On the 9th November 2020, Chancellor Rishi Sunak declared that for Solvency II purposes the UK deems the regimes of each EEA state equivalent to that of the UK. Notably, such a determination feeds into a larger picture of the UK Treasury canvassing the EU for reciprocal determinations of equivalence. With both factual and political considerations underlying such determinations, this was most likely a political move by the UK Treasury, made on the EU equivalency chessboard.
What is the EU equivalency framework?
The equivalency framework, as established by the EU, allows for those third countries with regulatory and supervisory regimes equivalent to the standard of those found in EU member states to be acknowledged as such, with a “declaration of equivalency”. However, equivalence is not the Holy Grail that some assume it to be. Importantly, it is not the passporting regime by another name. Whilst the passporting regime gave licence to a financial institution authorised in an EEA member state to carry out certain business in any other EEA state, the equivalency regime is far more limited. Equivalency provisions (which are set out throughout EU law) instead relate to specific areas. As such, the corresponding requirements, and subsequent benefits of receiving an equivalency decision vary dependent on the provision in question.
The Solvency II Directive provides for three types of equivalence: Article 172 (Reinsurance), Article 227 (Group Solvency Calculation) and Article 260 (Group supervision). The respective effects of each decision are as follows:
- Article 172 – an EU insurer can treat a reinsurance contract with a third-country equivalent reinsurer in the same way that it would treat a reinsurance contract with an EU reinsurer. Absent equivalence, the third-country reinsurer may have to post collateral, if it wants to reinsure the relevant EU risks;
- Article 227 – when an EU group calculates its solvency, it can ask its third-country equivalent subsidiaries to calculate their contributions using local rules, instead of Solvency II, saving time and money and, in all probability, generating a lower capital requirement than would otherwise have been the case; and
- Article 260 – if a group is owned and controlled by an entity in an equivalent third-country. EU regulators can work with the supervisors in that country, and rely on them to lead on group supervision. Absent equivalence, the EU supervisors would have to supervise the whole group, quasi-extraterritorially .
The corresponding assessments for each of these provisions are laid out in the Solvency II regulation, at articles 378, 379 and 380 respectively.
It’s all about the politics
An important piece of the equivalency puzzle is the discretion afforded to the Commission. Just because a third country has fulfilled the relevant criteria for a determination of equivalency does not mean the Commission is bound to declare it as such. Equivalency determinations are embroiled in politics. It is helpful, therefore, to have a brief overview of significant political discourse to date.
Underlying much of the communications surrounding equivalency is an imbalance of power or perhaps more interestingly, a different approach to equivalence (not least an impression that it gives greater help than it really does). The UK has maintained, as Mr Sunak reminded the House last week, that it strives for a “comprehensive set of mutual decisions on equivalence”, whilst the EU has seemed rather ambivalent to this kind offer. Notably, in April 2017 Vice President Valdis Dombrovskis, European Commissioner for Financial Stability, Financial Services and Capital markets, gave a speech against the backdrop of the UK’s announced departure from the EU, stating that “equivalence was not a right for all third countries and it was not a blank cheque whereby the EU would give up control over key systemic risks to its financial stability.” Fundamentally, the EU does not want to allow a situation in which the UK can have its cake and eat it too, although it has also been seen as surprising sabre rattling, when the regime in the UK is currently identical. The UK is of course, already considering reforms, which could include potential departure from the Solvency II regime. It is unsurprising, therefore, that the EU has not yet made any determinations of equivalency for Solvency II purposes, fearing regulatory arbitrage, although it might assist the EU to grant equivalency if it is looking to keep the UK regime closer.
However, the Commission must also take account of intra-EU politics and any prudent economic considerations. It was acknowledged at the French AMRAE conference earlier this year that the continental corporate market places a great deal of reliance on the capacities of the UK insurance market. Without it, there are concerns that the continental European-based insurance companies such as Allianz and AXA will not together have the capacity required to replace the UK’s insurance and reinsurance market, if EU risks cannot be placed in the UK. In particular, this will likely impact the availability of flexible policies tailored to meet unusual risk profiles. It is unsurprising, therefore, that there are disgruntled EU-situated corporates lamenting the Commission’s stand-offish approach to UK equivalency. As such, this may increase internal pressures for reciprocal determinations.
It is against this political backdrop that we can analyse the recent UK declarations of EU equivalency.
The ironies and errors of the UK equivalency determinations
Pursuant to the UK/EU Withdrawal Agreement, the UK has also established an equivalency framework and in November 2020, the UK Treasury published an overview of UK equivalence decisions that would apply on 1st January 2021. Included in these decisions are those relating to Solvency II, or as the UK Treasury have rebranded it “Solvency 2”. “The Solvency 2 Regulation Equivalence Directions 2020”, the SI that enacts these decisions is however, quite bemusing: it is full of both ironies, and errors.
Turning first to the ironies, the statute is explicit in:
- assessing the EU for equivalence for the same purposes as those set out under the EU equivalency framework, and
- assessing that equivalence using the criteria laid down in and by EU law. The SII does so by specifically referring to those purposes set out in articles 172, 227 and 260 of the Solvency II Directive and those assessments set out at articles 378, 379 and 380 of the Solvency II Regulation. It is also notable that the UK has implemented the SII Directive and is onshoring the Solvency II Regulation, to ensure it becomes UK statutory law post-Brexit. Having done so, the UK’s determination boils down to asking itself whether the EU’s Solvency II regime will be equivalent to the UK’s copied out version, on the same three bases that the EU’s Solvency II regime uses, by applying the criteria in EU law. It is therefore unsurprising that this circular process results in a finding of equivalence!
In other words, the UK Treasury has declared that the supervisory and regulatory regimes of EU states have sufficiently met the criteria of EU law… a rather circular notion.
However, this may be a political move by the UK Treasury. Offering equivalency for the same purposes, and on the same basis as that of the EU suggests an intention to align with the EU (or more critically, to submit to the EU). In doing so, the UK Treasury is likely hoping to prompt a reciprocal determination.
Interestingly, however, the UK’s Solvency 2 equivalence direction is riddled with errors. Whilst the UK direction attempts to map onto the relevant EU legislation, viz. the Solvency II Regulation and Solvency II Directive, it does not do so accurately. This is most obviously highlighted by s.1(2) which defines “the relevant UK law” by reference to an “Article 1(61) of the Solvency 2 Regulation”, an irrelevant article concerning the definition of “client”. Furthermore, there is reference at s.1(2)(a) to a “determination under (3)(a)” which also has no apparent meaning. Amusingly, this anomaly can be explained by a quick look at “The Equivalence Determinations for Financial Services and Miscellaneous Provisions (Amendment etc) (EU Exit) Regulations 2019” which reveals the source of this wording, which has seemingly been copied and pasted by UK legislatures.
So, what next? Polishing up the statutory instrument aside, it is difficult to predict with any certainty what will happen next in relation to Solvency II equivalency decisions. A best guess would be that the Commission will bide its time, to form a better view as to the UK’s intentions for reform of the Solvency II regime. If the UK align with the EU sufficiently, they may well be rewarded with a determination of equivalency. However, any grand departures from the Solvency II regime are likely to be met with EU obstinacy – insufficient European insurance cover will just be collateral damage, until disaster strikes.