Alan Ball and Fiona Walden, senior underwriters leading the structured risk solutions team at Liberty Specialty Markets, answer SCI's questions

Q: How did Liberty Specialty Markets become involved in providing capital relief-driven transactions?
A: We're one of the leading insurers operating in the London insurance market, providing both specialty insurance and reinsurance. Our structured risk solutions team was set up just over three years ago to provide insurance cover for transactional risks and structured financial risks.

Our involvement in capital relief-driven transactions grew out of our work on transactional risks. Traditionally, cover for these risks was provided not because the policyholder was concerned about the risk to be covered, but because it enabled them to achieve another strategic goal.

For example, by taking out insurance against breach of warranties in a share purchase agreement, a private equity fund can more quickly distribute the proceeds to its investors. This is because the insurance mitigates the need to reserve for contingent liabilities arising from the share purchase agreement.

Based on our growing experience with transactional risks, we began to explore other areas in which similar dynamics and motivations existed. Capital relief cover was one such area.

We originally insured legacy non-core credit assets held by banks, for which they struggled to find solutions via traditional routes. These assets represented good quality credit risks, but had become capital intensive as a result of the changing regulatory landscape.

Having analysed the legislation, we drafted our policies to meet the requirements for eligible credit risk mitigation set out in the Capital Requirement Regulation (CRR). This enables a banking client to realise the associated capital benefits as a result of the risk transfer.

Relevant regulators are aware that insurance is being used as eligible credit risk mitigation under CRR and Basel 3. Some clients have shown our policies to their regulator in advance of signing a deal; others have been audited by their regulator post-signing.

Since writing our first policy, we've worked with a number of major financial institutions and have deployed a significant amount of cover across of a variety of risks, jurisdictions and sectors.

We take a principles-based approach to our underwriting and risk selection. This is important to give us the flexibility to deliver effective solutions to our clients, as many risks we cover are bespoke or niche and require suitably tailored solutions.

One of our key underwriting principles is that while insurance is clearly the business of risk transfer, there needs to be a wider, credible strategic goal driving the purchase of insurance - not simply a desire to offload poor quality credit risk. We scrutinise the motivation for insurance cover closely in our underwriting and look for alignment of interest with our insureds to prevent any moral hazard.

Q: What are your key areas of focus today?
A: Initially, we focused on solutions for legacy non-core assets held by banks. An example would be providing default cover for legacy securitisation positions, such as SPV liquidity facilities.

Such facilities are unrated and therefore attract a high capital weighting relative to the risk they represent. This is because the risk weighting is driven by the rating of the most senior note tranche. Insuring the default of the facility reduces the capital requirements of the bank through PD substitution - the bank no longer has exposure to an unrated SPV, but to a single-A rated insurer.

Interest rate swaps for legacy RMBS are also of interest to us.

While we remain open to working on legacy non-core banking assets, they represent a finite pool of opportunity, so we've begun to focus on other risks, such as providing portfolio credit solutions. Portfolio credit solutions can be structured in a variety of ways, such as insurance of a junior tranche on a portfolio of loan assets, allowing the bank to achieve significant risk transfer using unfunded credit risk mitigation. Alternatively, where a bank has aggregation to a particular sector or territory, insurance can facilitate increased flow of business for the bank.

We've also provided cover in relation to securities lending indemnification exposures and are familiar with the counterparty credit risk issues in this area. Here, the driver can be capital: simply affording the lending agent's clients an extra layer of comfort or addressing some other issue that is unique to that particular lending agent.

Provided there is a strategic driver for cover and the risk insured is financially catastrophic for that asset class, rather than ordinary course losses, the scope of credit risks we can look at is very diverse.

Q: How do you differentiate yourself from your competitors?
A: We're the only team in London that focuses on structured credit risk transfer through insurance. In terms of our team's expertise, we have insurance, corporate, legal, private equity, structured finance and tax expertise, with 25 years' professional experience in leading and advising on unique, complex and often precedent-setting transactions.

This broad range of experience means we are comfortable approaching unique or niche risks. It also means that we have a first-hand, intimate understanding of deal dynamics and the challenges and constraints (both internal and external) that parties trying to execute such transactions can face. The key reason behind our success has been the backing of a stable, creditworthy insurer such as Liberty and the ability to effectively translate regulatory issues and financial risks into insurance grounding.

We typically form long-term partnerships with all of our clients. Our hope is that after executing an initial transaction, we can replicate a transaction with the same client or tackle other areas of their business.

Q: Which challenges/opportunities does the current environment bring to your business?
A: Creating awareness of the possible usages of insurance for structured credit risk transfer is certainly a challenge. We have a genuinely differentiated offering, given how we approach transactions. It's our ability to bridge the disconnect between banking and insurance.

We strive to keep on top of the multitude of issues facing financial institutions at the moment. We are starting to see more actions focused on asset managers and private equity funds, rather than solely banks.

Q: What is your strategy?
A: To grow our profile and continue to execute on innovative transactions, as well as establishing long-term partnerships. The focus of our book is swinging to risks driven by strategic motivations, rather than solely capital relief.

The nature of the risks we target means that we have to be flexible and adaptable to the commercial and regulatory environment, but we also want to target areas where we think there is longevity. In this regard, the area of portfolio credit risk transfer is particularly interesting.

CS