BREXIT: What would a 'hard Brexit' scenario mean for insurers and wealth managers?

Out-Law Analysis | 14 Nov 2016 | 11:51 am | 6 min. read

FOCUS: Over four months on from the Brexit vote, it seems that we are no closer to knowing what the 'end game' looks like.

UK prime minister Theresa May's statement that "Brexit means Brexit", together with pronouncements from various EU politicians, means that speculation has increased that the UK is heading for a 'hard' Brexit. This would mean leaving the single market without any special deal, with the UK being treated like a third country across the board at least initially.

There is increasing focus on transitional arrangements since a final deal looks to be several years away at least. Firms cannot wait that long for certainty to emerge before doing what is necessary for their businesses to continue and grow.

In October 2016, May announced her government's plan to trigger Article 50 of the Treaty on European Union, which starts the two-year process of formal negotiations, before the end of March 2017. This would mean that the UK would be out of the EU by the summer of 2019.

This analysis is based on the assumption that the UK will indeed exit the EU as per this timetable; against the backdrop of the High Court's ruling of 3 November that the UK parliament must vote on whether to trigger the Article 50 notice, and pass appropriate legislation authorising the same, before the government can do so.

Although there are common areas to deal with, different parts of the insurance and wealth management industries will be affected differently by a 'hard Brexit'. Each business will need to assess its own needs and requirements well ahead of actual Brexit, including whether it can use its current structure or will need to implement any restructuring quickly.

Access to market and employees

Access to markets across the EU is achieved by a combination of 'passports' under various directives, which permit a firm to establish a branch or to provide cross-border services without the need for local authorisation, and free movement of employees. The importance of these rights varies across the different types of financial services and according to the structure and business focus of individual firms.

There has been much media speculation that the financial services industry will migrate from London. However, while the UK's exit from the EU is bound to have an effect on London's position, even a 'hard Brexit' is unlikely to produce a sudden shift to another jurisdiction. London is likely to remain a major financial services centre - albeit with some additional fragmentation across other centres such as Frankfurt, Paris, Dublin and Luxembourg over time, subject to restriction in infrastructure and levels of local expertise.

Issues for insurers

The retail insurance industry has a strong domestic focus, meaning that the EU passport is perhaps not of such fundamental importance to these insurers in the UK as it is in some other parts of the financial services industry.

For those insurers it does concern, under Solvency II there is no regime governing the establishment of branches of cross-border provision of services within the EU by a non-EU insurer or reinsurer. Insurers who do wish to continue or set up operations in the EU will need to establish an EU-based operation. Applying for authorisation takes time in any jurisdiction, and it will not take a vast increase in the number of applicants to start to swamp many of the EU regulators.

Some insurance groups already have EU authorised insurance subsidiaries, in which case it may be simply matter of increasing capacity and assessing the impact of capitalisation. Group solvency calculations can benefit from equivalence provisions in the Solvency II directive, provided the UK's regulations will be deemed 'equivalent' to the EU's. Although this seems likely to be the case at the time of Brexit, changes in UK law over time or EU changes not reflected in the UK may endanger continued equivalence. The UK's Treasury Select Committee is already looking at Solvency II in this context, which could be a sign of things to come as the UK gradually distances itself from the EU following Brexit.

Other insurers which have operated on a passport out from the UK will need to seek their own authorisation, and perhaps incorporate a local entity to do so. This may lead to restructuring; either to set up new subsidiaries, or perhaps to sell off uneconomic business based in other EU states. Rationalisation of EU business could create opportunities for firms that currently have the ability to carry out insurance in other EU states without the need for a passport to acquire business from insurers not wishing to turn a passport into a local authorisation.

Lloyds and the London market should be mentioned separately, as they conduct significant amounts of business in the EU. For example, in 2015, the EEA accounted for 11% of Lloyd's premiums. A loss of passporting rights through a 'hard Brexit' arguably would have a more appreciable adverse impact for this part of the insurance industry. Lloyd's is lobbying strongly for a continuation of the current passporting regime, although political pressure in the UK to restrict freedom of movement following the Brexit vote is a real challenge to achieving this result. The likely time required to reach any sort of deal requires some focus on alternative approaches if the Brexit is abrupt, and there are reports of Lloyd's considering a continental base.

A 'hard Brexit' may have different implications for different types of insurance. One very practical consideration concerns motor insurance. The current Motor Insurance Directive stipulates that subscribers to compulsory motor insurance policies in all EU countries, such as third party insurance, are covered for motoring throughout the EU. The directive also abolishes border checks on motor insurance, to ensure that vehicles can be driven as easily between EU countries as they are within any single member state. A hard Brexit may lead to the UK government needing to negotiate exchange agreements with each of the different member states to continue these arrangements, with pressure on agreeing transitional arrangements in the meantime.

Issues for wealth firms

In contrast to the insurance position, there are some provisions in relation to offering services to professional clients and for establishing non-EU branches within the EU without the need for authorisation by an EU regulator under the relevant legal instruments: the recast Markets in Financial Instruments Directive (MiFID II) and Markets in Financial Instruments Regulation (MiFIR). However, although possible, this is piecemeal and requires a formal assessment of equivalence.

Similarly, under the Alternative Investment Fund Managers Directive (AIFMD), there is a limited ability for alternative investment funds to be marketed under a passport system to professional clients. These non-EU marketing and branch passports need to be switched on, and have not been tested. To have access to them, the UK would need to be formally assessed as equivalent from the EU perspective.

If a business wished to have easy pan-European access, the main option remains to establish and get authorised an EU-based operation. However, as for insurance, this is a time-consuming process and EU regulators may not be able to deal with demand.

Assessments will be needed as to how an EU business will be able to delegate or outsource to a UK operation, and vice versa. The directives applying to wealth businesses anticipate such arrangements, and put in place certain requirements to ensure that any such action operates within a suitable regulatory environment. The ability to delegate, outsource or reinsure is now of utmost importance to the UK. It will be important that a formal understanding is reached between the UK competent authorities and those in the remaining EU that the UK is a robustly regulated jurisdiction. For related investment management, the ability for EU businesses to delegate portfolio management to a non-EU manager is currently available under the various applicable directives.

The term "equivalence" has started to be used as a suggested answer to hard Brexit. However, even where it does apply, it is not a panacea that will provide a comprehensive regime. Although helpful, a process is required and it may not be able to replace more concrete measures such as local authorisation. EU regulators will also want to ensure that operations in their jurisdictions have sufficient substantive presence, rather than simply plaques with the names of businesses attempting to operate entirely from London.

This is not just an issue for the UK looking out, as EU-based businesses trying to passport services into the UK will face similar problems and equivalence requirements. There will be other issues to resolve from a wider EU perspective as part of Brexit, particularly in the case of a swift exit. For example, London is the location of a number of significant trading venues which currently operate as regulated markets or multilateral trading facilities (MTFs) under MiFID.

Tobin Ashby is an insurance law expert and Elizabeth Budd a financial services regulation expert at Pinsent Masons, the law firm behind