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Expert opinion
17 August 2022

Tutti frutti available as LMA inks credit insurance model contract

Middle East & Africa, Americas, Asia-Pacific, Europe
Head of Trade, Treasury and Risk
A new template credit risk insurance policy from the Loan Market Association has taken more than two years to achieve. Why is the template important? How will it improve capacity? How can standardisation help with regulators’ understanding of the credit insurance market, and banks’ appetite for the product and is it a competitor to other templates? And what do ice cream flavours have to do with anything?

August is always a challenging time to put out important market news, particularly for something billed as ground breaking, and the first of its kind in the credit and political risk world. As it is August, I will be using ice cream metaphors to aid your digestion in the heat. Keep a multi-flavoured tutti frutti ice cream in the back of your mind, as I shall return to that image of sub-sections of the insurance/surety markets before it, and I, melt.  

On 10 August, the Loan Market Association (LMA), in conjunction with the Lloyd's Market Association (Lloyd's) and the International Underwriting Association (IUA), published a model form of the Credit Risk Insurance policy (CRI policy) document. 

This is the culmination of two years’ work from the LMA, CRI brokers, industry bodies and a cohort of credit risk insurers. In short, the model policy, the LMA says, was drafted in order to insure single borrower credit risk arising from a loan agreement and with an eye on the CRR requirements for unfunded credit protection. CRR is the Capital Requirements Regulation, and this is important as the treatment of trade is under review with Basel III revisions.  

Why is the new template significant? How will it impact capacity? How will it help with regulators’ and banks’ understanding and is it a competitor to other template documents? 

 “The LMA document is hugely important for the market,” says Audrey Zuck, director of A2Z Risk Services. According to Zuck, it principally serves four important purposes: “First, it provides a solid starting point for negotiations as it is sponsored by the industry association trusted by banks as provider of template documentation. Second, it was negotiated by a working group comprised of insurers and brokers as well as banks so is a document accepted market-wide. Third, it meets a key regulatory concern that there be well-understood, standardised documentation for an important credit risk mitigation tool. And fourth it should provide comfort to banks new to non-payment insurance that they are embracing a proven product.” She adds: “It is not intended to compete with other templates. In particular the associations involved have stressed that it is not a replacement for users’ existing template wording.”

There could also be a positive impact on the market’s capacity. Sian Aspinall, managing director at brokers BPL Global, says that in addition to evidencing a level of standardisation of core terms to banking regulators, the new template provides a degree of comfort and reassurance to potential new bank entrants evaluating whether to use the market. “It creates an established basis from which to start negotiations, reduces barriers to market access and expands the potential product demand. When demand expands there comes opportunity and typically supply moves to match it either by enhanced offerings from existing carriers or via new insurer entrants. However, I think it is more likely to be a demand-led expansion.”

No one flavour fits all for insurance

To rewind, why is this interesting to outsiders? Once upon a time, everything seemed simple, bilateral, plain vanilla (to bring things back to ice cream). Now it’s multiple parties. Buyer to seller becomes supply chain, bank becomes banks, insurers – surety, guarantees, brokers, underwriters, reinsurers evolve. Soon we have every proverbial body under the financial markets’ sun and layers of complexity and flavour. We evolve public market subordination, syndicated loans, swaps and all manner of documentation under the wings of LMA, ISDA, ISMA, ITFA, BAFT. Tutti frutti. Which is not necessarily bad in itself, but it can confuse the palate.

The problem is, the insurance market and banking markets haven’t always been speaking the same language and there is plenty of opacity. Even the terminology of the insurance industry illustrates its differences – ‘special situations’ is a case in point. In fact the risk taken is often contract risk, but of course, the real risk is always the insured. The more complicated life gets, the more important it is to get back to simpler flavours to be able to understand them and make the right blend, use the right layers. 

Coordination of approach

As the market evolves, there has been a need to try and ensure that credit insurance gets the appropriate treatment as a dependable credit risk mitigation tool in the eyes of regulators, banks and end users. 

“Coordination of approach is essential as banking regulators work towards implementing a finalised Basel III,” says Aspinall. “The historic confidential nature of the credit insurance policies for banks has not served the industry well when creating a profile and wider knowledge of the characteristics and benefits.”

Trade body endorsements via the provision of published documents are vital to creating greater transparency, as is the provision of cumulated market data. These are necessary to support vital advocacy efforts on behalf of the industry. “The goal is ultimately to create a distinct identity for non-payment insurance within the requirements of unfunded guarantees that are reflective of the products’ specificities and provide appropriate treatment in the same way that regulation recognises those of, for example, credit derivatives,” says Aspinall.

Coming back to the ice cream analogy, let’s look at some of the layers that can be eaten individually. Do they melt together? As trade bodies help create standardisation, they are in the best positions to be catalysts to help move the markets. Each different trade body has a slightly different flavour and has focused on different parts of the business.

Jean-Maurice Elkouby, chair of the ITFA regulatory sub-committee for insurance, says ITFA very much welcomes the LMA initiative. “There is no overlap with the BAFT template for sureties, or the named buyer insurance cover for receivables spearheaded by Willis Towers Watson,” he says. “Each template caters for a sub-section of the credit insurance market: single risk non-payment on loans for the new LMA template, receivables for the ITFA-Willis template and contractual obligations for the BAFT ITFA surety template.”

Certainly, the LMA model form is focused on non-payment insurance for banks for loan agreements with typically one obligor. ITFA’s recent credit insurance policy is more focused on insuring a bank providing trade receivables finance to one client (supplier) that is supplying multiple obligors (buyers). The respective trade bodies’ individual initiatives reflect the composition of their membership and the focus of their members’ core activities. There is no expected overlap between the policies and what they will be used for. So no need to worry about the flavours melting together to the detriment of the whole. 

“All these efforts reflect a strong desire by the credit insurance industry to standardise their product, which will greatly assist advocacy for the product,” says Elkouby. “Indeed, regulators often look for transparency and homogeneity when analysing one market and these developments are very helpful in fostering greater transparency and homogeneity.”

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