Brexit Continues to Shape the Regulatory Landscape as EIOPA Consults on the use of Third-Country Branches

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Brexit Continues to Shape the Regulatory Landscape as EIOPA Consults on the use of Third-Country Branches

September 5, 2022

Consultant

John Larkin

On 1 August 2022, the European Insurance and Occupational Pensions Authority (EIOPA) published a consultation paper setting out a draft supervisory statement on the use of governance arrangements in third countries (Draft Statement).

Context

The stated aim of EIOPA’s Draft Statement is to ensure the appropriate supervision and monitoring of compliance of insurers and intermediaries with the requirements of the Solvency II Directive and the Insurance Distribution Directive in terms of their governance arrangements in third countries (i.e. countries outside the EEA). Though EIOPA makes explicitly clear that the Draft Statement is equally relevant in respect of all third countries, it is undoubtedly those EEA head-officed insurers and insurance intermediaries that structured, and indeed restructured, their business and staffing arrangements in the aftermath of Brexit around the establishment of a UK third-country branch which will be paying particular heed to this development. The outcome of this consultation process remains to be seen (responses due by 31 October 2022); however, it seems likely that further challenges may lie ahead for those firms who sought to facilitate continued access to UK-based staffing resources, particularly underwriters.

Key Takeaways

In the introduction to the Draft Statement, EIOPA reiterates that it had previously stressed the need for insurers not to display “the characteristics of an empty shell” but rather demonstrate an appropriate level of corporate substance proportionate to their business which should allow for (a) suitable oversight of governance arrangements to ensure effective decision-making and risk management and (b) proper supervision by the relevant regulator. The Draft Statement goes on to state that a particular governance arrangement which raises concerns is where a branch (or similar) is used to conduct regulated activity such as underwriting in respect of EEA policyholders as this, amongst other risks, has the potential to impair policyholder protection (though the Draft Statement does not elaborate on this concern).

The Draft Statement also articulates EIOPA’s belief that the purpose of a branch, or a similar governance arrangement in a third-country, of an insurer or intermediary, should be primarily to serve the market in which it was established. Consequently, EIOPA’s view is that governance arrangements established in third countries “with the sole objective of supporting entities based in the EU, should be avoided”.

The Draft Statement also indicates that any third-country branch arrangement involving regulating activity should not be conducted in a way that leads to the relevant insurer or intermediary being “disproportionately dependent” on the third-country arrangement to support its activities in the EEA. EIOPA states that the arrangement should also not materially impair the system of governance, increase operational risk or undermine policyholder protection. These themes will be very familiar to readers acquainted with the ongoing regulatory focus on outsourcing and operational resilience. Although the Draft Statement explicitly acknowledges that third-country branch arrangements do not constitute outsourcing, EIOPA appears to regard the risks involved as similar and may well recommend that they be addressed in a similar way. Additionally, it is clear from the Draft Statement that a key concern of EIOPA is to ensure that on-site inspection rights for supervisory authorities are in no way impaired.

What’s Next?

The deadline for submissions to the consultation process is 31 October 2022. This topic is likely to prove controversial for some industry participants across the EEA, and therefore, it is likely to garner plenty of feedback for EIOPA to consider. One of the most interesting (and instructive) aspects of the Draft Statement is the impact assessment annexed to the end of the document. It sets out the three potential policy options for stakeholders to consider, namely:

Policy Option 1 – no action to be taken. In other words, the Draft Statement would not be issued in any form.
Policy Option 2 – a detailed supervisory statement is issued. It is proposed that such a statement would set out the specific functions or activities that should be located locally (i.e. inside the EEA).
Policy Option 3 – a principles-based supervisory statement would be issued (i.e., along the lines of the current Draft Statement, which does not detail the specific functions/activities to be conducted inside the EEA).

EIOPA’s cost/benefit analysis in the impact assessment refers positively to “enough flexibility” being conferred on supervisory authorities. It acknowledges that too prescriptive an approach may constrain the activities of EEA insurers and intermediaries and impact policyholder protection. Nevertheless, it remains to be seen what the preferred course will be once the Draft Statement is finalised.

From an Irish regulatory perspective, the Central Bank of Ireland has typically adopted a reasonably robust approach to corporate substance and the related themes under discussion in the Draft Statement. As such, many Irish-based insurers and intermediaries may not be over-awed by many of the points being made by EIOPA. However, we would encourage all impacted insurers and intermediaries to consider the scope of the activities of their UK branches in light of the Draft Statement and engage with the consultation process to ensure their views are heard.