London-based specialist insurance and reinsurance marketplace, Lloyds, has issued a new market bulletin for members which outlines some changes to the use of letters of credit (LOCs) within Tier 2 capital limits, and underlines the need for frequent confirmation of the validity of each LOC issued.
It appears as though this guidance document related to Tier 2 capital is the first to note the importance and requirement of regularly confirming the validity of LOC’s used by Lloyd’s members to support their Economic Capital Assessment (ECA) requirements.
The bulletin confirms that a number of existing requirements, such as an allowance for members to fund up to 50% of their ECA with LOCs at the point they first provide capital, remain in force, but also introduces some changes.
This includes existing members being able to increase LOCs by as much as 10% of their ECA per annum without seeking prior approval from Lloyd’s, so long as the new ratio does not exceed the 50% threshold.
If an increase of more than 10% is sought, existing members can now apply for an increase and prior consent must be sought in advance from Lloyd’s, with the 50% limit still applying.
The guidance also confirms numerous other changes, but perhaps most notable, is that within the Lloyd’s list of general guidance to be followed, the marketplace emphasises the need for regular checks on the validity of LOCs issued.
“Lloyd’s require all issuing banks to confirm the validity of each LOC issued on behalf of members on a six-monthly basis. If this confirmation is not provided by the issuing bank, Lloyd’s reserves the right to discount the value of the LOC as part of a member’s FAL until such time as the bank provides the necessary confirmation,” reads the bulletin.
Now, it’s not clear whether this part of the guidance is in response to the fraudulent LOC issue at insurtech Vesttoo, but as far as we can tell, this is the first time Lloyd’s has mentioned this in its Tier 2 capital guidance for members.
Nevertheless, it’s clear from this statement that Lloyd’s is serious about securing regular validity of LOCs issued at a time when the LOC process is in the spotlight following the fraud surrounding Vesttoo.