The first edition of the ILS show, presented by CCR Re in parallel with its quarterly ILS newsletter, provided the opportunity to review several topics associated with ILS and the development of the Paris Marketplace.
To discuss these topics, we brought together a panel of recognized specialists: Olivier Desmettre, Brigade Chief at the French Financial Supervisory Authority (ACPR), Benoit Liot, Chief Retrocession Officer at Scor, Edouard Chapellier and Patrice Doat, associates at Linklatlers, Stephan Ruoff, Business Leader at Schroder and Quentin Perrot, Senior Vice President at Willis Securities.
In this article that focuses on the first edition of the ILS Show, we address issues relating to the taxation of Insurance-Linked Securities in more detail.
What are the specificities of taxation that apply to French securitization mutual funds or FCTs? What are the advantages and the disadvantages?
Edouard Chapellier: With respect to taxation, the securitization mutual fund (FCT) is a very well-known and well-defined financial vehicle. A certain number of administrative positions from the tax administration explain the way in which everything must be done. In contrast, for FCTs carrying insurance risk, there has been, up until recently, a blind spot: most of the administrative positions that were taken concerning FCTs expressly ruled out those carrying insurance risk.
Therefore, in the framework of the initial implementation of an FCT carrying insurance risk, we needed to define the tax scheme for this FCT. The objective was to ensure that there is no significant tax friction that would outweigh the financial performance for the investors. For example, is there VAT that causes friction on the flows? Are there territorial economic contributions to pay? Are there registration fees? Will social solidarity contributions become due?
First question: corporate tax. This is not a problem as the FCT is not subject to corporate taxes. The FCT is a completely transparent vehicle, neutral for investors, with no tax friction insofar as concerns the revenue it generates.
Another question: taxation for investors. Here, the underlying principle is transparency: the investors are put in the same position as if they were collecting revenue. The principle enables the investor to not be taxed more unfavorably if he invests in this vehicle than if he carries the insurance risk directly.
Another important point is the VAT applied to cash flows. French tax legislation provides that the cash flows are not subject to VAT. So, there is no VAT on the flows invoiced by the FCT and no VAT on the commission that is invoiced either. Within this financial ecosystem, the fact that we have a way of neutralizing VAT is a significant advantage.
For registration fees: the purchase, the cession and the creation of shares are not subject to registration and the right to share for all intents and purposes is insignificant. As for French corporate social solidarity contributions, we also received confirmation that the French tax legislation does not affect the FCT.
Lastly, for the territorial economic contribution—formerly the French professional tax—that could have affected the FCT, this does not apply.
Also, in defining the tax scheme, we were able to create a vehicle that is as neutral as possible from a tax perspective. And, this is what was defined and validated by the tax authorities for this initial FCT carrying insurance risks. It was the first essential step in making the launch of the vehicle possible.
How does one select a jurisdiction, when issuing an ILS, regardless of its form (Cat Bond or sidecar)? What aspects must be taken into account in the selection process? Is taxation an important point?
Benoit Liot: At Scor, taxation is indeed a major factor that is taken into account especially when approaching the investors. Scor has issued Cat Bonds for a number of years. For a long while, we issued them out of Ireland. Two bonds were issued in 2018 and 2019 from England, and in 2020, two new bonds were issued from Ireland. When selecting the location from where the bond is issued, several criteria are taken into consideration:
- Solvency II compliance. This may seem obvious, but the jurisdiction must be compatible with Solvency II so that Scor can benefit from the transaction;
- The level of efficiency or speed of the ecosystem enabling the issuance of the Cat Bond. This includes the regulator, all the service providers, the banks, the lawyers and everyone who helps us structure the Cat Bond. It is important to have a diverse panel of actors at instant T when we decide to issue;
- The ability to issue several forms of contracts. The FCT enables the operation, regardless of whether it takes the form of a derivative or of a reinsurance contract;
- The possibility, or impossibility, of creating “programs”. Once an ILS is issued, it is necessary to go back and request approval again, even when re-issuing a very similar vehicle from another compartment;
- The compatibility of the place of issuance with the investors' criteria; given that when a Cat Bond is issued we strive to include a maximum possible number of investors, so as to obtain as many carriers as possible for the issuance. This is why it is crucial to be certain of the choice of jurisdiction so that one does not dissuade any potential investors.
It is essential for Scor to have a plurality of choice at every instant when deciding on an issuance. This is because we know that at instant T, a regulator can have other business to handle and not be highly reactive or the service suppliers may be less available.
What advice could you give a potential issuer?
Olivier Desmettre: It is essential to prepare and to anticipate the operation as best as possible. As is the case for all authorizations, we suggest filing a mock request. A mock request provides the opportunity to identify, prior to processing the official request, the areas that are not clearly delineated and could block the authorization. The “official” phase then goes much faster since an in-depth analysis has already been performed. There are also no registrations fees to pay the supervisory body when filing a mock request or an official request.
It is also very helpful, in the course of the regular exchanges between the organizations and their control departments, to be able to quickly identify the organization's needs so that resources may be freed up and also to be in a position to deliver within the shortest possible time frame.
Naturally, needlessly repeating iterations is to be avoided. The key to this type of operation is speed of implementation. Therefore, iterations are necessary when they provide only those elements that are deemed fundamental.
If an operation is repeated, and presents close similarities in comparison to the initial operation, it is obvious that our analytical process is going much faster.
What role do investors play in the choice of a jurisdiction?
Stephan Ruoff: The influence of investors on the choice of the jurisdiction is rather limited. For most ILS, we do of course perform due diligence which obliges us to examine the place of registration of the sidecar or special-purpose vehicle. However, the issuers select the jurisdiction on the basis of the possibility, or impossibility, that the investors may include the ILS in the funds and in the investments.
Bear in mind there are two major classes of transactions made on the ILS market:
- Public transactions such as Cat Bonds. These are transactions that are also sold on a secondary market on which products are traded;
- Private transactions. These often include investments that are made and retained by investors up until termination or expiration. Private deals are generally contracted in amounts of between 20 and 75 million. More often, 144A public deals are contracted in higher amounts.
The question of the jurisdiction differs for each of these two groups.
The FCT operates as a French fund; however its assets can be acquired under foreign law. Therefore, the FCT can very well subscribe to an English-law contract to transfer risks. The liabilities are very flexible. The FCT can issue debt securities, under every law possible and imaginable. This is why 144A placements are used, especially for large CMBS placed in the US, or for products issued under Australian law.
Quentin Perrot: About ten years ago, ILS investors were probably less experienced, and so they expected more from the cedent and wanted it to put more effort into the process of transforming the securities. Today, the majority of investors who have reached a certain size are able to offer reinsurance proposals directly to cedents and take care of the transformation process themselves. So, private Cat Bonds tend to be disappearing bit by bit. The 144A also has the advantage of lowering the spread by creating competition between different investors and setting a market price.
Can the development of the Paris marketplace attract new investors?
Quentin Perrot: Yes and no. No, because French investors can already invest in Insurance-Linked Securities today. The two major French ILS investors—AXA IM and Scor Investment Partners—already invest in ILS that are not issued by FCTs. Today, there is a certain misunderstanding in France of how an ILS functions, and of how one can invest in an ILS. To this extent, promoting the Paris Marketplace and the FCT—which is an asset that is very familiar to French investors—is very important.
This being said, today, the cedents benefit more from an efficient FCT scheme than the investors. This provides them with access to the capital markets more easily than by going through Ireland, and then England with Brexit and the accompanying uncertainties.
Which jurisdictions are used by investors and are not entirely compatible with an FCT?
Edouard Chapellier: In the framework of the transparent scheme mentioned earlier, the investor is taxed in France as if he receives the underlying portion on a direct basis. However, these products may be subject to French withholding tax. To eliminate the withholding tax, the investor is required to have offices in those countries that have tax treaties with France. France has the greatest number of tax treaties in the world (approximately 170) which cover almost all countries except off-shore countries in which the efficiency of the FCT is limited. Concerning off-shore investors, the use of tax treaties can play a part in the structuring of their own mechanisms and in the investment fund's or the special-purpose vehicle's architecture that sometimes includes off-shore components. They may also have affiliates located in countries with tax treaties such as Ireland, England or Luxembourg.
Patrice Doat: We often see investors, for example American investors, use a structure based in Luxembourg that will invest directly in the FCT in France in a somewhat traditional manner.
How do we attract ILS investors not toward the funds located in off-shore jurisdictions that are not really compatible with FCTs but more toward the European jurisdictions?
Stephan Ruoff: Approximately 50% of ILS investors are US investors. Other markets allocate enormous amounts of cash to ILS investments. These include the UK, European (especially in the Nordic countries) and the Swiss markets. These investors must domicile their funds in a manner that is sometimes a bit different than for US investors. There are also investors from Australia, Japan, Korea and also Canada. The landscape is rather broad. Two factors guide investors: taxation and the acceptability margin of the special-purpose vehicles. The FCT and France enjoy the benefit of tax treaties with a number of countries, yet France is not the only country to share in this worldwide acceptance.
Patrice Doat: YHistorically, the market has never been located in France. Certain habits have therefore taken root in Ireland, the UK and Bermuda and it is sometimes easier to repeat things that have already been done several times. There is therefore much to be done in terms of educating. And it is sufficient, as CCR Re has already primed the pump enabling other cedents or other investors to invest in a new type of vehicle that offers pretty much the same type of covers and more legal comfort.