The 29th of March 2018 will mark a year since the British government triggered Article 50 of the Lisbon Treaty, initiating the two year countdown to Britain’s formal withdrawal from the European Union (‘EU’). The triggering of the Article 50 process coming in response to the British electorate’s 51-48 vote to leave the EU.
The main concern for the UK’s insurance industry and for financial services generally at the time of the referendum was the damage that might be done by an extended period of uncertainty and, unfortunately for the industry, not much has been done to alleviate this. While other British industries have been consulted and have been consulted on by the Government, the future of financial services remains shrouded in a tentative hush.
Somewhat counterintuitively, the lack of progress on a vision for London’s financial services comes as a result of the industry’s importance to the economy, whilst nationalist platitudes regarding other industries have proven useful political tools; mistimed or reckless statements on the future of the City of London can send sterling into a tailspin and capital fleeing for safety.
As uncertainty reigns in the UK, Britain’s negotiating counterparts across the channel have stood fast in their view of what Britain cannot have: leaving the EU means reduced access to the European single market and a loss of coveted passporting rights. We also now know that by mutual agreement there will be a two year transition period within which it is likely that Britain will continue to function as a member of the EU and that during this period things will remain largely the same. While in outline the transition period has been set out, what is not at all clear is what the UK will be transitioning to. There are various scenarios which the City of London may be faced with after transition and these can be summarised broadly as; a good deal, a bad deal, no deal and no exit.
A good deal
It is thought that the best deal for London will be some form of regulatory equivalence where the EU recognises UK financial services regulations as being equivalent to its own. This would be likely to involve the UK mirroring EU financial services regulations and would be a welcome arrangement in the City of London where a large majority of industry players are happy to continue adhering to the current regime and tracing its natural evolution. As Britain is already 100% aligned with EU regulatory requirements, there would be no substantial adjustments for businesses to make.
A bad deal
Countries are not usually willing to have matters which affect core financial stability settled by negotiation or consensus and so financial services are usually not included in Free Trade Agreements. It is not entirely clear what EU redlines are but it appears that a bad deal for the UK is likely to resemble most of the EU’s external trade deals with financial services not being included and with the UK being on trade terms similar to those of Canada or Turkey. In this scenario, there is some discussion of a narrow equivalence being granted to the UK for capital requirements under the EU’s Solvency II directive, however there would be no replacement for passporting.
The so called “cliff edge” or “hard Brexit” scenario is backed by a handful of Brexit hardliners and is generally considered as being the nightmare scenario for all, particularly the financial services sector.
In such a scenario there would be no deal on trade in goods or services and Britain would engage with the world on World Trade Organisation terms until it was able to make bilateral trade agreements with individual nation states. Insurers who are not prepared for this would face myriad problems.
As Britain would become a “third country” under EU law, insurers would face increased capital requirements to operate in continental Europe and it now seems that the loss of passporting will make it illegal for insurers to continue to perform obligations under existing contracts. The European Insurance and Occupational Pensions Authority has stated that no deal would likely prevent insurers from being entitled to pay claims in Europe - with the subsequent damage to reputation which this would bring - as claims payments are a discrete category of regulation requiring approval. Some jurisdictions may, in the interests of customer protection, seek to waive new authorisation requirements for claims or run off business but this is far from guaranteed.
British insurers are also accustomed to using the authority of European regulatory directives to dispose of and acquire portfolios of risk in a fairly standardised process. Under this process, authorities in only one European jurisdiction need to confirm the validity of a transfer and billions of dollars worth of risk from across the continent can be segregated, bought and sold within tight timescales. In a no deal scenario it is likely that a UK entity would need to secure approval from regulators in every jurisdiction in which the portfolio had elements, making many deals too time consuming and too costly to carryout.
The emergence in the press of EU communiques with major European industry bodies suggesting that they prepare for this ‘no deal’ scenario came as something of a shock to the UK government but (perhaps unsurprisingly for an industry whose entire focus is the management and mitigation of risk), the no deal scenario is the scenario which most high calibre insurance businesses in London have initiated contingency plans for. The London insurance market Lloyds has established a subsidiary in the EU’s administrative capital Brussels. It is hoped that this will allow all Lloyd’s syndicates to enjoy continued rights to passport into other EU countries as Lloyds is currently recognised under EU directives as a single entity for (re)insurance purposes allowing all it’s members to utilise it passport without each securing their own.
Non-Lloyds insurers have also taken significant steps to consolidate their continental European presence with over 40 insurers establishing offices, relocating staff or moving head quarters. Dublin and Luxembourg have been the big winners of the Brexit exit and among the names which, since the leave vote, are carrying out various degrees of restructuring are AIG, AVIVA, Britannia, Chaucer, Chubb, FM Global, Hiscox, Liberty Specialty Markets, MS Amlin, RSA, Sompo, Tokio Marine and XL.
There is an increasing clamour amongst so called “Remainers”, the 48% who voted to remain in the EU (of whom the British parliament is mostly constituted), for there to be a second referendum on the terms of the proposed post-transition deal once it has been negotiated. Should this happen and the proposed deal be rejected it is not clear what the next step would be except to say that by that time the outcome is likely to be something of an irrelevance to London’s insurance businesses which would already have fully implemented their Brexit strategies thereby making another change unlikely to cause significant disruption either way. Were rejection of the deal to mean that Britain remained in the EU, the irony is that an attempt to increase perceived national autonomy would in fact have led to the dispersal of the country’s main industry and necessitated increased interchange with its continental European counterparts.
While the City of London continues to await clarity on a proposed future for the world’s top financial centre, major changes have already been put in place by the insurance industry to manage worst case scenarios. It remains to be seen how other industries will fare but it is safe to say that an overview of the insurance industry reveals a well managed process of change, no matter the outcome, the insurance names that people know will be in a fairly strong position to take advantage both of London’s new landscape and of the increased activity generated by their enhanced continental European engagement.