Summary: Months after firing the starting pistol on Brexit negotiations, we are no further forward in understanding the practical impact for the UK financial services industry. The PRA has not revealed much about its plans, although it expects firms with cross-border EU activities to have contingency plans. Gerry Quirk and Adam Bogdanor look at the range of possible outcomes that firms need to consider.

UK insurers – to relocate or not?

For UK insurers with live underwriting operations covering EU risks, the only way to guarantee continuation of that business post Brexit is to set up a vehicle in the EU. A number of large insurance groups have taken this approach. There is no clear frontrunner in terms of favoured jurisdictions, with Luxembourg, Belgium, and Ireland all being chosen.

The costs of setting up in another EU state could be significant. For those hoping to have a lean operation with significant outsourcing back to the UK, EIOPA fired a warning shot in its guidance to EU supervisors. EIOPA wants to ensure convergence in approach to avoid UK insurers being incentivised to favour one state over another when deciding where to set up. It expects supervisors to require an appropriate level of local corporate substance for new insurers, and a level of local staff commensurate to the insurer’s business. This hardening attitude to supervisory convergence seems to be a theme, making it increasingly difficult for supervisors to exercise discretion in the interpretation of EU rules.

A fronting arrangement may be an option, although EIOPA wants supervisors to require a minimum retention in the fronting entity of 10% of the business written. Unless the EU grants the UK equivalence for reinsurance, the EU fronter may not be able to take full credit for the reinsurance in calculating their SCR, unless collateral is provided, which may make these arrangements unattractive. Collateral would be essential in any case to reduce counterparty default risk.

For existing business, the hope is that insurers will be able to continue to administer claims under existing policies covering EU risks from the UK. Anything else would be contrary to policyholder interests. As with so much on Brexit, though, there is no formal position on this. While insurers could choose to transfer EU risks to an EU insurer, this can take 18 months and there is no guarantee that it would be complete before March 2019. For some, a solution may to be convert to a SE by setting up and merging with a shell EU company, migrating the SE to an EU state and administering any UK risks from outside the UK. Depending on the nature of the business and the approach of the regulator in the target jurisdiction, this could take less time than a Part VII transfer.

Incoming insurers

The Bank of England expects to make an announcement by the end of 2017 on whether UK branches of EEA firms will be allowed to become third country branches, or whether a subsidiary will be required. We are expecting that firms with UK operations below a certain size will be able to operate through a branch, with larger operations being required to subsidiarise. Pre-Brexit there is no mechanism for an EU insurer to apply for branch authorisation. We expect that provision will be made for a pre-application process so that firms can begin to prepare, and the regulators to consider, applications in advance of March 2019.

Incoming EU insurers may question whether the additional regulation and capital requirements in keeping separate UK and EEA businesses are worthwhile if their UK business is small or non-core and, if not, they will likely dispose of their UK business.

Whatever contingency plans firms adopt, there is a justifiable concern that the UK regulators will struggle to deal with the inevitable flood of applications (whether for authorisation or approval of change of control or a transfer) in time. Restructuring EU business following Brexit is likely to become more complex. Mutual recognition of transfers will cease and mechanisms such as cross-border mergers and the formation and migration of a European company will no longer be available, in the absence of an agreement to the contrary. So while firms may feel that the best strategy is to wait and see, there is a risk that by the time the future rules for cross border operations are clearer, restructuring options may be far more limited.