In last year’s report, we identified a number of ‘grey swan’ events – predictable, but perhaps underestimated – that might affect the insurance market. One such event occurred on 23 June 2016, when the UK voted in a referendum to leave the European Union. The result caused short-term turmoil on financial markets around the world, and the UK Prime Minister, David Cameron, announced that he would be standing down.
It is important to note that the UK referendum does not in itself have any legal effect; it is advisory only. Nothing immediately changes and the formal process for the UK to leave the EU begins only when the UK serves formal notice, under article 50 of the Treaty on European Union, of its intention to leave the EU. The indications at the time of writing are that this will happen at the earliest towards the end of 2016.
When that notice is given, the two year process towards an exit, set out in article 50, begins. Any extension to that two year period requires the unanimous agreement of all other member states. While those two years are intended to give time in which the terms of an exit agreement can be agreed, the assumption must be that exit will happen at the end of the two years (assuming member states do not agree an extension) whether an exit agreement is reached or not.
Implications for passporting
In the absence of any agreement between the UK and the EU to the contrary, on Brexit, passporting rights for UKauthorised firms into the rest of the European Economic Area (EEA) will cease. However, it is possible that the UK and the EU could agree terms on which existing passporting rights could continue for a transitional period until a more wideranging trading relationship between the UK and the EU can be agreed. Alternatively, the so-called Norwegian option, of the UK joining the EEA, whether for a transitional period or permanently, would preserve passporting rights for insurers and brokers.
In relation to policies written before Brexit, clear transitional provisions would seem to be essential in any event, otherwise it would be unclear whether a UK insurer that had covered a risk located in another member state before Brexit, either on a freedom of establishment or a freedom of services basis, could lawfully continue to provide cover and pay claims under that policy following Brexit. In the case of statutory insurance, insureds in other member states may need certainty that cover issued by a UK insurer pre-Brexit will continue to meet the statutory requirements for cover throughout the term of the policy.
In terms of passporting into the UK, it would in principle be possible for the UK to retain passporting into the UK for EEA firms, either in general or through bilateral agreements with individual member states in return for reciprocal arrangements.
It also seems likely that, should the UK cease to be part of the EEA, it would need to apply for equivalence status under Solvency II. However, that will not be a substitute for passporting rights, since under Solvency II equivalence applies only in the context of reinsurance, solvency calculation and group supervision.
Implications for UK law
There is currently a huge body of UK law that derives from EU law. Dismantling this, and even identifying and agreeing on which aspects should be dismantled, will be an immense task. It will not simply be a case of repealing the European Communities Act 1972 (ECA), because the many regulations made under the ECA, both in Westminster and in the devolved administrations, will need to be retained until freestanding UK legislation can be implemented.
As a priority, EU regulations, which have direct effect in member states without the need for domestic legislation, will have to be replaced by UK law immediately on a Brexit. Examples include the Solvency II Delegated Regulation and the General Data Protection Regulation. As a stop-gap, it may be necessary simply to provide that such Regulations continue to take effect as if they formed part of UK law.
In the longer term, where it is intended that domestic legislation should move away from the position previously required under EU law, that will need to be the subject of consultation and political debate in the UK.
The likely direction of future regulation
A key question is: what will UK financial services legislation look like following Brexit? We think the answer is that it will look very similar to the way it does now. This is partly because a number of key European measures implement agreed international principles (such as Basel III and the IAIS Common Framework), which it seems reasonable to assume the UK would wish to continue to adhere to. In addition, any trading agreement with the EU is likely to require a close degree of harmonisation of laws in the areas covered by that agreement.
While some changes might occur at the margins, therefore, particularly given the willingness of the UK to gold-plate financial services directives in the past, there seems little reason to expect a bonfire of regulation immediately following Brexit.
What steps should insurers and brokers take?
As a starting point, all businesses should try to identify the risks and opportunities associated with Brexit that they will face. These are likely to include:
- passporting: we expect a number of UK-based insurers to consider incorporating subsidiaries in other member states to ensure that they can continue to underwrite risks in the EEA;
- possible restrictions on the free movement of people, goods, services and capital;
- policy wordings: these will need to be reviewed in terms of territorial scope and to identify risks which are materially different as a result of Brexit;
- the potential loss of regimes such as the mutual recognition of insurance under the motor insurance directives and the EHIC healthcare scheme;
- the ability to effect transfers in the UK involving risks located in other EEA member states under Part VII of FSMA may be significantly more difficult as a result of the UK leaving the EU;
- long-term contracts, such as leases and distribution agreements, may need to be reviewed and options considered to terminate or amend them. Termination rights in new contracts should be considered carefully to build in as much flexibility as possible.
Finally, do not forget that other significant legal changes, some highlighted in the rest of this publication, will require resource to continue to be devoted to them. Don’t be blinded by Brexit!