On 30 April 2013, Andrew Tyrie, Chair of the UK’s Parliamentary Commission on Banking Standards and the UK’s Treasury Committee, published his exchange letters with Andrew Bailey, a Deputy Governor of the Bank of England and CEO of the Prudential Regulatory Authority.  It’s clear from these letters that Tyrie and Bailey have written to each other at least twice, but Tyrie’s opening salvo hasn’t been published.

It’s not clear why.In his replies, Bailey makes four points:

  • Solvency II is “an evolution of the current UK framework, but … a major change for Germany [and] France … [I]t is unclear to us that the French authorities will … be able to agree to any directive that we consider prudentially acceptable. Germany, in contrast, has long been supportive of a relatively prudent agreement … but needs a long transitional arrangement ... The process to finalise SII in the EU has ground to a halt in the face of these different national interests”;
  • When Solvency II “eventually” emerges, it will be maximum harmonised. This will make it difficult “for national supervisory authorities to impose sensible treatments to deal with more idiosyncratic risks. There is a risk that this … will be a battleground of the future as the judgmental approach of the PRA comes up against narrow interpretations of EU law”. “[A] principal concern is that Solvency II will be accompanied by overly-prescriptive rules … that will seek to establish a single approach to risk assessment and supervision that does not reflect the realities facing us in respect of individual firms…”;
  • “… there is a risk of over-reliance on complex models and of models being used to pare capital requirements. Moreover, there is a risk that SII overloads supervisors with very detailed model approval requirements. [This] is not consistent with the PRA’s … approach to supervision. To mitigate this risk, we plan to use ‘early warning indicators’ … We believe we can implement these … Indicators in the UK within the SII framework but in any event we would pursue this approach and accept the risk of EU challenge”;
  • “…I have been very concerned about … costs, which have been … staggering”.  “It would be a help if Parliament could cast light on a process which has gone on for … ten years, and in which the EU process has assumed that firms and regulators will spend very large amounts of money to prepare for something that carries no promise in terms of when, or in what form, it will be implemented”.

This is all rather curious:

  • So far as I’m aware, this is the first time that a senior UK regulator has publicly accepted that Solvency II has “ground to a halt”, and that it’s done so for reasons of national interest, even though the trilogue negotiations on Omnibus II effectively ground to halt on 12 July 2012 for the same reasons. It is also the first time that a Deputy Governor of the Bank of England and the CEO of the PRA (or the FSA, its immediate predecessor) has been prepared impliedly to criticise other EU Member States;
  • We’ve always known that Solvency II would be maximum harmonising, and that it would gradually lead to a single European approach to supervision, a single European Handbook and - in all probability - a single European regulator. That’s part of the raison d’etre for (i) the Lamfalussy process (which is being used to build Solvency II); and (ii) EIOPA (a key contributor to the new regime, and an organisation that clearly sees itself as a single European regulator in waiting). That didn’t seem to trouble the FSA, although it was never going to go down well at the Bank. It’s now clear that it isn’t going down very well at the PRA either;
  • The reference to over-reliance on complex models, and models being used to pare capital requirements, reflects the Parliamentary Commission on Banking Standard’s Report on the failure of HBOS which notes that (i) Basel II relied too heavily on complex models; (ii) these models were used (in part and by some) to pare capital requirements; (iii) Basel II implementation generated so much work that it distracted banks and their regulators from other more immediate and more material concerns… oh, and (iv) Basel II is now widely regarded as a failure. This must be a lesson well learned.

What’s less clear is precisely what Bailey thinks the lesson is (his language suggests that his principal concern is that supervisors will be overloaded by the number and complexity of internal model approval applications in the pre-implementation phase); and whether the PRA’s proposed early warning indicators will really help (after all, the PRA insists that its early warning indicators have been designed to make sure that each firm’s internal model remains properly calibrated in the post-implementation phase – they won’t therefore do anything to mitigate the pre-implementation risk Bailey has properly identified).

The reference to the early warning indicators is also interesting for a second reason: so far as I am aware, this is the first time a senior UK regulator has impliedly accepted that these indicators may be unlawful because they go beyond what Solvency II seems to envisage or require. But no matter -  the PRA accepts that risk; and

  • The PRA has invited Parliament to “cast light on a process which has gone on for … ten years”, when the FSA – the PRA’s immediate predecessor – was heavily involved in the Solvency II negotiations, and must have known precisely what was happening and why.

In his response, Tyrie explains that “The Committee takes your concerns very seriously and plans to examine them further in the coming months”. It will be interesting to see if this results in another critique of the FSA, whether it will be used to seek to persuade the European authorities that Solvency II should be switched from maximum towards minimum harmonisation, and whether it will eventually lead to the unpicking of some parts of Solvency II – even though the FSA regarded the Solvency II Directive as a major UK success, and the best outcome that could realistically be achieved.

One other thing is striking – but perhaps it’s no more than co-incidence: the Bailey/Tyrie letters were published in the UK on 30 April 2013. As a result, they were already the stuff of gossip and conjecture by the time the US/EU Insurance Symposium opened in Washington DC at the crack of dawn on 1 May 2013.  Their publication could therefore easily have had – and may have been intended to have - a material impact on that Symposium.  If that was the intention, it failed. The European and US delegates read out their prepared statements without reference to the Bailey/Tyrie letters – and without any apparent embarrassment at the fact that that was what they were doing. Even so, a different story played out in the margins.  Some European delegates were clearly unhappy with Bailey, and regarded the publication of the letters as especially unhelpful at that time; others saw them more as pre-cursor to another set of “special pleadings” from the UK … a country that’s gradually moving to the European periphery and losing its influence as it goes.

Perhaps the most interesting thing now will be to see how the Committee examines the issues Bailey has raised (apparently at the Committee’s invitation), what conclusions it reaches, what recommendations it makes and what impact this will have on the final shape of Solvency II in the UK and elsewhere. Firms may therefore wish to look out for opportunities to give evidence to the Committee – whether it called for it, or not.

In the meantime, the Bailey/Tyrie letters are herehere and here. My previous blogs about the trilogue negotiations on Omnibus II are here and here; and my most recent blog about the PRA’s early warning indicators is here.