In January this year the Solvency II directive for insurance and reinsurance business in Europe, was finally enacted. Then came Brexit. Pádraig Floyd finds out if this means the UK will choose a new direction.
In September, the House of Commons Treasury Select Committee launched an inquiry in light of the Brexit vote as to whether Solvency II should be retained, or if the UK should consider a different direction for financial regulation.
The trouble with doing your own thing is the scope of these regulations. Solvency II is a directive that consolidates regulation not only around capital adequacy, but cross-border business. It covers the rules about the operation of passporting services across Europe, which remove the need to set up business in each country.
This allows operations like the London market and Lloyd’s of London to write group business without having to have a presence in other European nations. There is, however, a tension within the market between those who wish to operate within an EU regime and the UK-focused insurance companies that are not necessarily on the same page. “If they are not doing cross-border business, their interaction with the EU legislation is less critical,” says Hugo Laing, international insurance partner at Eversheds.
Should the UK decide to go it alone there are alternatives, such as the Norwegian model, which mean signing up to existing rules, which seems unlikely. The Swiss model uses bilateral agreements to operate within the same rules and this has not been a hindrance to its banking and insurance industries.
“Alternatively, the select committee may choose to negotiate some form of equivalence of Solvency II whereby the EU will recognise similar regimes,” says Laing. While this may satisfy some of the insurers, other insurers, the banks and asset managers all have their own views. Meanwhile, some parts of the financial services sector – US banks in particular – are considering whether London will remain the best place to do business.
There’s a good bit of ‘wait-and-see’ going on, says Michael Tripp, partner and head of financial services at Mazars, though some insurers have made noises about moving part of their operation into the EU. “I don’t think any of them will be moving lock, stock and barrel out of London,” says Tripp. “It seems likely we will keep some form of equivalence in order to make the UK attractive on a global basis.
“Quite apart from that, so much work has already gone into Solvency II that no one will want to start all over again.”
Solvency II is a risk-based regime that most people support in principle and which was founded on a UK idea for a capital regime. However, the UK has a tendency to not only follow the rules, but gold plate them.
The benefits of Solvency II are that it is a risk-based regime, but the reporting looks incredibly complex, says Tripp. London is an attractive location as a hub for financial services. People like living here and it is already the centre of excellence in the mixture of knowledge, skills and experience which is unique, says Tripp. If moving elsewhere, the loss of key skills and the cost of a subsidiary would have to be taken into account.
Even if the UK wishes to deviate, there are more international global standards on the horizon that companies operating from London or the UK will have to comply with.
Laing would tend to agree that the best case scenario would involve the EU recognising the UK as a properly supervised market and agree an equivalent or abridged version of Solvency II, providing the best of both worlds.
There will be parts some won’t like, but the worst-case scenario could leave UK-based firms facing large organisational restructuring and huge short-term costs to exit markets or gain a European foothold. “People here are very innovative and will find ways of making it work, even if some players choose to move part of their business elsewhere to hedge their bets.”
Ashley Smith, SVP business development, at technology company Silverfinch believes while the regulator has been lenient in 2016, and he anticipates a much stronger stance for 2017 compliance.
“It doesn’t help that the market is split among regulators, with insurers under the PRA and asset managers under the FCA,” says Smith. But, it is unlikely companies will be able to ignore Solvency II as changes in another part of the sector are causing it to become integrated. It is developing much faster in asset management and we are seeing a link between solvency and PRIIPS (packaged retail and insurance-based investment products).
Finally, those who want to see the UK pull out of Solvency II should be careful of what they wish for, warns Laing. Currently, there are some things the regulators cannot rule on, but if the FCA or PRA had greater autonomy, they would also have greater power. Is that a consequence financial services entities are prepared to entertain?