Brexit Analysis

The consequence of this is that key pieces of upcoming EU financial services legislation will have to be implemented before the UK formally leaves the EU.

On 29 March 2017, the UK Government invoked Article 50, and therefore began the formal two-year negotiation period with the EU, at the end of which the UK’s membership of the EU will cease. As a result, the UK will cease to be a member of the EU on 29 March 2019. The UK Parliament has also passed the European Withdrawal Act, which repeals the European Communities Act 1972 with the purposes of ending the supremacy of EU law in the UK, and converts existing EU law into UK domestic law to preserve a working Statutory Framework (which the Government is then empowered to amend by Statutory Instrument to correct any deficiencies).

Presently, a two-year transition period has been agreed to as part of withdrawal negotiations between the EU and the UK, during which EU law would continue to apply and firms can continue to rely upon existing passporting rights while the details of the future relationship between the EU and the UK are agreed. While the EU has stated that the transition period will only take effect if a full withdrawal agreement is ratified by the relevant EU and UK bodies (which has yet to occur), the FCA and PRA have stated that financial services institutions can incorporate a two-year transition period into their Brexit planning.

The UK’s post-Brexit relationship with the EU

Since the invocation of Article 50, there has been considerable uncertainty concerning the future relationship between the EU and the UK, the extent to which the EU and UK regulatory regimes will be aligned following the UK’s withdrawal from the EU and the resultant level of access the UK will have to the EU single market. While a number of details are still to be negotiated and agreed with the EU and the ultimate outcome of negotiations remains subject to change, the UK Government has now agreed to a proposed model for its post-Brexit relationship with the EU, published in a white paper on 12 July 2018, with the following key features for the insurance industry:

• that the UK will "maintain a common rulebook for all goods" with the EU, maintained by a treaty and overseen by Parliament. The common rulebook would (amongst other things) cover agricultural products and environmental, employment and consumer protections;
• a ‘facilitated customs arrangement’ between the UK and the EU to minimise border friction and allow for a ‘combined customers territory’ in which domestic policies may be applied to goods intended for the UK, but EU equivalents would be applied to goods to be exported into the EU. The intention is stated to be that the UK controls its tariffs with respect to trade with the rest of the world, but applies EU trade policy to trade with the EU;
• a "joint institutional framework" to interpret agreements between the UK and the EU, with disputes to be resolved by joint committees and by independent arbitration with a joint reference procedure to the European Court of Justice for the interpretation of EU rules;
• "regulatory flexibility" in the services sector, with arrangements on financial services, but which do not replicate the EU’s existing passporting regime. It is proposed that these arrangements will include the mutual recognition of professional qualifications, reciprocal recognition of equivalence under existing third-country regimes, a bilateral framework of treaty-based commitments facilitating market access and reciprocal supervisory cooperation; and
• the end to free movement, but "reciprocal mobility arrangements" with the EU in a number of defined areas in the interest of economic, cultural and scientific cooperation, including: visa-free travel for short-term business reasons, students and tourism, participation in cultural exchanges such as Erasmus+ and streamlined border arrangements.

This model for future relations is without precedent; it would entail less than the full single market access engendered by the "Norway Model" (by which the UK would join the European Economic Area (EEA) and the European Free Trade Association (EFTA) and be subject to EU standards and regulations in most areas). However, in some areas (in particular, the market for goods) it would entail greater access to the single market and regulatory alignment than a "no deal" Brexit and a reversion to World Trade Organisation (WTO) rules.

The proposal has yet to be agreed with the EU and as such, may be subject to change in the course of continuing negotiations. However, the proposal to maintain "regulatory flexibility" in the services sector would, if agreed to by the EU without amendment, mean that the UK will have reduced access to the EU single market and lose the benefit of the EU passporting regime. This analysis proceeds on the basis that the UK will, accordingly, be treated as a "third country" post-Brexit.

Regulatory flexibility would also mean that the UK regulatory regime is not required to be aligned with the EU regulatory regime after the UK withdraws from the EU and any transition period expires, and that their respective regulatory regimes may diverge over time. Nevertheless, three factors suggest that the UK is likely to retain a robust regulatory regime following Brexit:

• UK thought-leadership - the UK has been at the forefront of the development of modern financial services regulation;
• the international nature of regulatory developments - the UK has adhered to a number of international commitments beyond its membership of the EU, including (by way of example) the commitments on financial services regulation made at the G20 meeting in Pittsburgh in 2009; and
• equivalency decision - should the UK wish to be deemed “equivalent” under European financial services legislation (to allow some level of access to the EU financial services markets post-Brexit), it will be necessary to maintain robust regulatory standards.

Insurance companies and insurance intermediaries

• The impact of Brexit on insurance companies and insurance intermediaries will ultimately depend upon the nature of the Brexit model adopted. The following analysis assumes (in line with the UK Government’s proposal of "regulatory flexibility") that, after leaving the EU, the UK will not be a member of the European single market for services and will be considered to be a "third country". Currently, UK insurance companies and insurance intermediaries have direct access to a single insurance market that enables them to conduct cross-border business in all other EU member states. Alternatively, UK insurance companies and insurance intermediaries can carry on insurance in the EU through local branches.
• The UK’s membership of the single market allows UK insurers to underwrite risks across the EU without requiring separate authorisation in each member state. UK insurers benefit from only needing to report to UK regulators when conducting cross-border business, since this reduces compliance and operating costs.
• Post-Brexit (unless the UK government negotiates a different outcome) UK insurance companies and insurance intermediaries that currently rely on passporting rights to underwrite risks from the UK into EU member states will no longer be able to do so. Consequently, some insurers may need to restructure their corporate groups to be able to continue writing business in the EU.
• The key EU regulation for insurers is the Solvency II Directive (Solvency II). The UK supported and developed the Solvency II requirements, although UK regulators have criticised elements of the implementation. Therefore, it is far from clear that there will be a reduced regulatory burden for insurers post-Brexit and the UK may want to ensure regulatory equivalence with the EU.
• Since the UK would no longer benefit from existing trade agreements between the EU and third countries at the point of exiting the EU, UK-based insurers may face new barriers to providing services in certain other jurisdictions, unless the UK government concludes separate trade arrangements with those third countries.

Passporting

• In the context of EU financial services legislation, passporting is the exercise of the right by a firm, authorised within one EU member state (its home member state), to carry on activities in another EU member state (a host member state) on the basis of its authorisation in its home member state without the need to obtain additional authorisation from the host member state.
• Solvency II does not provide a passporting mechanism for insurers based outside the EU to provide services to EU-based customers. Similarly, the passporting mechanism for insurance intermediaries contained in the Insurance Distribution Directive (IDD), which has applied since 23 February 2018, does not apply to companies based in third countries. Therefore, once the UK leaves the EU, subject to any revision to Solvency II and IMD / IDD, UK insurance companies and insurance intermediaries will no longer be able to conduct cross-border services in other EU member states.
• In some EU jurisdictions, the regulated activity of providing insurance or reinsurance is deemed to take place in the jurisdiction where the risk is situated and failure to be appropriately authorised to provide such services in those jurisdictions is a criminal offence. At the point at which the UK leaves the EU and UK insurers lose their ability to provide services on a cross-border basis, steps taken by a UK insurer in connection with the operation of an on-going insurance or reinsurance contract could be illegal. In this scenario, UK insurers may need to transfer risk to another EU group entity that is appropriately authorised to carry the risk or cease to provide insurance to such policyholders at the point of Brexit. This position is, of course, subject to the UK negotiating an alternative outcome in EU exit negotiations.
• Insurers that carry out cross-border business may therefore want to consider at an early stage their options for continuing to operate in the EU, in the event that the UK ceases to be part of the European single market.

Options for continuing to carry out business in the EU

• UK insurance companies and insurance intermediaries that currently provide cross-border EU business may wish to carry out a cost-benefit analysis to determine the potential impact of a loss of access to EU business post-Brexit. For some UK insurance companies and insurance intermediaries, the potential impact of the loss of passporting rights is likely to justify the expense and inconvenience of restructuring their business. Other firms may be content to wait and see if alternative arrangements are agreed to in the course of UK exit negotiations on the basis that a loss of EU business would not be material to their revenue flow and future business strategy. However, no such arrangements form part of present proposals for the UK’s future relationship with the EU, so firms may need to consider the lead-in time involved in restructuring their business, if necessary, before the potential loss of passporting rights comes into effect.
• UK insurance companies and insurance intermediaries which determine that the loss of passporting rights would have a significant adverse effect on profitability will need to consider their existing corporate structures when evaluating options for providing services in the EU.
• The loss of passporting rights will be felt most acutely by insurers with a single UK regulated firm. To be able to continue writing business within the EU, such insurers will need to consider setting up a new authorised firm within the EU. An EU-authorised insurance firm would itself be able to service other EU markets on a cross-border basis in reliance on Solvency II passporting rights.
• Insurance groups that already have a regulated insurer in another EU jurisdiction in addition to the UK should be affected to a lesser extent by any loss of passporting rights. If such insurers currently provide cross-border services exclusively from the UK, they should explore the possibility of providing cross-border EU services from the other EU regulated entity. This will ensure that passporting rights continue to be effective at the point of Brexit, from their non-UK EU regulated firm.
• Setting up a new EU insurer or insurance intermediary will need to be considered from a senior management and staffing perspective. Firms should also have regard to likely regulatory capital and compliance implications. A UK insurer / insurance intermediary will need to consider the best location for a second office and the balance of staff between the existing and new offices. Bolstering the workforce of an existing EU firm will also have implications for staffing and recruitment, although this is likely to be faster and easier to implement than setting up and staffing a completely new entity.
• There are legal mechanisms that may assist UK insurance companies to transfer business to an EU group company, including the EU cross-border mechanism and the insurance business transfer mechanism under Part VII of the UK’s Financial Services and Markets Act 2000. Since these mechanisms are contained in, or based on, EU law they may no longer be available to insurers at the point the UK exits the EU if a transition period is not put in place as part of the withdrawal agreement. Consequently, insurers wanting to utilise these provisions should ensure they do so in good time before exit.
• As the UK gets closer to the point of exiting the EU, UK insurers should have a clearer picture of the options available for continuing to write business on a cross-border basis. It is possible that alternative solutions may evolve, such as making use of the Lloyd’s market if Lloyd’s is able to secure EU market-wide licencing. However, at this stage of negotiations no such proposals have been made, so insurers will therefore need to monitor developments and anticipate a potential loss of passporting rights.

Equivalence

• The regulatory landscape for insurers following Brexit will depend on the extent to which the UK seeks to maintain equivalence to EU laws. In the insurance space, the UK was closely involved in the development of Solvency II, which makes a radical departure from these rules post-Brexit unlikely.
• Solvency II includes a procedure for third countries to be deemed equivalent to the EU’s insurance regime, focusing on provisions relating to reinsurance supervision, the solvency calculation and group supervision. At the point the UK exits the EU, the UK’s regime would arguably be automatically equivalent to Solvency II, although, subject to an agreement to the contrary in exit negotiations, the EU Commission will still need to carry out a formal equivalency assessment. If the UK is not granted equivalence for Solvency II purposes, UK-headquartered European-wide groups may be subject to supervision both under the UK regime and Solvency II. Therefore, the UK government may wish to seek to negotiate provisional UK equivalence under Solvency II at the point the UK exits the EU, pending a formal equivalence decision.
• Insurance companies trading derivatives within the scope of the European Markets Infrastructure Regulation (EMIR) are subject to extensive requirements regarding trade reporting, clearing and risk mitigation requirements. EMIR is an EU regulation and, therefore, is directly applicable in each member state without the need for national implementing legislation. Post-Brexit, EMIR will cease to apply. However, as EMIR stems from the UK’s commitments as a G20 member, it is likely that the UK will implement national regulations that are similar to EMIR. Insurance companies facing EU counterparties will still, to some extent, have to comply with the requirements of EMIR to enable their EU counterparties to themselves comply.
• Bearing in mind that the UK Government’s current proposals are for "regulatory flexibility" in the services sector, the UK could decide to depart from EU Directives in particular areas, while seeking to maintain a broadly equivalent regulatory regime. The UK may decide to implement a less stringent data protection regime, for example, that may result in less onerous requirements for the insurance industry. Insurers will also want to closely monitor whether the UK Government intends to continue following the Gender Directive post-Brexit, which currently prohibits insurers from taking account of gender when pricing insurance contracts.

Business outside the EU

• The EU has entered into a number of trade agreements between the EU and various non-EEA states. The UK currently benefits from these trade agreements through its membership of the EU.
• Once the UK leaves the EU, UK insurers will no longer automatically benefit from existing trade agreements between the EU and other third countries that have opened up insurance and reinsurance markets in those third countries. Of course, the UK may negotiate bilateral agreements with these third countries. However, it is likely that most trade agreements between the UK and non-EU countries will only be finalised some time after the UK exits the EU. Even assuming that the UK is able to conclude trade agreements with these non-EU third countries, UK insurers will still not necessarily be able to access the relevant markets on the same terms.

Other sector specific insurance issues

• There are a number of other sector specific insurance-related issues to be addressed as a result of Brexit. For instance, in the motor insurance industry, one key question is whether consumers will need to arrange additional cover to their UK insurance to permit them to drive in Europe. For travel insurance providers, one area the UK Government will need to address in negotiations is the European Health Insurance Card (EHIC). If UK citizens lose the benefit of the EHIC, this is likely to result in higher premiums for travel within the EU. 

Market Abuse Regulations (MAR)

• MAR came into effect on 3 July 2016 and repeals and replaces the previous civil market abuse regime in the UK. The FCA is unlikely to relax regulation in this area when the UK leaves the EU, and it is likely that the UK will be required to maintain compliance with MAR for equivalence purposes under other regimes.
• Regardless of whether the UK maintains compliance with MAR, the regulations themselves have extra-territorial effect as they apply to all actions and omissions relating to financial instruments admitted to trading on an EU trading venue (and other financial instruments whose price or value depends on or impacts a financial instrument traded on an EU trading venue). However, financial instruments admitted to trading on a UK trading venue will no longer fall within the scope of MAR once the UK leaves the EU.

Fourth Money Laundering Directive (MLD4)

• MLD4 replaced MLD3 and was implemented on 26 June 2017. Even when the UK leaves the EU it is unlikely to make major changes to the MLD4 legislation as it is committed to compliance with the Financial Action Task Force Recommendations.
• On leaving the EU, the UK will become a third country under MLD4 and will no longer be in scope. However, it may still impact UK firms to the extent that they deal with entities based in the EU, particularly in relation to due diligence requirements. In addition, given the UK’s commitments as a member of the Financial Action Task Force, it would be required to implement a broadly equivalent domestic anti-money laundering regime in any event.

Tax

• Post-Brexit, the UK may be in a position to simplify its current VAT regime and reduce the VAT applicable to certain products. However, whether it would do this given the revenue VAT generates is a different matter. The UK’s double tax treaty will be largely unaffected by Brexit, however, provisions which assume the UK’s membership of the EU may require amendment.
• Without the benefits of EU directives, tax leakages in cross-border transactions and payments may occur. Consideration should be given to implementing any cross-border mergers before the UK leaves the EU. Additionally, without a requirement to comply with EU case law, the UK Government could reverse legislative changes made to accommodate EU treaty principles. 

Implications for staff who are (non-UK) EU nationals

• Until the UK leaves the EU, European Economic Area (EEA) nationals working and living in the UK retain their rights in respect of free movement and can continue to live, work and study in the UK.
• At present, it is considered unlikely that any negotiated exit from the EU would result in EEA nationals who are already in the UK being required to leave suddenly as this would likely result in any British citizen living in an EEA country being required to return to the UK. The EU and the UK have agreed an implementation period, running from the UK’s withdrawal from the EU to 31 December 2020, during which the rights of EU citizens and their families living in the UK will not change.
• The UK Government has also announced that EU citizens entering the UK post 29 March 2019, as well as EU citizens already resident within the UK, will automatically be eligible to apply for settled status once they have remained in the UK for five years.
• People who are living in the UK by 31 December 2020 will have until 30 June 2021 to make an application for status under the scheme. From 1 July 2021, EU citizens and their family members in the UK must hold or have applied for UK immigration status to reside and / or work in the UK legally.
• Individuals can take the following steps to consolidate their UK position if they are concerned about their status:
  • apply for a registration certificate;
  • apply for a document certifying permanent residence (applicable if you have been exercising an EU Treaty right in the UK for at least five years); or
  • apply for British nationality (again applicable if you have been living in the UK for at least five years).
• EEA nationals born in the UK may already possess British nationality, depending on their date of birth and the residency status of their parents at the time of their birth.
• There is significant potential for policy and operational changes to the UK immigration system as it is currently only designed to cope with processing applications from those coming from outside the EEA. The Government’s statement on the position of the UK’s future relationship with the EU dated 6 July 2018 stated that withdrawal from the EU will mean the end of free movement "giving the UK back control over how many people enter the country". Major reform may be necessary to deal with the possibility of all EEA nationals becoming subject to immigration controls. However, the UK Government’s statement and white paper goes on to propose an agreement between the EU and the UK on a "mobility framework" permitting intra-corporate transfers, streamlined border arrangements, and visa-free travel in a number of defined areas including for short-term business reasons, which may suggest an intention that movement of labour between the UK and EU remains relatively frictionless.

Impact for UK or EU-based pension schemes

• The final text of the EU Pensions Directive (IORP II) was agreed in June 2016. It came into force on 1 January 2017 and requires implementation by member states within two years. As the UK will still be a member of the EU when the IORP II comes into force, it will be required to implement it. Firms should be aware of the key changes made by the directive and the steps they should take to implement its requirements.
• No immediate change in pensions regulation is anticipated and the long-term impact will depend heavily on the Brexit model.
• The greatest short-term effect is likely to be the impact of markets on funding levels for defined benefit schemes and investment returns for defined contribution schemes.
• In terms of future outlook, UK pension schemes could avoid prospective EU laws requiring insurance-style funding and might not be so affected by IORP II. That said, the Department for Work and Pensions have expressed their intention to implement it.
• There is a possibility that UK pension schemes may also avoid possible requirements to equalise guaranteed minimum pensions, an uncertain and administratively complex exercise driven by the interaction of historic UK legislation and EU law.