Insurance Authority consults on draft rules for insurance-linked securities regulatory regime

On 4 September 2020, the Insurance Authority (IA) launched a six-week consultation on the proposed Insurance (Special Purpose Business) Rules (SPB Rules). The consultation ties in with the introduction of the new regulatory regime for the issuance of insurance-linked securities (ILS) which is expected to come into operation in 2021. The SPB rules will be added upon commencement of the new ILS regime.

New ILS regulatory regime

The Insurance (Amendment) Ordinance 2020^[1] was enacted by the Legislative Council in July 2020 to amend the Insurance Ordinance (Cap. 41) (IO) and provide for a bespoke regulatory framework for the issuance of ILS^[2] through the introduction of a new type of authorized insurer under the IO (i.e. special purpose insurers (SPIs)). The new regime is intended to make Hong Kong a more conducive domicile for ILS, bringing Hong Kong on par with other ILS jurisdictions such as Bermuda and Singapore.

Under the new regulatory regime, SPIs will be authorized to carry on special purpose business (SPB), a new class of insurance business for the purpose of acquiring insurance risk from another insurer/reinsurer under a reinsurance/risk transfer contract and then issuing ILS to investors to collateralise the risk acquired. A company will need to meet certain requirements in order to be authorized by the IA as an SPI.

SPB Rules

ILS are considered sophisticated financial products and are deemed unsuitable for the risk appetite of ordinary retail investors. There have also been calls to prohibit institutional investors from “repackaging” ILS into other types of financial products for sale to retail investors, and debarring constituent funds of Mandatory Provident Fund (MPF) Schemes from investing in ILS.

The SBP Rules are intended to address these issues by (i) limiting the scope of “eligible investors” to whom ILS may be sold or offered for purchase; (ii) prescribing a minimum investment size for ILS to prevent “repackaging”; and (iii) prescribing offences and penalties for contravention of the SBP rules. The SPB Rules are included in Annex A to the consultation paper which we summarise below.

Scope of “eligible ILS investors” (Rule 3(4) of the SPB Rules)

The IA proposes that eligible investors of ILS should include the following types of institutional investors:

banks or authorized financial institutions;
insurance companies;
corporations carrying on business of the provision of investment services;
governments, central banks and multilateral agencies;
exchange companies; and
collective investment schemes excluding, as set out in Rule 3(2) of the SBP Rules, retail funds authorized by SFC, MPF funds, approved pooled investment funds which can be invested by MPF funds, and occupational retirement schemes.

Minimum investment size for ILS (Rule 3(1)(c) of the SBP Rules)

The IA proposes that the consideration for which the ILS are to be acquired, subscribed, underwritten or disposed of under the relevant agreement should not be less than US$1 million or the equivalent of such amount in other currencies.

Offences and penalties (Rule 3(3) of the SBP Rules)

The IA proposes that a person commits an offence if he or she enters into or offers to enter into an agreement, or invites, induces, attempt to invite or induce another person to enter into an agreement for that other person to acquire, subscribe or underwrite ILS or to dispose of ILS to that other person, unless:

that other person is an “eligible ILS investor” as defined in Rule 3(4) of the SBP Rules;
that other person is not an excluded person as defined in Rule 3(2) of the SBP Rules; and
the consideration is of an amount not lower than the minimum investment size as prescribed in Rule 3(1)(c) of the SBP Rules.

A person who contravenes the above commits an offence and is liable to a fine and imprisonment of up to 2 years. The penalty levels will be prescribed under the new section 129A(3) of the IO (as added by the Insurance (Amendment) Ordinance 2020).

The consultation is open until 16 October 2020.

A copy of the consultation paper can be found here.

^[1] To read our previous blog post on the ILS framework when the related bill was first introduced, please click here.

^[2] ILS are risk management tools that allow insurers/reinsurers to raise capital by offloading insured risks to the capital markets through securitisation, and are often described as another form of reinsurance.

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