The Financial Services Authority is developing rules to ease the regulation of special purpose vehicles in the UK.

The FSA is proposing to ease rules governing insurance special purpose vehicles (ISPVs), also known as sidecars, which are currently regulated in the same way as traditional reinsurance companies, despite assuming lower risks.

The proposed ISPV regime is part of a wider consultation on the EU Reinsurance Directive, which is likely to be implemented in the UK in December. “Although the consultation paper derives from the Reinsurance Directive, which emanates from Brussels, this is another sign of the FSA seeking to emphasise the need to preserve the competitive position of the UK insurance market,” said James Bateson, an insurance and corporate finance lawyer at Norton Rose.

ISPVs aren't new – but until now have not been a viable option under the UK's tax and regulatory system. They have been used to great effect in other jurisdictions to transfer certain portfolio risks to the capital markets. By transferring risk this way an insurer or reinsurer can thereby reduce its capital requirements and potentially take on more business whilst keeping the same level of technical reserves.

ISPVs must be fully funded, ie the market value of its assets must exceed the amount of exposure underwritten. “An ISPV will raise money in the capital markets by issuing bonds to investors,” explained Dr Thomas Huertas, FSA director for wholesale firms. “The rate of interest will be related to the likelihood that bond holders will get their money back.”

Under the Reinsurance Directive the FSA plans to implement a regime whereby ISPVs can be set up under a more “streamlined” authorisation process. This will remove unnecessary information requirements and place greater focus on self-certification than for a traditional insurer or reinsurer. “If it's economically feasible and viable to use an ISPV then from a regulatory point of view we're not in the habit of stopping something sensible like that,” said Huertas.

A conducive tax regime is also necessary to encourage the use of ISPVs. On 13 June 2006, HM Revenue and Customs proposed the implementation of a new taxation regime for special purpose vehicles, to take effect from 1 January 2007. It is seeking the industry's views on whether ISPVs should be included in that regime. “It is vital that the tax and regulatory regime operate in synch – one without the other is like a bicycle without wheels,” said Bateson.