those actions being taken, except where the conditions of
Art. 254(2) apply. Such actions could include withdrawing the
authorisation of the SPV, which would mean that no regulatory
benefit could be derived from the contract with the SPV, or
requiring it to transfer its risks to another entity (e.g. back to
the
undertaking).
3.3.9. Documentation requirements
3.50. The following documents should be submitted (if applicable),
in
writing, in relation to any possible SPV authorisation:
a) A copy of the proposed contract between the SPV and the
undertaking and a statement containing a description of that
contract, accompanied by or including satisfactory information
about the identities and qualifications of:
o the ceding undertaking under the relevant SPV contract;
o the persons (if any) who are or will be appointed to act as
trustees of the SPV’s assets;
o the persons who are or will be officers of the SPV;
o those persons who have qualifying holdings (whether direct
or indirect) in the SPV and the amounts of those holdings;and
o the persons who are providing or will provide management
and other professional services (such as accounting) to the
SPV.
b) A copy of the SPV’s memorandum and articles, or proposed
memorandum and articles of association;
c) The description referred to in sub-paragraph (a) shall include
the
following:
o any relevant triggering event(s) for payments under the
contract between the SPV and the (re)insurance undertaking;
o the aggregate limit of the relevant contract between the SPV
and the (re)insurance undertaking; and
o a statement as to how the SPV is or will be fully funded,
including stress and scenario tests run to determine if the
fully funded concept has been met, where appropriate.
d) Actuarial review of underlying business;
e) Prospectus/Offering Circular or Private Placement Memorandum;
f) Rating agency’s pre-sale report on behalf of the SPV;
g) Details relating to the potential use of financial guarantors
on
any of the ‘tranches’ of notes to be issued;
h) Trustee Agreement (if any);
i) Overall risk management plan including details as to how the
SPV will continue to be fully funded during the term of the
contract;
j) Financial projections over the expected life of the SPV;
k) Investment authority and guidelines for assets held in Trust,
along with details of any leverage permitted within these
guidelines;
l) Details of the SPV’s liquidity strategy, including structure of
waterfall, types of positions, and noteholder withdrawal rules;
m) Risk implications of the SPV’s investment strategy;
n) Details of any intended hedging instruments, such as interest
rate swaps or currency contracts;
o) Details of Directors/Management fitness and probity;
p) Capital including size, growth, investor concentration, and
management share of the capital base;
q) Outsourcing and service contracts, and,
r) Any other document deemed necessary by a supervisory
authority.
3.4. Governance requirements
3.51. The Directive separates governance requirements for SPVs
into
three separate categories:
a) ‘Fit and proper requirements as referred to in Article 42 of
the persons running the SPV’
Explanatory text
3.52. The differences between an SPV and conventional reinsurance
undertakings do not appear to justify holding those personnel
responsible for discharging key functions within the SPV to a
different standard, with regard to fit and proper requirements,
than
those of any other reinsurance undertaking.
Those persons
running the SPV should therefore have an adequate level of
knowledge to be able to understand the risks transferred to the
SPV
and the nature of the SPV transaction that has taken place.
SPVs shall have in place documented policies and procedures
to
ensure that all persons subject to fit and proper requirements
comply with those requirements.
SPVs shall notify the supervisory
authority where the SPV is established, of the persons who
effectively run the SPV.
CEIOPS’ advice
3.54. The persons running the SPV shall be held to the same fit
and
proper standard as those running a reinsurance undertaking, as
established in Article 42 and Article 42a.
3.55. SPVs shall have in place documented policies and procedures
to
ensure that all persons subject to fit and proper requirements
comply with those requirements.
3.56. SPVs shall notify the supervisory authority where the SPV is
established of the persons who effectively run the SPV.
b) ‘Fit and proper requirements for shareholders or members
having a qualifying holding in the SPV’
Explanatory text
3.57. This could be interpreted as applying to those who have the
voting
rights which a shareholder in a conventional business would have.
Similar conditions should apply to SPVs as those that apply to
shareholders in any other reinsurance undertaking as set out in
the
Directive.
For example, Article 58 of the Directive refers to the
sound and prudent management of the (re)insurance undertaking
in which an acquisition is proposed, and having regard to the
likely
influence of the proposed acquirer on the (re)insurance
undertaking, the suitability of the proposed acquirer and the
financial soundness of the proposed acquisition all of which
should
be appraised against a number of criteria.
These criteria include
an
assessment of the reputation and experience of any person who will
direct the business of the (re)insurance undertaking as a result
of
the proposed acquisition and of the risk of money laundering or
terrorism financing.
3.58. CEIOPS believes that the fitness and propriety of the
shareholders
or members having a qualifying holding in the SPV should be
assessed against the following criteria:
(a) its reputation and integrity;
(b) its financial soundness, in particular in relation to the type
of
business pursued and envisaged in the SPV.
3.59. More specifically, at least some shareholders and members
having a
qualifying holding in the SPV should be independent from the
undertaking, in order to guarantee the segregation of the SPV from
the undertaking as a bankruptcy remote vehicle.
CEIOPS’ advice
Fit and proper requirements for shareholders or members having
a qualifying holding in the SPV
3.60. Similar conditions should apply to SPVs as those that apply
to
shareholders in any other reinsurance undertaking as set out in
Article 58.
The fitness and propriety of the shareholders or
members having a qualifying holding in the SPV should be
assessed against the following criteria:
(a) its reputation and integrity;
(b) its financial soundness, in particular in relation to the type
of
business pursued and envisaged in the SPV.
3.61. At least some shareholders and members having a qualifying
holding in the SPV should be independent from the undertaking.
c) ‘Sound administrative and accounting procedures, adequate
internal control mechanisms and risk management
requirements’
Explanatory text
3.62. The SPV should have sound administrative and accounting
procedures comparable to a (re)insurance undertaking.
Records
should be maintained and accounting procedures established so as
to accurately record the activities and transactions of the SPV.
Financial statements of the SPV should be recorded under both the
same general purposes financial statements (under the national
laws where the SPV is established) along with a Solvency II
valuation which may differ.
3.63. The SPV should have sound governance requirements to a
standard
as required by the Directive in relation to reinsurance
undertakings
taking into account the proportionality principle.
An SPV should
not
be required to comply with all the requirements of the system of
governance within the Directive concerning reinsurance
undertakings (such as having an internal audit function or an
actuarial function) unless the supervisory authority deems that
the
nature of the business of the SPV requires these governance
functions.
The SPV should, instead of having these functions
itself,
make use of relevant functions and expertise within the ceding
undertaking, as appropriate, to ensure it has a sound system of
governance overall to a standard as required by the Directive in
relation to reinsurance undertakings.
Any arrangements with the
ceding undertaking must be formally agreed in an outsourcing
contract.
3.64. CEIOPS will develop, under its Level 3 work on the
Supervisory
Review Process, harmonised criteria to be used when deciding on
the need for the SPV to develop its own governance functions
regarding the nature of its business.
3.65. Any application for an SPV must adequately disclose any
material,
or potentially material, conflicts of interest that may arise in
respect
of the interactions among the various parties to the transactions
into which the SPV will enter (including any such conflict
concerning
the applicant/cession undertaking).
Any such conflict of interest
must be disclosed to stakeholders, including the investors.
CEIOPS’ advice
Sound administrative and accounting procedures, adequate
internal control mechanisms and risk management requirements
3.66. The SPV should have sound administrative and accounting
procedures comparable to a (re)insurance undertaking.
Records
should be maintained and accounting procedures established so as
to accurately record the activities and transactions of the SPV.
Financial statements of the SPV shall be recorded under both the
same general purposes financial statements (under the national
laws where the SPV is established) along with a Solvency II
valuation.
3.67. The SPV should have sound governance requirements to a
standard as required by the Directive in relation to reinsurance
undertakings taking into account the proportionality principle.
An
SPV shall not be required to comply with all the requirements of
the system of governance within the Directive concerning
reinsurance undertakings unless the supervisory authority deems
that the nature of the business of the SPV requires these
governance functions.
The SPV shall make use of relevant
functions and expertise within the ceding undertaking, as
appropriate, to ensure it has a sound system of governance overall
to a standard as required by the Level 1 text in relation to
reinsurance undertakings.
Any arrangements with the ceding
undertaking shall be formally agreed in an outsourcing contract.
3.68. An SPV shall adequately disclose any material, or
potentially
material, conflicts of interest that may arise in respect of the
interactions among the various parties to the transactions into
which the SPV will enter.
Any such conflict of interest shall be
disclosed to stakeholders, including the investors.
3.5. Supervisory reporting (accounting, prudential and
statistical information requirements)
Explanatory text
3.69. Primarily, a situation should be avoided in which the
on-going
supervisory reporting requirements of SPVs are unduly
burdensome.
Supervisory reporting should be proportionate to the
nature, scale and complexity of the risks while at the same time
providing supervisors with the information they need to continue
to
monitor the SPV.
The SPV should not, for example, be required to
submit its own regular supervisory reporting such as the Solvency
and Financial Condition Report (SFCR).
It should however be
required to file annual accounts in accordance with the national
law
of the jurisdiction where the SPV has been established and, if
different, on a Solvency II valuation basis.
The annual accounts
should be sent to the supervisory authority where the SPV is
established as they are responsible for the SPV’s on-going
compliance, and also to the supervisory authority of the
undertaking.
These annual accounts provide access to regular
information (on a Solvency II basis) for the supervisory authority
where the SPV is established.
3.70.
The (re)insurance undertaking who has established the SPV is
required to report all material risks through its supervisory
reporting (which includes details on its risk profile and its Own
Risk
and Solvency Assessment (ORSA)).
This includes those risks arising
out of any off-balance sheet financing activities (including those
that are beyond the scope of this paper e.g. SPVs that transfer
non insurance
risks or SPVs set up outside the European Economic
Area).
The supervisory reporting completed by the undertaking
should provide details on the SPV including a reconciliation of
the
accounting valuation basis to the Solvency II valuation basis for
the
SPV along with details of how the fully funded concept is being
met.
3.71. These annual accounts of the SPV, together with the
undertaking’s
supervisory reporting (which includes details on its risk profile
and
its ORSA), would be considered the minimum information required
for regulatory purposes for the supervisory authority where the
SPV
is established (to monitor on-going compliance of the SPV after
authorisation) and for the supervisory authority of the
undertaking
(to monitor the undertaking).
The SPV should also be taken into
account in the on-going supervision of the undertaking, for
instance
through supervisory assessment of the undertaking’s risk profile
or
ORSA.
3.72. If the supervisory authority where the SPV is established
has any
concerns with the SPV the supervisory authority where the SPV is
established should inform the supervisory authority of the
undertaking immediately except where the conditions of Article
254(2) apply.
3.73. The SPV may however be required to submit further ad hoc
statistical and financial information above the minimum required
as
determined by the supervisory authority (of the undertaking or
where the SPV is established). Such reported information could be
required following a pre-defined event such as a breach of any
mandatory conditions or if the SPV has further risks transferred
to
it, which would require approval or in case of deteriorating
market
conditions.
These requirements should be assessed on a case-by-case
basis.
3.74. CEIOPS anticipates supervising the SPV directly in parallel
with the
SRP of the ceding (re)insurance undertaking in line with the
proportionality principle.
3.75. Any separate regulatory reporting requirements on the SPV in
excess of the annual accounts will be determined on a case by case
basis.
CEIOPS’ advice
Accounting, prudential and statistical information requirements
3.76. The SPV should be subject to the same prudential valuation
rules
as used for (re)insurance undertakings under Solvency II.
3.77. On an on-going basis, an SPV should be required to file
annual accounts in accordance with the national law of the jurisdiction
where the SPV has been established and, if different, on a
Solvency II valuation basis.
The annual accounts should be sent to
the supervisory authority where the SPV is established, and also
to
the supervisory authority of the undertaking.
These annual
accounts together with the undertaking’s supervisory reporting
requirements (which include details on its risk profile and its
ORSA), would suffice for regulatory purposes for supervisory
authorities to monitor SPV compliance after initial authorisation.
3.78. The SPV may however be required to submit further ad hoc
statistical and financial information above the minimum required
as
determined by the supervisory authority (of the undertaking or
where the SPV is established).
3.79. If the supervisory authority where the SPV is established
has any
concerns with the SPV they should inform the supervisory authority
of the undertaking immediately except where the conditions of
Article 254(2) apply.
3.6. Solvency requirements
Explanatory text
3.80. Given the Directive requires the SPV to be fully funded it
appears
that it would not be appropriate for the SPV to be subject to the
MCR or SCR capital requirements.
However, its credit within the
undertaking should be equal or less than the value of the assets
recoverable from the SPV.
As referred to by Recital 61, the
recoverable amounts from an SPV should be considered by the
undertaking as amounts deductible under reinsurance or
retrocession contracts.
CEIOPS’ advice
Solvency requirements
3.81. An SPV should be fully funded at all times and is not
therefore
required to calculate an individual MCR or an SCR.
Annex 1 - Requirements for undertakings who use
SPVs
Explanatory text
3.82. This section sets out requirements for undertakings who use
SPVs.
These requirements are out of the scope of Article 209 but are
nonetheless important considerations for supervisory authorities
and have therefore been included within this paper.
This material
has also been included in other CEIOPS Consultation Papers as
deemed relevant.
3.83. It is the responsibility of the administrative or management
body of
the undertaking to ensure that all mandatory conditions are
present
within the contractual arrangements at the time of the SPV’s
authorisation..
Effects of the fully funded concept on the undertaking
3.84. CEIOPS proposes that the fully funded requirement should be
continuously monitored by the undertaking through its system of
governance.
The maximum reinsurance credit taken by an
undertaking for an SPV should be capped at an amount equal to the
lower value between the aggregate maximum liability transferred
and the aggregate value of the assets of the SPV.
Any fall in the
value of the assets within the SPV should be mirrored by a
corresponding fall in the reinsurance asset within the
undertaking.
Risks remaining within the undertaking
3.85. CEIOPS would expect that any remaining risk (credit, market,
liquidity, operational risk or ‘burn-through’ that may occur if
the
insured cost were to exceed the maximum amount payable by the
SPV) from the SPV to be fully taken into account in the
undertaking
through the its risk management system and also taken into
account within the calculation of its regulatory capital
requirements.
After authorisation, if this is not properly considered by the
undertaking within its capital requirements, the supervisory
authority should consider supervisory actions to address these
risks.
The undertaking should be particularly aware of any
residual
insurance risk arising from the SPV if there were losses in excess
of
those envisaged at the time of authorisation.
These losses above
the funding provided would revert back to the undertaking.
Alignment of interests between the undertaking and the SPV
3.86. There should be an alignment of interests between the
undertaking
and the SPV to ensure, for example:
o that claims management processes in the undertaking
operate effectively;
o to provide a discipline on the underwriting of risks within the
undertaking, i.e. the undertaking can not just transfer risks it
may not have fully understood or properly managed to an
SPV; and
o the SPV is established and subsequently run in an
appropriate manner for all the interested parties.
3.87. This alignment could be achieved by the undertaking
retaining an
investment through a convertible loan note or a lower rated
security in the SPV or the undertaking retaining some of the risks
reinsured on its balance sheet.
Where any assets or rights of an
SPV are held or controlled by the undertaking those assets must be
separately identified by the undertaking.
This provides the
undertaking with a vested interest in the operations of the SPV
which may also make it a more attractive investment as investors
have confidence the undertaking retains an interest in the risk
being reinsured to the SPV.
3.88. In principle, full disclosure must be provided by the
undertaking to
the supervisory authority and all relevant parties on how the
interests are aligned, and any relationship between the parties.
In
these circumstances, regulatory capital relief should be reduced
from this alignment. Such actions may have the economic effect of
reducing the level of reinsurance cover or increasing the risks
covered by the solvency capital requirement, and the supervisory
authority should be confident this has been properly taken into
account.
Transparency
3.89. Full disclosure within the SFCR and the annual accounts of
the
undertaking should be made regarding its reinsurance with the SPV.
The undertaking should also disclose any financial interests it
has in
the SPV (i.e. convertible loans, if it has retained or invested in
any
notes of the SPV).
3.90. Details should also be disclosed of whether it has invested
in notes
related to other SPVs and details of risks that have been
reinsured
to them, and how the undertaking has satisfied itself any
concentration risks are within its risk appetite.
Fit and proper requirements for the undertaking
3.91. Before the undertaking enters into an SPV transaction, the
supervisory authority should assess whether the administrative or
management body of the undertaking has the appropriate
modelling and risk management understanding to fully comprehend
the risks being transferred to the SPV and the consequences of
such actions.
Annex 2 – Background details on SPV transactions
An undertaking can use an SPV to transfer insurance risks through
a
contract, much in the same fashion as the undertaking would cede
(retrocede) insurance risk to a typical reinsurance undertaking.
The
undertaking reinsures risks to the SPV and may transfer an amount
of
supplementary assets or pays an adequate premium necessary to
offer
investors a rate of return (appropriate to the risk).
This rate of
return is
calculated as a percentage of the amount to be raised from the
market.
The undertaking would, as suggested by Recital 61 of the Level 1
text,
then take credit for the risks ceded to the SPV as reinsurance
recoverables
calculated in accordance with Article 80.
The SPV funds its maximum reinsurance obligation (equal to the
aggregate maximum liability of the contract with the SPV) through
the
issuance of notes/bonds to the market.
Article 80 prescribes how
amounts
recoverable from the SPV must be calculated, requiring the
undertaking to
take account of the timing differences between its insurance
obligations to
policyholders and the speed with which it can recover amounts
owing from
the SPV.
To provide a simplified example of an SPV transaction, the
undertaking is
provided with e.g. €300m of cover for its aggregate maximum
liabilities
from a windstorm in Europe.
The coverage is agreed for 3 years.
The
undertaking pays e.g. €9m per year for 3 years to the SPV as a
premium.
The SPV raises €300m from investors in the form of notes (Annex 2
details a (re)insurance undertakings’ balance sheet before and
after the
SPV transaction).
The notes are typically ‘tranched’ in order for priority payment
of interest
and repayment of capital.
Tranches allow for the ability to create
one or
more classes of securities whose rating is higher than the average
rating
of the underlying liabilities.
This is accomplished through the
use of credit
support specified within the transaction structure to create notes
with
different risk-return profiles.
The first-loss tranche absorbs
initial losses,
followed by the mezzanine tranches which absorb some additional
losses,
again followed by more senior tranches.
Thus, due to tranching,
the most
senior claims are expected to be insulated – except in adverse
circumstances – from the risk of the underlying liabilities
through the
absorption of losses by the more junior claims..
Some of the notes
may be
“wrapped” by a financial guarantor in order to obtain credit
enhancement.
Step 1:
The SPV invests the proceeds of the notes (€300m) in
predefined
assets such as government bonds with a fixed interest rate of e.g.
4%.
Step 2:
The SPV enters into a total return swap arrangement with a
counterparty, typically an investment bank, to swap the fixed rate
return
(4%) for a floating rate return (such as EURIBOR).
The purpose is
to
hedge out interest rate risk to avoid mark-to-market losses in the
assets
of the SPV from rising interest rates, as these losses would
effectively
reduce the reinsurance asset of the ceding undertaking.
This
provides
stability to the value of the assets for the bond holders and the
undertaking on paying claims (and the value of the reinsurance
asset).
Step 3:
If there are no claims, the SPV receives the fixed return
on
government bonds (4%) and swaps this for a floating rate (such as
EURIBOR).
Step 4:
If there are no claims the SPV pays the investor the
floating rate
plus the premium (in this instance €9m). This is an attractive
return and
theoretically has little correlation to the performance of other
asset
classes held by the investor. It also provides the investor with
an
opportunity for diversification within its investment portfolio.
Step 5:
If there is a claim on the liabilities reinsured with the
SPV, the
undertaking receives the amount of the claim from the SPV.
For
example,
in year 3 if there was a claim for €300m, the undertaking would
receive
€300m.
In this case the investor receives nothing back from the
SPV.
Step 6:
If there is no claim by the end of year 3 on the
liabilities of the
SPV, the investor receives back the principal (€300m) as well as
the
scheduled interest payments.
There are a number of mechanisms used by SPVs as trigger events
that
would oblige the SPV to make payment to the undertaking.
These
could
include:
• Parametric – a pure parametric trigger is based on an actual
reported physical event (e.g. magnitude of an earthquake, wind
speed of a hurricane or an increase in longevity);
• Indemnity – an indemnity transaction is based on the actual loss
of
the undertaking;
• Model Loss – insurance losses are determined by inputting actual
physical parameters into an agreed fixed model which then
calibrates the loss;
• Industry index – based on an industry wide index of insurancelosses; and
• Hybrid (a trigger combining more than one of the above
triggers).
Supervisory authorities may consider other aspects of the coverage
provided by the SPV (such as an “Ultimate Net Loss” clause) which,
when
combined with the model loss and parametric triggers, attempt to
mirror
indemnification.
  
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