introduction
On 1 November 2024, the UK implemented Securitisation Regulation 2024, which is reshaping how institutional investors — such as Lloyd’s syndicates — assess the structured securities markets. This departure from the EU regulations has modernised the regulatory approach, which aligns better with practices in the US market, and streamlines compliance for UK-based institutional investors.
This publication discusses the investment opportunities for Lloyd’s syndicates and other London Market entities.
Regulatory Changes
The UK’s new framework replaces the retained EU regulations with a principles-based approach. Key changes include:
- Removal of prescriptive reporting templates (which were incompatible with US and some global deals).
- Flexible due diligence rules, allowing investors to independently assess risk without rigid formats.
- The scope of “institutional investor” expanded to include Financial Conduct Authority (FCA) investment firms, broadening access.
For insurers, the most consequential areas relate to the risk retention and due diligence requirements.
Risk Retention
A “material net economic interest” in the securitisation of “not less than 5%” should be retained by the originator, sponsor, or original lender. This can be achieved through retaining 5% of the nominal value at each tranche / exposures level, including through retaining a certain level of “first loss” exposure.
A certain proportion of issuances now have risk retention language in the documentation that commits to complying with Solvency II / Solvency UK’s requirements.
Due Diligence Requirements
The investor is required to have “a comprehensive and thorough understanding of the securitisation position and its underlying exposures” and have certain risk management policies and procedures in place.
An investor, such as a (re)insurance firm, can delegate the compliance with and surveillance of the due diligence requirements to an asset manager, with the asset manager being responsible for complying
with them.
Why are Structured Securities attractive to Lloyd’s Syndicates?
Certain types of structured securities, as highlighted to the right, align well with the unique investment requirements of Lloyd’s syndicates. The broad spectrum of available securities allows syndicates to tailor credit quality, duration, and liquidity profiles to suit their liability matching and capital efficiency objectives.
From a portfolio construction perspective, structured securities can bring the following benefits.
- Higher risk-adjusted yield than corporate securities: as shown in exhibits 1 and 2 below, these structured securities can provide higher spreads and yields than corporate bonds, while the historical credit loss experiences are significantly lower. Exhibit 1 compares the yields between selected structured securities and investment grade corporates. In addition to the potential yield pick-up opportunities, comparable structured securities also offer higher credit ratings – sometimes at a much shorter duration – both suiting the profile of a Lloyd’s portfolio.
- Diversification and risk protection: Lloyd’s portfolios tend to have a concentration in credit exposure to the corporate sector; introducing structured securities would help diversify the credit risk exposure. Structured securities also benefit from protections such as credit enhancement, subordination, over-collateralisation, and performance tests. By combining multiple protections, structured securities can maintain very low default loss rates in senior tranches — even if the underlying loan pool experiences significant stress.
- Liquidity: High-rated ABS and CLOs typically offer reasonable liquidity even in stressed markets.
- Floating rate with CLOs and CMOs: Floating rate securities pay interest tied to a benchmark (typically SOFR1) so coupon payments increase (decrease) when interest rate rise (fall). In addition, floating rate instruments provide a natural hedge to any duration and inflation exposure.
Lloyd’s Syndicates
When it comes to Lloyd’s syndicates and investing for premium trust funds, the types of structured securities detailed above are permitted within both regulated (e.g. Credit for Reinsurance Trust Fund) and non-regulated (e.g. Lloyd’s Dollar Trust Fund) portfolios.
Exhibit 3 shows the impact of adding structured securities to a representative Lloyd’s portfolio demonstrating the yield pick-up of c. 30 bps while increasing the average portfolio credit quality by 1 notch from AA- to AA.*
Funds at Lloyd’s (FAL)
Structured securities can also be used as part of a FAL investment portfolio, subject to meeting credit quality, duration, and liquidity requirements/preferences. Incorporating structured securities into FAL portfolios could enhance income while maintaining capital efficiency.
Per Lloyd’s regulation,2 up to 80% of the FAL portfolio can be invested in AAA/AA rated structured securities, before risk capital charges being potentially applicable to the capital provider.
Solvency UK Capital Treatment
Solvency UK, like Solvency II, applies higher standard formula capital charges on structured securities than on corporate bonds. However, syndicates or entities using internal models can achieve lower capital requirements that better reflect the actual credit risk. Treatment may vary depending on the internal model’s philosophy and structure, but the structured holdings above should attract a lower capital charge than A rated corporate bonds.
In our experience, a 5% to 10% allocation to high-rated structured securities typically has an insignificant impact on the Solvency Capital Requirement (SCR), after allowing for diversification effects.
Exhibit 4 assesses the level of impact on the SCR (under standard formula) of introducing a 5% allocation to AAA rated structured securities to a $1.0 billion investment portfolio of an insurer.
How to Make It Happen?
Bringing it all together, what are the steps a Lloyd’s / London Market entity should take to add structured securities to their portfolios? We propose a 4-step process:
1. Partner with an experienced asset manager in structured securities. The manager should also have solid knowledge on insurance regulation (including Solvency UK and Lloyd’s regulations).
2. Conduct strategic asset allocation (SAA) – Ideally, the risk and return characteristics of structured securities are evaluated as part of an SAA exercise. This will help determine the levels of allocation to the different types of structured securities.
3. Obtain board / investment committee approval and formally delegate due diligence obligations to an asset manager. This process will also help ensure that the insurer complies with the Prudent Person Principle under Solvency UK.
4. Deploy the strategy with an asset manager. Where applicable, investment guidelines and benchmarks may need to be revised. The deployment period could vary depending on the mandate size and availability of qualifying investments.
Key Takeaways
- UK’s post-Brexit securitisation regulation allows flexibility and broader access to structured securities.
- Certain high-grade ABS, CLOs, Non-Agency RMBS and CMOs meet the risk retention requirements and provide potential yield enhancement with structural credit risk protections.
- Opportunities exist for Lloyd’s syndicates to use structured securities to diversify risk, enhance yield, and manage duration.
- Robust due diligence, careful security selection and rigorous portfolio construction are essential to unlocking benefits, while insurers should also manage any capital implications.
Endnotes
1 Secured Overnight Financing Rate (SOFR) is a measure of the cost of borrowing cash overnight collateralised by Treasury securities.
2 See Lloyd’s Market Bulletin Y5435 “Clarification of Membership & Underwriting Conditions and Requirements (‘M&URs’): Investments”
