The European Council has published the final version of the Omnibus II Directive. The European Parliament is expected to adopt this version of text at its first reading on 25 February 2014. The Directive will be published in the Official Journal of the European Union and come into force shortly after that.

There’s nothing in the final version of the Omnibus II Directive about third-country branches, or the early warning indicators currently being trialed by the PRA. However, the text does include amended third-country equivalence transitional arrangements, which are materially different from the transitional arrangements (i) included in previous drafts of Omnibus II; and (ii) previously reported in the UK press. It also includes a new group structure disclosure obligation.

Solvency II third-country equivalence issues arise in three ways:

  • Reinsurance: if an EEA insurer takes its reinsurance from an EEA reinsurer, it can take that reinsurance into account to a certain extent for regulatory capital purposes. If the EEA insurer takes its reinsurance from a third-country reinsurer, it can only take that reinsurance into account to the same extent if the reinsurer is domiciled in a Solvency II equivalent third-country or the reinsurer posts collateral;
  • Subsidiaries: if an EEA insurance or reinsurance group includes a third-country subsidiary, when the group calculates its (a) group capital requirements; and (b) group capital, it can calculate the subsidiary’s contributions to these calculations using the subsidiary’s local rules if: (i) the calculation is carried out using “consolidated accounting”; or (ii) the calculation is carried out using “deduction and aggregation accounting” and the subsidiary is in a Solvency II equivalent jurisdiction. If the group uses deduction and aggregation, and the subsidiary is in a non-equivalent third-country, the group must use Solvency II’s rules instead - and that’s likely to materially increase the subsidiary and group capital requirements; and
  • Group supervision: if a European insurer or reinsurer is part of a group that is owned / controlled by a third-country top-co, group supervision will be carried out by the top-co’s local regulator if top-co is in a Solvency II equivalent third-country. If it isn’t, the European supervisors will have to decide how to supervise the group – for example, by requiring the group to create a European sub-group before supervising the sub-group under Solvency II; or by supervising the whole group through the European companies.

At present

  • Switzerland and Bermuda are expected to be Solvency II equivalent for all of these things;
  • Japan is expected to be Solvency II equivalent for some of these things;
  • The USA and Canada are not expected to be Solvency II equivalent for any of these things.

Some countries will seek equivalence, but they won’t achieve it before Solvency II begins to apply to firms on 1 January 2016. Early drafts of the Omnibus II Directive included transitional arrangements, which allowed the EU to regard these countries as Solvency II equivalent for up to 5 years if (eg) they gave a written commitment to become Solvency II equivalent within that period, and they were working through a fully funded plan that would deliver equivalence with that 5 year period. But these arrangements wouldn’t work for the USA or Canada because they won’t give a commitment to seek Solvency II equivalence.

Early reports of the final trilogue negotiations suggested that the trilogue parties had agreed to allow the European Commission to deem a country to be Solvency II equivalent for 10 years, renewable indefinitely, and regardless of their commitment to seek equivalence over time – an arrangement which, if true, would have allowed the Commission to treat the USA and Canada as Solvency II equivalent in any event.

These reports were correct for Solvency II subsidiary equivalence; but mistaken for reinsurance and group supervision equivalence. This could be very good news for European insurers and reinsurers with US and Canadian subsidiaries; but it could also be quite bad news for US and Canadian reinsurers and groups. For example, European insurers may now be more inclined to take their reinsurance from European reinsurers, and those based in Solvency II equivalent countries, in preference to those based in the US and Canada. US and Canadian groups may also find themselves notionally divided, for group supervision purposes, into two different but overlapping groups, with two different group supervisors and two different sets of groups rules to comply with. If nothing else, this is likely to add materially to the cost and complexity of compliance for these firms.

The new group structure disclosure obligation will insert a new article (article 256a) into the Solvency II Framework Directive, which will require: “insurance and reinsurance undertakings, insurance holding companies and mixed financial holding companies to disclose publicly, at the level of the group, on an annual basis, the legal structure and the governance and organisational structure, including a description of all subsidiaries, material related undertakings and significant branches belonging to the group".

More to follow…