Draft Solvency 2 and Insurance (Amendment, Etc.) (EU Exit) Regulations 2019 Draft INSURANCE DISTRIBUTION (Amendment) (EU EXIT) Regulations 2019 DRAFT FINANCIAL CONGLOMERATES and Other Financial Groups (Amendment Etc.) (EU Exit) Regulations 2019

Jonathan Reynolds Excerpts

Monday 4th February 2019 General Committees

[Jonathan Reynolds (Stalybridge and Hyde) (Lab/Co-op)]

It is a pleasure to serve under your chairmanship, Sir Henry. Once again the Minister and I are here to discuss a statutory instrument that makes provision for a regulatory framework after Brexit in the event that we crash out without a deal. On each of those occasions, I and my Front-Bench colleagues have spelt out our objections to the Government’s approach to secondary legislation.

The volume of EU exit secondary legislation is deeply concerning for accountability and proper scrutiny. The Government have assured the Opposition that no policy decisions are being taken. However, establishing a regulatory framework inevitably involves matters of judgment and raises questions about resourcing and capacity. Secondary legislation ought to be used for technical, non-partisan, non-controversial changes, because of the limited accountability it allows. Instead, the Government continue to push through far-reaching financial legislation via this vehicle. These regulations could represent real and substantive changes to the statute book. As such, they need proper in-depth scrutiny. In light of that, the Opposition want to put on record our deepest concerns that the process regarding the regulations is not as accessible and transparent as it should be.

Our request for a debate on the Floor of the House regarding the markets in financial instruments directive in December 2018 was rejected, but I note that in the Treasury Committee’s oral evidence session last Tuesday, the Chair said that she was writing to the Leader of the House to ask for a debate on the draft Financial Services and Markets Act 2000 (Amendment) (EU Exit) Regulations 2019. Given that we now have more parliamentary time due to the cancellation of the February recess to focus on this very issue, I hope the Government will heed the calls now coming from across the House for more in-depth and open debates on these matters.

Today we turn our attention to three items that make provision for the UK insurance industry in the event that we leave without a deal. The UK insurance market, centred on Lloyd’s of London, is the world’s oldest insurance industry of its kind. It attracts business from all over the globe as it is often the only place where the combination of specialists can be found to provide products to cater for all of today’s highly complex risks, especially those of terrorism, cyber-attack and natural catastrophes. From its humble beginnings as a coffee house in the 17th century, Lloyd’s of London has become central to world insurance markets, paying out more than £18 billion in gross claims in 2017. Yet the insurance sector, which is so fundamental to the way in which businesses and individuals manage daily risks, is still in complete limbo over its post-Brexit future.

As I have said in this Committee before, relying on equivalence arrangements will fall short of what our financial sector as a whole needs if we are to use it when we leave the European Union. For the insurance sector, it is obviously even worse, as there is simply no equivalence framework for brokers under the insurance distribution directive. We would therefore be going into uncharted territory. The London Market Group, which represents brokers and underwriters, has said:

“It would be unacceptable to see EU clients left in a detrimental position, not knowing whether their claim would be paid or not.”

Inevitably, we have seen the consequences of that as the insurance community has been forced to move forward with its own contingency plans in the absence of any clarity from the Government. Lloyd’s became authorised to write EEA business from the beginning of the year, and is now working on transferring all EEA business to Lloyd’s Brussels before the end of 2020. Brokers here in London intermediate business all over the world, but the third-country regime was not designed for market participants already operating globally; it was intended to bring external countries into the regime.

The Minister has presented three instruments that the Government argue will allow for a basic framework to function in the event that we crash out without a deal. The first is the draft Solvency 2 and Insurance (Amendments) (EU Exit) Regulations. Given the systemic importance of the insurance industry, there has been a co-ordinated effort over the past decade to ensure that capital requirements are sufficient to protect insurers and policy holders against insolvency. Those regulations have been vital to building a more robust insurance sector post-financial crisis. It is critical, in the view of the Opposition, that there is no move to water them down in the wake of our exit from the EU.

Typically, the industry representatives I meet have no desire to bring about a bonfire of regulation, but there is no guarantee that there are not forces who wish to see that outcome in the UK and plan to lobby for it. The Opposition are strongly against any adaptation of Solvency 2 in such a way that would weaken capital requirements. Although I see no evidence of that in this instrument, the area that is cause for concern relates to the end of preferential treatment for EU sovereign debt.

As we discussed during the Committee on the draft Capital Requirements (Amendment) (EU Exit) Regulations 2018, if we crash out without a deal, the zero risk weighting for EU sovereign debt will instantly change. It will no longer receive preferential treatment, but instead be treated as third-country debt. The reverse would apply with regards to UK sovereign debt. That has the potential to be highly disruptive, as big institutions would be expected to recalculate capital ratios and recapitalise when there has not been any real change in risk.

Sam Woods of the Prudential Regulation Authority insisted during a Treasury Committee evidence session, which the Minister participated in, that this is a decision for Parliament, which is why it has been included in an SI. However, he also emphasised the need for making the change very carefully, through proper risk processes and governance, as it will affect reported capital ratios. In a no-deal scenario, where market conditions are likely to be volatile, the last thing needed is for banks and insurance companies to be uncertain about their published capital ratio.

I therefore ask the Minister: what provisions are the Treasury making for that scenario? It is not mentioned in the impact assessments that have been circulated, which is of deep concern to the Opposition. We urgently want to know what provision is being made. As the Association of British Insurers has directly highlighted:

“The Government has already publicly stated its commitment to applying transitional relief in this area, but it is vital that the PRA applies this effectively so that firms can consider their asset portfolios and make any necessary changes in an orderly fashion.”

Moreover, the ABI has underlined further outstanding concerns shared by the Opposition. The PRA is assuming hugely important decision-making powers, and therefore the ABI views the structure as an emergency process to address immediate challenges. As the ABI has publicly stated, there must be genuine checks and balances on how the PRA exercises those functions, replicating the European Parliament’s existing role in scrutinising how those functions are currently exercised at EU level.

I have made this point in Committees related to other items of financial services legislation: the Government cannot simply port over the same regulatory framework as the European Commission and its regulators, when our Treasury and supervisory authorities do not interact in the same way. In the Opposition’s view, that then becomes an implicit policy decision.

On the draft Insurance Distribution (Amendment) (EU exit) Regulations, the insurance distribution directive was a relatively new piece of legislation that helped to level the playing field for consumers buying insurance and to improve conduct standards. As such, there could be a significant consumer detriment in removing those protections, which try to ensure that policy holders are treated fairly and consistently.

However, our real concern is that we continue to lack any kind of equivalence provision for the IDD in a post-Brexit world. As the London & International Insurance Brokers’ Association wrote in its letter to the Prime Minister in 2018, an enhanced equivalence regime will see intermediaries losing access. Our primary concern must be that markets can continue to function and that there is no consumer detriment, or any legal risks, created for insurers or brokers. Can I therefore ask the Minister to provide some clarity on whether any progress has been made in that field?

I would also like to know why the term “insurance-based investment product” is being redefined here. It is not clear how that flows from the European Union (Withdrawal) Act. Regulation 12 transfers insurance-related regulation-making functions to the Treasury. Why the Treasury, and not the PRA? Why have the Government not publicly rationalised their transfer of some functions to different bodies? As I have said, simply porting functions over to institutions in the UK ignores the fact that EU institutions and regulators interact entirely differently. There should be a wider debate about those decisions, so we can ensure the right checks and balances are in place.

Moving on to the third statutory instrument, the draft Financial Conglomerates and Other Financial Groups (Amendment etc.) (EU Exit) Regulations 2019, the Opposition has the same concerns with regard to capital buffers and how they are calculated if preferential treatment for EU sovereign debt is removed. Regulation 3 suggests an amendment referring to the “relevant competent authority”. Can the Minister clarify who that might be, and why it is not possible to specify that yet? That is all I wish to ask. Subject to the Minister’s reasonable reassurances, I do not intend to divide the Committee on these draft regulations.