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EIOPA Issues Opinion on Supervisory Convergence in Light of Brexit

Introduction

Following the UK’s vote to leave the EU, (re)insurers have been engaging in contingency planning with the aim of ensuring continuity of service post-Brexit. With this in mind, EIOPA on 11 July 2017 published its opinion on supervisory convergence in light of the UK’s withdrawal from the EU (the “Opinion”). 

The Opinion provides guidance to the national supervisory authorities (“NSAs”) regarding the authorisation of new Solvency II undertakings. The Opinion follows on from a similar opinion issued by ESMA on 31 May 2017 and in many ways follows the same themes, although in some greater detail. These documents have been issued in light of complaints of “dangerous competition” in the approach of certain NSAs. 
Speaking on the Opinion, Gabriel Bernardino, Chairman of EIOPA, stated that the principles set out: “… will support the NSAs to secure sound and convergent practices linked with the authorisation and supervision of activities of insurers…seeking relocation of activities (following Brexit)…Empty shells or letter boxes are not acceptable.” 

Content, Objective and Scope

The Opinion assumes that, following Brexit, the UK will become a “third country” (non-EU/EEA) for the purposes of the Solvency II framework. As such, it is mindful of a possible “hard Brexit” and that, upon withdrawal from the single market, UK (re)insurance undertakings will lose their right to conduct business across the remaining 27 EU Member States on a freedom of establishment or freedom to provide services basis. EIOPA recognises that this may result (and in fact has resulted) in UK undertakings seeking to relocate business in the other Member States.

EIOPA calls for a common effort at EU level to ensure a consistent supervisory approach to the relocation of undertakings and encourages communication between the UK and EU NSAs in this context. EIOPA states that while the principle of proportionality allows NSAs a certain judgmental evaluation in the application of the requirements of the Solvency II Directive, it is important to emphasise that proportionality is not a means for lowering standards or for disregarding prudential requirements.

Authorisations and approvals

With respect to an application for authorisation, NSAs should satisfy themselves that the undertaking has provided sufficiently detailed information to allow them to assess compliance with the requirements under the relevant legislation. These requirements should be met from “day one” of the authorisation.

Although a concept which has been mooted recently in some jurisdictions, EIOPA rules out the possibility of allowing automatic recognition of an authorisation granted by another NSA e.g. by the UK’s PRA. This is on the basis that the conditions of authorisation would not be identical to those on which the initial authorisation (e.g. by the UK) was granted.

EIOPA recognises that authorisation and approval processes take time and encourages NSAs to exchange information on previous approvals/rejections of authorisations.  There does therefore seem to be some permitted level of recognition of “streamlining” in the regulatory approach, although within confined parameters. 

Governance and risk management

The Opinion states that undertakings should not display the characteristics of what EIOPA describes as an “empty shell.” In this respect, EU undertakings must demonstrate an appropriate level of corporate substance, proportionate to the nature, scale and complexity of the planned business. This entails appropriate local physical presence of the administrative, management or supervisory board members (i.e. board of directors) and key function holders as well as a level of local staff proportionate to the nature and amount of business being run from the entity. Again, this seems contrary to the heavy outsourcing reliances which certain NSAs have recently flagged as being potentially acceptable. 

The Opinion indicates that transfers of risk by the new carrier will be scrutinised carefully by NSAs. The levels of reinsurance carried out by an undertaking should not undermine the responsibility or capacity of the entity to manage its risks. Reinsurance should be part of a coherent, well considered strategy which is aligned with the undertaking’s risk appetite. A minimum retention of risks by the authorised undertakings should be required by the NSA. EIOPA indicates that a minimum retention of 10% of the business written could be envisaged. This seems to run contrary to some recently flagged potential new authorisations in certain Member States which it would appear suggested that lower retention levels might be acceptable.

Outsourcing of critical and important activities

While EIOPA recognises that outsourcing has many efficiencies, it highlights that outsourcing can also pose a number of challenges, especially when the outsourcing is critical to the functioning of the undertaking and particularly where the service provider is located outside the EU (e.g. the UK post-Brexit). While it may be acceptable for undertakings with simple risk-profiles or a small scale of business to outsource a significant part of their key functions, EIOPA indicates it would not be acceptable for undertakings with complex risk-profiles or a large scale of business to do so. 

Extensive outsourcing of functions and activities, such that lead to the depletion of corporate substance and repercussions on the adequacy of management and on the effectiveness of supervision by the relevant NSA, will not be permitted.

On-going supervision 

NSAs should have in place the appropriate monitoring tools to assess existing and arising risks. They should have access to the relevant information, including information on outsourced activities.

The Opinion states that NSAs should ensure that the conditions set at the moment of authorisation are met on a continuous basis. Again, this indicates that new Brexit applicants cannot expect particular treatment outside the existing regulatory norms. There should be no legal impediments to enforcement or, for example, to on-site inspections. 

Monitoring by EIOPA

Grievances have already been expressed by certain Member States regarding “regulatory arbitrage” in the context of Brexit planning and the approaches being taken by certain NSAs. Importantly, EIOPA plans to monitor developments. It says it will apply a risk-based approach using information collected from Members States. It will make use of its powers and oversight tools to support what it describes as “supervisory convergence” through bilateral engagements with the supervisory authorities and by providing opinions and initiating investigations when the need arises.

To view the longer form article on this topic, please click here

Contributed by Eoin Caulfield

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