Solvency 2 and Insurance (Amendment, etc.) (EU Exit) Regulations 2019
(5 years, 10 months ago)
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Lord Bates
To move that the draft Regulations laid before the House on 8 January 2019 be approved.
The Minister of State, Department for International Development (Lord Bates) (Con)
My Lords, as this instrument has been grouped, with the leave of the House I will speak also to the draft Financial Conglomerates and Other Financial Groups (Amendment) (EU Exit) Regulations 2019 and the draft Insurance Distribution (Amendment) (EU Exit) Regulations 2019.
The Treasury has been undertaking a programme of legislation to ensure that, if the UK leaves the EU without a deal or an implementation period, there continues to be a functioning legislative and regulatory regime for financial services in the UK. The Treasury is laying SIs under the European Union (Withdrawal) Act to deliver this, and a number of debates on these SIs have already been undertaken in this place and in the House of Commons. The SIs being debated today are part of that programme and have been debated and approved by the Commons.
These SIs will fix deficiencies in UK law on the prudential regulation of insurance firms, the distribution of insurance products, and financial conglomerates, in order to ensure that they continue to operate effectively post exit. The approach taken in this legislation aligns with that of other SIs being laid under the EU withdrawal Act, providing continuity by maintaining existing legislation at the point of exit but amending where necessary to ensure that it works effectively in a no-deal context.
Three SIs are being debated today: the financial conglomerates and other financial groups regulations, the insurance distribution regulations and the draft amendments to the Solvency II regulations. The financial conglomerates and other financial groups regulations set prudential requirements for financial conglomerates or for groups with activities in more than one other financial sector. The insurance distribution regulations set standards for insurance distributors regarding insurance product oversight and governance, and set information and conduct-of-business rules for the distribution of insurance-based investment products.
Solvency II sets out the prudential framework for insurance and reinsurance firms in the EU. Prudential regulation is aimed at ensuring that financial services firms are well managed and able to withstand financial shocks so that the services they provide to businesses and consumers are safe and reliable. Solvency II is designed to provide a high level of policyholder protection by requiring insurance and reinsurance firms to provide a market-consistent valuation of their assets and liabilities, understand the risks that they are exposed to and hold capital that is sufficient to absorb shocks. Solvency II is a risk-sensitive regime, in that the capital that a firm must hold is dependent on the nature and level of risk that a firm is exposed to. In a no-deal scenario, the UK would be outside the EEA and outside the EU’s legal, supervisory and financial regulatory framework. The Solvency II and insurance regulations, the financial conglomerates and other financial groups regulations and the insurance distribution regulations therefore need to be updated to reflect that, and ensure that the provisions work properly in a no-deal scenario.
I shall start by addressing the changes to the financial conglomerates and other financial groups regulations. Under the EU financial conglomerates directive, a financial conglomerate is defined as a group with at least one entity in the insurance sector and at least one in the banking or investment services sector. One of these must be located within the EEA, while the others can be located anywhere in the world. This statutory instrument will amend the geographical scope of the definition so that one entity must be located within the UK rather than the EEA in order to be subject to the UK regime. This statutory instrument also amends the definition of a competent authority, so that it no longer includes regulators based in the EEA.
In line with the approach taken for other statutory instruments, this instrument transfers several functions from the EU authorities to the UK regulators. For example, the EU financial conglomerates directive requires EU authorities to publish and maintain a list of financial conglomerates. This function will now be carried out by the Financial Conduct Authority and the Prudential Regulation Authority. In addition, the responsibility for developing binding technical standards will pass from the European supervisory authorities to the appropriate UK regulator.
The Earl of Kinnoull (CB)
My Lords, I declare my interests as set out in the register, especially those in respect of the insurance and reinsurance industries. I will speak briefly to two of the three statutory instruments: the Solvency II and insurance regulations and the insurance distribution regulations.
Turning to the Solvency II and insurance regulations, and thinking about the near term, I congratulate the drafters of the statutory instrument; I know the ABI has been sitting with Treasury and PRA officials. First, it gives great comfort to the board of an insurer or reinsurer in the near term—I was thinking about how I would analyse it. It gives certainty on capital required, rollover for capital models and the ability to use reinsurance as temporary capital, and the asset values in an insurer’s balance sheet are unaffected. Secondly, I think the mutual equivalence regime is clever. It would have been possible to put equivalence for EU countries in the statutory instrument, but instead it is left to the Treasury to decide what to do. I think that is important because otherwise it would be possible for us to grant equivalence and then find that our Lloyd’s market had no equivalence granted back to it in the EU, which would be quite wrong. Mutuality of interest is preserved by that. Finally, I think the selection of measures designed to reduce that horror for all insurers, multiple regulation of the same action, is as good as can be done in the circumstances, so I congratulate the drafters on that.
However, thinking about the longer term, I put a question to the Minister. Solvency II—which came into force on 1 January 2016, for those who did not know, and is a regulation dating from 2009—is very much a one-size-fits-all solution to the problem of having the right amount of capital in your insurance market. Accordingly, it was not designed for the British situation. If you look at equivalent regimes in other jurisdictions—I am particularly familiar with the Bermuda jurisdiction, which is equivalent to the EU, but there are others such as Japan, Australia, Canada and the US, which is of course 50 jurisdictions in insurance terms—it seems that some changes could be made.
Your Lordships might well ask for some examples and I can think of two. There is a lot of gold plate around; that can go away. But one dynamic that has always surprised me is that over the last 15 years or so a large number of insurers and reinsurers have been set up, notably in Bermuda, while I do not think any have been set up here in the UK, the home of insurance. A review could properly investigate that dynamic. There are many reasons for it but I hope a review could address them because, to be competitive, I hope that new insurers and reinsurers will be born here, and soon. I would like to hear the Minister’s views on whether a review is warranted and can be expected.
I turn to the insurance distribution regulations. The directive on insurance distribution came in during 2016 and was the update to the 2002 insurance mediation directive. Insurance brokers were then hit by a regulation in 2017, which expanded on the directive, and in 2018 were hit by GDPR. A substantial series of changes have thus been made to how they need to operate, and a period of stability for them would be quite important. I come from the insurance underwriting world but I know the absolute necessity of having a healthy insurance intermediary world to feed our insurance underwriters.
One statistic that is a little worrying is that when the FSA, as it then was, took over the regulation of brokers there were 8,000 insurance brokers in Britain. Britain now has a bigger economy and we are down to under 5,000 of them, which does not feel right to me. I know that it is extremely difficult to found new insurance businesses. Does the Minister feel that, in the longer term, a review would be warranted here? It could seek out gold plate—insurance brokers are sure, and I am convinced, that the cost of regulation in this country is far greater than in other EU countries—but also look at why we have a shrinking number of brokers and why it is so difficult to start up a new broking business. A good review there would certainly give us a fitter and healthier insurance industry.
Baroness Bowles of Berkhamsted (LD)
My Lords, I too thank the Minister for his introduction. When I was involved in legislation in Europe, Solvency II was perhaps the first time that I discovered that I could be right while the Treasury was wrong. When I chaired the committee that gave me the confidence to trust my own judgment and to have few, if any, disagreements with the Treasury.
As it was originally done, Solvency II did not manage to cater for everything that the UK needed. In particular, we forgot about annuities; so did the ABI and the Treasury. I have to tell your Lordships that Parliament did not forget about annuities, but we were not strong enough to work out what to do about that because there was a big row going on, particularly between the UK and France, on equities and volatility. When I came back and discovered that I was to chair the committee, one of the first things on my agenda was Omnibus II, which aimed to sort things these out. We had the volatility adjustment for France; we had extrapolation for bonds in the eurozone, which were desperately needed by Germany; we also had the so-called matching adjustment, which we needed because otherwise the fact that insurance companies naturally tried to match the term of the assets that they collected to their liabilities would have been forbidden. They were supposed to account for their assets separately from assessing their liabilities, which in the business of annuities is a pretty stupid thing to do. Because we were having to box and cox with three other things, that meant that the solutions were probably less than perfect in the end, so in the fullness of time it might perhaps be made a little more perfect.
Lord Deben (Con)
My Lords, I point out my declaration of interest, particularly as chairman of PIMFA, the wealth management and independent financial advisers organisation. My noble friend will know that these SIs are not very acceptable to me because they are based on a number of hypotheses that are quite difficult to deal with. I will not repeat what I have said before on that, but I just want to remind my noble friend of those facts. However, there are some particular ones that I am concerned about.
The first is that anyone who deals with these issues is concerned about costs. Once again, we have a new system that means there is more work for the financial regulators. Every time we talk about that, no one tells us how much it will cost and quite how it will be paid for. Each time my noble friend explains with charm and elegance that there is not an awful lot of cost just here and that the FCA and Prudential Regulation Authority are both happy that they will be able to deal with this within their present resources.
The trouble is that I have heard that so often now that I am not sure this really works. There does not seem to be a position in which we have added these costs up. I have a suspicion that if we are not careful we shall end up with a lot more costs. One of the issues about people saying how much we pay into the European Union and how much we get out of it is that we forget an awful lot of things which, if you do them together, are much less expensive than if you do them apart. When I was Minister of Health and Safety I remember how useful it was that there was only one authority that tested ladders. We did not all have to test them ourselves. I am afraid we are in that situation here. I would like my noble friend to tell me whether these bills have been added up and how they will be paid. What sort of assurances can he give us that we will not find ourselves with significantly greater regulatory costs as a result of this?
The second point I want to raise is, in a sense, to pick up something raised by the noble Earl, Lord Kinnoull, about gold-plating. I think he and I are on the same side here. I do not think we disagree, but it is terribly important to say that most of the gold-plating I have ever found has been put there by the British. Gold-plating is a mechanism that happens in our system particularly. Having been a Minister in these circumstances, I know how it happens. A civil servant arrives and says, “Minister, we thought that if you do it this way round then somebody could find this answer, and it would be better therefore if we make sure that we close off all possible ways of avoiding whatever it is we’re talking about. Better not leave it until we discover—better do it first”.
Therefore, almost all our regulations, way outside the financial services area, are much more expensive regarding time, regulation and the rest of it than many other European countries. So the noble Earl was right to say that quite a lot could be done here about the reduction of gold-plating, but we could do that anyway because this is our gold-plating. There is no advantage in leaving the European Union to do this. The sad thing is that we have not done it before, and how we have managed to organise it.
There may be some things that we can do that we could not otherwise, but that leads me to my third point, which worries me considerably. In dealing with each of these SIs the Minister used the fascinating phrase—I would love to know who produced it—that were we to leave the European Union without a deal we would no longer have to inform the other authorities in the European Union of what is happening here. However, it will be discretionary to whatever the British regulator is to share this information, if that would be sensible, regarding our own regulation.
I am worried about this word “discretion”. Who decides that the discretion will be used? Is it something that the Government will press on these regulators? What do we mean by using “discretion” if this were, in the particular circumstances, valuable to regulation? Do we mean merely to our own regulation, or that we will be in a friendly situation because the regulation of others nearby will have a great effect on us? Is this really a cover word for saying what we do now together, because we are in the same organisation, we will sort of do in the future but pretend we are not doing and call it “discretion”? It seems that is precisely what is really happening here. This is a mechanism of recognising the need to do things together, but not actually putting ourselves into a position in which we have to do things together. Therefore it will be much less good, we will have to do a good deal of it and it will be much less possible to run regulation properly.
The last of my four points is simply that we are now creating a whole new language in which quite a lot of words are used without any clear meaning. The one I want to press my noble friend on is “equivalence”. It is a very useful word but I suspect it does not mean anything very precise. When we want to say that we will not be difficult with our neighbours, that we will recognise that markets, particularly financial markets, are very much interlinked, then we talk about the search for equivalence—no doubt we shall use discretion to search for that equivalence. I would very much like to know exactly the definition of “equivalence” as used with reference to these three SIs, because it matters quite a lot. If my noble friend could answer my four relatively simple questions, I would be most pleased.
Baroness Drake (Lab)
My Lords, I rise to comment on the Solvency 2 and Insurance (Amendment, etc.) (EU Exit) Regulations, applying in the event of a no-deal departure from the EU. My concern is from the perspective of the policyholder. Unlike the noble Lord, Lord Deben, I am keen to keep hold of some of the gold-plating that may exist in the current regulatory framework.
The driving intent of the Solvency II directive was policyholder protection, achieved by insurers complying with risk and capital requirements. The benefits are so important to both businesses and individuals that it is not surprising that the Government believe that provisions need to continue after Brexit.
The statutory instrument transfers responsibility for important technical functions from the EU authorities to the UK. The PRA will assume hugely important decision-making powers. Significantly, the risk-free rate—the rate that insurance and reinsurance firms must use to value their liabilities—will be transferred from the European Insurance and Occupational Pensions Authority to the Prudential Regulation Authority.
The PRA will take on responsibility for making binding technical standards. There must be robust checks and balances on how it exercises those functions. Similarly, the Treasury will be given power to make regulations dealing with the system of governance and risk management and methods and assumptions used in valuations and risk modules.
The UK insurance market attracts business from across the world. An efficient UK insurance sector is essential to businesses and individuals, allowing them to manage their risks. The sector is of systemic importance to the functioning of the real economy and individuals’ ability to manage their lives, but in a no-deal scenario there is a risk of the sector moving into uncertain territory.
Given the systemic importance of the insurance industry, continued confidence that capital requirements are sufficient to protect insurers and policyholders against insolvency is essential. There is a risk, and a growing fear, that in a no-deal scenario the Government will allow regulatory standards to drop in this area. My question is simple: can the Minister give an assurance that there will be no weakening of the standards of regulation, governance and capital requirements on exit from the EU?
Lord Tunnicliffe (Lab)
My Lords, I thank the Minister for introducing these three SIs. However, once again, it gives me no pleasure to be here; these various SIs have ruined yet another weekend and are in pursuit of an outcome which all sane people believe is stupid and potentially catastrophic. It need not have been this way. Even with the excuse of taking responsible action in case of a no-deal scenario, had we started the whole process earlier we could have been considering these SIs at a more modest rate and perhaps giving them more scrutiny than they are inevitably able to receive—certainly, from me.
Before turning to my own concerns, I want to comment on what other noble Lords have referred to. The noble Baroness, Lady Drake, and the noble Lord, Lord Deben, spoke of responsibilities presently held by EU bodies being transferred to UK bodies. There are two problems here. One is that the sheer complexity necessarily involved in doing that leaves the possibility of unintended mistakes having been made in the transfer. Secondly, the noble Lord mentioned costs. I am not too worried about costs; I am much more worried about resources. Do the FCA and the PRA have the resources to take on this burden? It has been explained to me that they will get their money from the industry and so on, but will the people involved be good enough, given the complexity of the situation that we are addressing?
The noble Baroness, Lady Bowles, talked about the generality of Solvency II. From my standing-start understanding of this area, which began on Friday night, I accept that there is some debate about Solvency II. On the solution suggested by the noble Earl, Lord Kinnoull, that the changes be introduced through this instrument, the Minister knows that I would be the first person to jump down his throat if he tried to do that.
The Earl of Kinnoull
I am sorry for having confused the noble Lord, but I certainly did not suggest that changes be introduced in the instrument. I suggested that Solvency II was a one-size-fits-all regulation with a number of things in it. The noble Baroness, Lady Bowles, must have known how difficult were the negotiations, taking place over such a long period and spanning a large part of the world, because of the interaction between the global insurance markets. I suggested merely that it might be wise to have a review and asked the Minister for his view on that. I apologise for any confusion.
Lord Tunnicliffe
I thank the noble Earl for that explanation and apologise for misunderstanding him.
The task we have is under Section 8 of the European Union (Withdrawal) Act, which is a very narrow task. My concerns are perhaps quite small and detailed, but I think that there is a fundamental concern about the process. There is a generality in political activity whereby what politicians do should be understood by a reasonably intelligent amateur—I am at least an amateur—and there is disquiet about the complexity of these three SIs. They are remarkably difficult to understand if one is not part of the industry. It is impossible to read the raw instruments. Much of them relates to FSMA 2000, which has been amended so many times that the original document is indistinguishable. Trying to understand the measure from the Explanatory Memorandum, in which I must trust because I have no other way of examining it, was difficult.
The Opposition will not oppose these instruments. As I read through them, they seem in general to do similar things, so I have no points to raise. However, paragraph 7.12 of the Explanatory Memorandum states:
“The European Commission’s responsibility for developing legislation will be transferred to HM Treasury which will be given power to make regulations for certain matters previously dealt with under Solvency II, e.g. the system of governance and risk management, methods and assumptions used in valuations and risk modules”.
That seems to be a pretty sweeping power which has been transferred. Does the Minister believe that is compatible with the withdrawal Act, particularly Section 8? What scrutiny, if any, will Parliament have of the exercise of these powers by HM Treasury? As set out here, they seem to be unrestricted.
Paragraph 7.13 says:
“EU assets and exposures held by UK insurers will no longer be subject to preferential risk charges when setting capital requirements for insurers that use the Standard Formula”.
At first sight, that sounds as though we are taking something away from the EU, that we are being beastly to them. It was only when I did further research that I realised that it has the opposite effect. As I understand it—I hope the Minister will be able to confirm this—the effect will be to increase the capital requirements for UK insurers, which will certainly reduce their profitability. As we know from previous debates, the objective of the withdrawal Act was to not introduce new policy. In his introduction, the Minister said that these instruments aligned with previous SIs. I do not think they do because, in order to stop cliff-edge changes in value, previous SIs have always had some sort of transition regime. If the effect is higher capital requirements, does that mean that UK insurers have been operating unsafely, with insufficient capital? If not, we will be introducing an increased burden on them. If my interpretation is right, why is there not a transition regime in order to make sure there is no cliff-edge change to that requirement?
Further on, in the section on impact, paragraph 12.3 states:
“UK insurers which use the Standard Formula for calculating capital requirements will be impacted by the removal of preferential treatment for EEA risk-weighted assets and exposures. Such insurers could face higher capital requirements unless they divest themselves of such assets and exposures. However, the government intends to legislate to provide regulators with powers to introduce transitional measures to phase in on-shoring changes to reduce the immediate impact on exit.
That hints that the Government are going to introduce a transitional regime through the regulators. Is that a proper interpretation of the paragraph? If so, when will the legislation alluded to, giving these powers to the regulators, come before the House? Why has this not been part of the SI?
Paragraph 7.15 of the insurance distribution instrument says:
“Regulations 6 and 12 of this instrument also transfer relevant legislative functions of the European Commission contained within Articles 25(2), 28(4), 29(4) and 30(6) of the IDD to HM Treasury. This includes the powers to make regulations about conflicts of interest, regulations about inducements, and regulations on assessments of suitability, appropriateness and reporting to customers, and specifying principles for product oversight”.
That seems to be a big bunch of powers. Will they be subject to any parliamentary scrutiny?
Finally, I was somewhat exhausted by the time I came to look at the conglomerates SI—we amateurs do have to work hard—but reassured by paragraph 7.12 of the Explanatory Memorandum which says:
“In practice this change will not have a material effect on financial conglomerates already operating in the UK”.
With that assurance, I have no questions on that SI.
Lord Bates
I thank noble Lords for their questions and of their scrutiny of these important SIs. I am sorry to have ruined the noble Lord’s weekend. I hope he got a chance to see the rugby.
Lord Bates
I hope that cheered him up a bit.
These are very detailed SIs but in your Lordships’ House there was a wealth of ability to understand them and raise some pertinent questions. The noble Earl, Lord Kinnoull, began by paying tribute to the parliamentary draftsmen and officials at the Treasury and the way they have worked with the ABI. I have witnessed that close working relationship and am grateful to the noble Earl for recognising it in his remarks. I do not have a note relating to his question about the insurance industry on the number of insurance brokers relative to the growth in the economy, and whether there is something about the competitiveness of the UK insurance market that we need to learn from. Those are interesting points and I will take his suggestion back to John Glen, the Economic Secretary to the Treasury and brilliant Cities Minister, who is looking at issues of competitiveness. I will then write to the noble Earl.
Most of the questions related to Solvency II, so I will group those and deal with the other ones as I go through. The noble Lord, Lord Tunnicliffe, asked about insurance distribution and why the Government need the additional powers in the SI. The instrument also transfers relative legislative functions of the European Commission contained within the insurance distribution directive to the Treasury. Any changes made to regulations by the Treasury would have to be approved by Parliament. I hope that that offers some reassurance.
The noble Baroness, Lady Bowles, asked whether the financial conglomerates regulations had resolved the problem of double gearing in the insurance model. FICOD has created new supervisory powers which increase standards of governance and oversight for the largest financial groups. This has helped address gaps that arise from the sectoral supervision of individual firms in a group, in particular the risk of double gearing, which can arise in the absence of robust, group-level policies on capital governance. As I was reading that, I wondered if it answered the question of whether the problem has been resolved. I think the answer may be yes, but I will say that we are working on it and I will write to the noble Baroness. I thank her for raising that point.
The noble Lord, Lord Tunnicliffe, asked about the transitional power referred to in the Explanatory Memorandum to the Solvency II regulations. This power can only be used to phase in the EU exposures changes that the noble Lord is concerned about; it cannot be used to avoid a cliff-edge impact. The power will complement transitional arrangements already approved by Parliament, including the temporary permissions regime. The noble Earl, Lord Kinnoull, asked whether we should have a review of Solvency II. The UK is putting in place all necessary legislation to ensure that, in the event of a no-deal exit in March 2019, there is a functioning legal regime. The Act does not give the Government the power to make policy changes beyond those needed to address deficiencies. That means, as far as possible, that the same rules apply. Let me extemporise a bit: the noble Baroness, Lady Bowles, made the point that the record of UK regulators in leading on Solvency II was widely acknowledged. I think that that is to be encouraged. In all likelihood, if our world-class regulators spot deficiencies in the new regime, they will keep that under review.
The noble Baroness, Lady Drake, asked whether we will be weakening standards. In many ways, as I have alluded to already, our intent—the Chancellor and many others have put this on the record—is to recognise that the UK’s reputation in financial services is earned because we have high standards, not because we have low standards. In a sense, there is a tension between the claim that we are going to be lowering standards and my noble friend Lord Deben asking whether we are going to be gold-plating standards, a question I will come to in a second. My noble friend asked about the definition of equivalence. The definitions that operate for each EU equivalence regime will not change and we will use the same criteria for making equivalence decisions in the future as the EU uses now.
My noble friend asked whether the regulators will have adequate resourcing for a no-deal scenario, a question picked up by the noble Lord, Lord Tunnicliffe. Figures on resources and any new costs are for the regulators to publish in their annual reports, which are laid before Parliament. I remain confident that the regulators are making adequate preparations and effectively allocating resources ahead of March 2019. They have actively participated in a wide range of groups in developing technical policy and regulatory rules and have chaired a number of committees and task forces, bringing their considerable experience in implementing EU legislation to bear.
The noble Baroness, Lady Bowles, asked whether there is a figure for EU holding of gilts compared to the rest of the world. To the best of our knowledge, there is no reliable data on EU firms’ holding of gilts; however, analysis by the regulators suggests that the capital impact of this change should not be significant.
My noble friend Lord Deben asked about gold-plating by the UK. Solvency II is a maximum harmonisation directive—I do not know whether that is another phrase my noble friend will pick me up on. There must be a level playing field across the EU and we are preserving these rules as much as possible. He also asked whether the instruments reduce the need for the PRA to co-operate and share information. The UK fully expects a high level of co-operation to continue after exit, as is currently the case with countries such as the United States.
The noble Lord, Lord Tunnicliffe, asked whether too much power has been transferred to the PRA. In the longer term we will need to review the regulatory framework in the UK, including the role of regulators and how far they should be accountable. He asked why we are increasing capital requirements under Solvency II —whether the current requirements are not adequate—and worried about what the past situation was. The prudential standards in Solvency II are not being altered. The capital standards that apply now are entirely appropriate and will be largely unaffected by exit. There are only two situations in which a firm may be required to hold more capital once outside the EU’s joint supervisory framework for group supervision. Some EU groups operating in the UK may be subject to an additional layer of supervision by UK regulators. He asked why we are giving new legislative powers on Solvency II to the Treasury. The EU withdrawal Act explicitly provides for EU functions to be transferred to UK bodies, which is what we are doing.
I will, as with previous secondary legislation, review the record of the debate with officials. Should I find that any points have not been covered adequately, I will write to noble Lords and copy in other Members. In the meantime, I commend the regulations to the House.