Opening the gates to cryptocurrencies
Shutterstock / Nichole R Young
Bermuda has worked hard to place itself at the forefront of technology and innovation in financial services. Bermuda:Re+ILS examines the recent developments.
Every jurisdiction that leads the market at any time wants to stay there, while those who are behind it want to overtake their rivals.
Finding a unique selling point, or garnering an advantage, is therefore key. Bermuda has in recent years grabbed not one but two concepts that it thinks will give it some advantages in the near future. The first is blockchain, the second is cryptocurrencies.
These concepts are both being heavily promoted by Bermuda’s Progressive Labour Party government. Premier David Burt has often mentioned these two areas in his trips to the UK and the US as he promotes Bermuda’s openness and accessibility for new business.
Blockchain is very much in the news at the moment, with ChainThat’s blockchain-powered risk and capital exchange the Bermuda Insurance Exchange on the Island scheduled to go live with a production trial in July 2019 (see story on page 32).
According to John Huff, chief executive officer of the Association of Bermuda Insurers & Reinsurers, innovation through insurtech, blockchain, and technology is taking the insurance industry by storm. Stakeholders around the world are appreciating the importance of comprehensive regulatory understanding and approval of these models.
As Huff points out to Bermuda:Re+ILS, Bermuda is leading the way. Bermuda’s Insurance Amendment Act 2018 created a framework to establish an ‘insurance regulatory sandbox’ to further position Bermuda in maintaining its status as a leading centre for insurance innovation.
“Technology-enabled innovation in the insurance industry—insurtech—has emerged to offer simpler products and streamlined customer experiences,” said Burt on the introduction of the act. He attended the George Washington University in Washington, DC, double majoring in finance and information systems and attaining a master’s degree in information systems development.
Hard work in the sandbox
Huff feels that the challenge for many insurance companies is to determine the best way to leverage technology to achieve strategic vision and business objectives.
“The Bermuda Monetary Authority established the insurance regulatory sandbox to enable testing of financial technology by a licensed insurer or a licensed insurance intermediary to a limited number of clients in a live environment for a limited time period,” he explains.
The Bermuda sandbox eligibility criteria are as follows:
- The technology must be new or use existing technology in a different way;
- Research must be conducted in advance of the application;
- Testing objectives must be clearly defined;
- An insurer or an insurance intermediary must demonstrate its understanding and assessment of the relevant risk;
- An insurer and/or an insurance intermediary must demonstrate that policyholders and counterparties are adequately protected against loss during the testing stage;
- An insurer and/or an insurance intermediary will be required to have a well-defined exit or transition strategy in case the testing is unsuccessful or discontinued; and
- An insurer and or an insurance intermediary must demonstrate that it has the intention, ability, and resources to deploy the relevant product, service or distribution channel upon successful testing and exit from the sandbox.
Huff adds that the global financial services market is highly competitive and companies seek to use a variety of elements to support their business objectives at any given time—including the choice of domicile.
“The sandbox assists Bermuda in advancing its ambition to remain a centre of insurance innovation, by providing the opportunity for new and existing companies to create and perfect innovative insurtech products in Bermuda,” Huff says.
Tom Johansmeyer, assistant vice president at Verisk Analytics, adds a note of caution about one leading area of insurtech.
“Blockchain has been the hottest new technology idea to hit the
re/insurance industry for several years,” he says. “Why hasn’t it taken off? After watching this space for four years, I’ve yet to see even the germ of a transformational solution.”
According to Johansmeyer, blockchain can’t change the re/insurance world “because it’s plumbing, not a solution”.
“One would use blockchain to build something that changes the world, and that ‘something’ has been in short supply,” he explains.
“The industry needs to think more about the use cases, and less about the bits and bytes. What are the problems that require the key advantages of blockchain, such as record permanence, fraud resistance, and reliable audit trails?
“Most of the efforts I’ve seen so far have been attempts to rehash industrywide solutions, ostensibly improving them through the use of blockchain,” he says.
“However, such attempts have fallen short of solutions that have attained broad adoption and enjoyed years of enhancement through focused end-user feedback. The ability of blockchain prototypes to overtake established solutions is likely to remain constrained by a disconnect between the benefits of blockchain and the specific business needs of the re/insurance community.”
Johansmeyer says that reinsurance placement tools are stuck competing with nimble startups that can help with the placement and management of risk without the rapidly growing overheads associated with record immutability. Claim repositories for fraud detection lack the rich functionality informed by decades of evolving organised threats.
There are more examples—the predictable outcome of the blind application of technology to a client’s problem rather than the targeted application of thought.
“Blockchain is a promising technology, but it needs to be brought the right use cases to make a meaningful difference in the worldwide risk transfer market,” Johansmeyer concludes. “Rather than use blockchain to mimic rules-based platforms, it makes more sense to invest in solutions for audit trail, record permanence, and trusted transaction completion.”
UK crypto fears
Bermuda’s emphasis on being open to cryptocurrencies comes at an interesting time for the market in these products.
In the UK the Financial Conduct Authority (FCA) is proposing rules to address harm to retail consumers from the sale of derivatives and exchange-traded notes (ETNs) referencing certain types of cryptoassets.
In January 2019, the FCA issued a Guidance on Cryptoassets (CP19/3) to clarify what types of cryptoassets fall within its current regulatory perimeter, which closed on April 5, 2019. The FCA expects to publish its final Guidance on Cryptoassets later in the summer, and has reflected feedback to that consultation in its proposals for crypto-derivatives.
In a statement the FCA said that it considers these products are ill-suited to retail consumers who cannot reliably assess the value and risks of derivatives or ETNs that reference certain cryptoassets (crypto-derivatives). This is due to:
- The inherent nature of the underlying assets, which have no reliable basis for valuation;
- The prevalence of market abuse and financial crime in the secondary market for cryptoassets (eg, cyber theft);
- Extreme volatility in cryptoasset price movements; and
- Inadequate understanding by retail consumers of cryptoassets and the lack of a clear investment need for investment products referencing them.
These features mean retail consumers might suffer harm from sudden and unexpected losses if they invest in these products.
As a result the FCA is consulting on banning the sale, marketing and distribution to all retail consumers of all derivatives (ie, contracts for difference [CFDs], options and futures) and ETNs that reference unregulated transferable cryptoassets by firms acting in, or from, the UK. A spokesperson for the FCA told Bermuda:Re+ILS that the proposed ban would not apply to British Overseas Territories.
Could this lead to Bermuda’s being able to exploit a possible opening in the market? The FCA announcement was made as Bermuda:Re+ILS went to press, so the implications of the UK’s move for Bermuda remain unknown for the time being, but the government of the Island is, no doubt, watching events closely.
Bermuda, cryptocurrencies, blockchain, innovation
Opening the gates to cryptocurrencies