As negotiations about the implementation of the Solvency II Directive continue both at EU and Member State level, the full effect of its new capital adequacy regime remains unknown. Industry uncertainty has been underlined by recent reports of firms looking to alter their location or structure in anticipation of the expected new rules. For example, Prudential announced on 13 March 2012 that it would consider leaving the EU altogether in order to avoid the potentially adverse effects of Solvency II on its US business. Then, a day later, it was widely reported that Hannover Re was considering changing its holding company from a German public company, Aktiengesellschaft (or "AG"), to a European public limited company, Societas Europaea (or "SE"), in order to more readily facilitate the possible relocation of its registered office from Germany to elsewhere within Europe.
This advisory looks at the reasons why a (re)insurer may wish to make such conversion to an SE and provides an overview of how to do so.
Background - Solvency II and the Solvency Capital Requirement
National regulators, such as the FSA (from 2013, the PRA) in the UK, will be responsible for enforcing and monitoring compliance with Solvency II. The second layer of capital which firms are required to hold under the new regime is known as the Solvency Capital Requirement (or "SCR"). The European Commission considers the SCR to be the "key solvency control level"; it is more risk-based than the first layer of capital, the comparably inflexible Minimum Capital Requirement.
Once the Solvency II regime is up and running (currently expected to be 1 January 2014 unless further delayed), each (re)insurer will need to calculate its SCR using either the "Standard Model" or a full or partial "Internal Model". An Internal Model is a firm's bespoke model, tailored to its individual risk profile but subject to prior approval by the relevant national regulator. If an Internal Model does not get so approved, the Standard Model provided by Solvency II will automatically apply.
As the general perception is that the Standard Model will result in higher capital requirements for most (re)insurers, firms across Europe are keen to obtain regulatory approval of their Internal Models prior to the implementation of the new regime.
Fleet of foot?
One reason a (re)insurer may wish to convert to an SE is to take advantage of the SE's pan-European nature in order to engage in regulatory arbitrage. Of the national regulators which have begun to review Internal Model applications, a number have already raised concerns in relation to their capacity and limited resources to be able to conduct such reviews within the current timeframe. Germany's BaFin, for example, has reportedly restricted Internal Model applications to a limited number of the largest firms in its jurisdiction. Accordingly, a (re)insurer may consider converting to an SE in the hope of finding a regulator which is willing and able to entertain an Internal Model application if its home regulator does not have the capacity and resources to do so.
Another possible reason a (re)insurer may wish to convert to an SE is as a result of the current form of the draft Omnibus II Directive which, once enacted, will make various amendments to Solvency II. Solvency II requires that Internal Models must be applied group-wide, meaning that sub-groups and subsidiaries must adopt the model of their wider corporate structure. Hannover Re, for example, is majority owned by Germany's Talanx AG insurance group and so would have to use the same Internal Model as Talanx, rather than a bespoke model taking account of its own particular risk profile.
However, the most recent draft of Omnibus II (dated 28 March 2012) provides for a seven-year transitional exemption whereby a company within a larger group may use a different Internal Model to that group, provided: (i) both the group and the applicant company are in the same Member State; and (ii) the company forms a distinct part of the group with a significantly different risk profile. As such, (re)insurance groups with distinct parts in different Member States may consider changing their legal form to an SE in order to facilitate the consolidation of their business into one Member State, thereby potentially bringing themselves within the terms of this draft transitional provision.
A European Company
An SE is a European public limited company, which can be created and registered in any one of the Member States of the EU. The concept was introduced by Council Regulation (EC) No 2157/2001 (the "SE Regulation") on 8 October 2004 and after a slow start (only 16 were registered in the first year), has become relatively popular: more than 600 are now registered, and their number includes several prominent German companies (Allianz, for example).
The SE Regulation provides a rather loose statutory framework for the SE entity, which is supplemented by the company laws of the Member State where the SE is registered. This means that when an SE migrates from one Member State to another, it needs to adapt into a new set of rules regulating its structure, governance and operation.
The SE Regulation provides that an SE must have a minimum subscribed share capital of EUR120,000, must be registered in a Member State and must have its registered office and head office in the same Member State.
There are several methods of creating an SE, whether by merger, conversion, or the creation of a new company, but each one reflects the basic requirement that there must be a genuine cross-border element to the company's formation. However, there is no requirement that any of the companies involved in the merger, conversion or creation of the SE must carry on an active business at the time of formation, meaning that a business in one Member State converting to the SE structure can use a specially-incorporated vehicle in another Member State. In each case, the SE Regulation, together with relevant national law, lays out the specific process which must be completed in order for the new SE company to be created.
Advantages of an SE
The primary advantage of an SE is that it facilitates cross-border restructuring within the EU and enables corporate migration. The SE Regulation creates the possibility of a genuine merger between two or more entities incorporated in different Member States (rather than, for example, a merger by acquisition). It also creates a broader range of possibilities for how this restructuring can take place – for example, it is possible to create a joint venture vehicle which is jurisdictionally neutral as between the two founding entities.
Secondly, once an SE has been established, its registered office may be relocated to any other Member State without changing the corporate identity of the SE and without the prior consent of its creditors (although the head office must move with it and so remain in the same destination Member State). As indicated above, this creates the possibility of using an SE as a vehicle for regulatory arbitrage (although this will be subject to the approval of the outgoing regulator as summarised below).
An SE provides flexibility regarding employee participation and so has proved popular with German companies seeking to mitigate the effects of mandatory co-determination rules which require that worker representatives are appointed to German companies' boards of directors. Note that where none of the companies participating in the SE is governed by employee participation rules before the registration of the SE (as is the case with UK companies), the SE will not be obliged to establish provisions for such participation. The SE Regulation also allows German companies to adopt the Anglo-American one-tier board model, rather than the two-tier supervisory/executive model which is prescribed for German companies.
Transferring a registered office
The process of transferring an SE's registered office from one Member State to another is partially set out in the SE Regulation, which requires that a directors' transfer proposal and explanatory report is made available to shareholders who must then approve the transfer at a general meeting.
This process is augmented by relevant national law: for example, for a transfer out of the UK, the SE must satisfy the Secretary of State that the interests of creditors and holders of other rights have been adequately protected by making a statement of solvency (and it is a criminal offence for a member of the SE's administration/management to do so without reasonable grounds). In the case of (re)insurance firms, regulators will want to be kept informed throughout the process and will be keen to ensure policyholders are sufficiently protected.
The following are examples of insurance firms which have used an SE for the purpose of redomiciliation:
- In 2007, Swiss Re created an insurer SE by acquisition in the UK through the merger of a UK insurance company, SR International Business Insurance Company plc, with Dutch insurance company Reassurantie Maatschappij Nederland. The resulting SR International Business Insurance SE then redomiciled to Luxembourg, transferring from regulation by the FSA to regulation by Commissariat aux Assurances in Luxembourg.
- In 2009, Chubb Reinsurance Company of Europe transferred its place of regulation from Belgium to the UK by creating an SE through a merger by acquisition of Chubb Insurance Company of Europe S.A. by a specially incorporated UK group company. The successor entity, a new UK incorporated SE, took over the entire business of its predecessor Belgian company and brought it within the jurisdiction of the FSA.
Converting a (re)insurer's holding company into an SE may prove to be a powerful tool in firms' negotiations with their regulators. Where those negotiations break down, an SE will enable a firm to approach other, more efficient or sympathetic regulators and to find a new home. This assumes that a (re)insurer can: (a) satisfy its existing regulator that the interests of its policyholders are protected; and (b) find a new regulator with the capacity and appetite to entertain such an advance.
Hannover Re estimates that its conversion to an SE will be complete by early 2013. It will be interesting to see if other firms follow its lead as Solvency II looms larger.