Guidance

Solvency II and Insurance (Amendments) (EU Exit) Regulations 2018: explanatory information

Updated 11 October 2018

1. Context

The EU Withdrawal Act 2018 (EUWA) repeals the European Communities Act 1972 on the day the UK leaves the EU and converts into UK domestic law the existing body of directly applicable EU law. The purpose of the act is to provide a functioning statute book on the day we leave the EU.

The act also gives ministers powers to make statutory instruments (SIs) to prevent, remedy or mitigate any failure of EU law to operate effectively, or any other deficiency in retained EU law.

HM Treasury is using these powers to ensure that the UK continues to have a functioning financial services regulatory regime in any scenario.

This SI is part of the wider work the government is undertaking to prepare for the UK’s withdrawal from the EU. It is not intended to make policy changes, other than where appropriate to reflect the UK’s new position outside the EU, and to smooth the transition. The changes made in this SI would not take effect on 29 March 2019 if, as expected, we enter an implementation period.

2. Notice

The attached draft SI is intended to provide Parliament and stakeholders with further details on our approach to onshoring financial services legislation. The draft instrument is still in development. The drafting approach, and other technical aspects of the proposal, may change before the final instrument is laid before Parliament.

3. Policy background and purpose of the SI

3.1 What does the underlying EU regulation and UK law do?

The underlying EU law is the Solvency II Directive, as implemented in UK law by the Solvency II Regulations 2015, the Solvency II Delegated Regulation and the PRA Rulebook.

The EU’s Solvency II regime, which came into force in 2016, is a harmonised prudential framework for insurance and reinsurance firms in the EU. Prudential regulation is aimed at ensuring 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 policy-holder protection by requiring firms to provide a market-consistent valuation of their assets and liabilities, understand the risks they are exposed to, and to hold capital that is sufficient to absorb shocks. Solvency II is a risk-sensitive regime in that the capital a firm must hold is dependent on the nature and level of risk a firm is exposed to.

The Solvency II framework is divided into three ‘pillars’:

• Pillar 1 sets out quantitative requirements, including rules to value assets and liabilities and determine the appropriate capital requirement (called the Solvency Capital Requirement) for firms;

• Pillar 2 sets out requirements for risk management, governance and details of the supervisory process that firms must comply with; and

• Pillar 3 addresses transparency requirements, including reporting to supervisory authorities and disclosure of information to the public.

3.2 Deficiencies this SI remedies

Consistent with the government’s onshoring policy of providing continuity to businesses and consumers, the policy approach of Solvency II and the key prudential requirements set out in Solvency II legislation will not change after the UK has left the EU. However, to ensure that the Solvency II regime continues to operate effectively once the UK is outside of the EU, certain deficiency fixes to the legislation will be necessary. These deficiency fixes are explained below.

Regulation of Cross-Border EEA Groups of Insurance / Reinsurance companies

As in other areas of EU regulation, insurers and reinsurers are subject to the EU’s joint supervisory framework. This enables Solvency II requirements for a cross-border EEA insurance or reinsurance group to be applied to the group, with one EEA supervisor allocated lead responsibility for supervision of the group in addition to supervision of solo firms by their respective EEA supervisors. Solvency II sets out the basis for this approach, including determination of which EEA supervisor is responsible for group supervision and how the group supervisor must cooperate with other affected EEA supervisors to ensure that group supervision across the EEA is effective. Supervisory cooperation takes place through a “college” of supervisors in which all the interested EEA supervisors take part.

Where the ultimate parent undertaking has its head office in the EEA, Solvency II group supervision currently applies at the level of that ultimate parent undertaking. Group solvency is assessed at the level of the ultimate parent undertaking. The group Solvency Capital Requirement (SCR) may be calculated using a Group Internal Model, subject to approval by the group supervisor and the other supervisory authorities concerned. Governance and reporting requirements also apply to the group and must reflect the nature of the group structure and its risk profile, considering the risks arising from all the different entities constitute the group.

After exit, in a no-deal scenario it is assumed that the EU will treat the UK as a ‘third country’ and the UK will be outside of the joint supervisory mechanisms which are the basis for Solvency II’s treatment of groups in the EEA. Therefore, UK groups with EEA insurance subsidiaries may become subject to group supervision by EEA supervisory authorities (if UK group supervision is not deemed to be equivalent). The UK Solvency II regime will be amended so that EU27 countries will be treated as third countries. This means that EEA groups with UK insurance subsidiaries will also be subject to group supervision by the PRA (in the absence of any equivalence assessments).

Equivalence

Under Solvency II, a third-country’s regulatory or supervisory regime may be deemed by the European Commission to be equivalent to the approach set out in Solvency II. A third-country regime may be equivalent in relation to reinsurance regulation, the solvency calculation that applies to insurers and reinsurers, or the supervisory approach to group supervision. Equivalence decisions reduce duplication in regulatory or supervisory requirements between the EU and third countries and may also facilitate the exchange of services and products.

When the UK leaves the EU, the UK will no longer fall under the jurisdiction of the European Commission. To ensure that the Solvency II regime can continue to operate effectively in the UK, HM Treasury will take on the Commission’s function of making equivalence decisions for third country regimes, while the PRA will take on the role that EIOPA currently has for providing technical assessments of third country regimes.

Where the Commission has already taken equivalence decisions for third countries, these will be incorporated into UK law by the EU (Withdrawal) Act and will continue to apply to the UK’s regulatory and supervisory relationship with those third-countries.

Risk weights for EU assets

EU financial services regulation, including Solvency II, provides preferential risk-charges for certain assets and exposures that originate from within the EEA. These include EEA sovereign debt and exposures connected with EU Long-Term Investment Funds (EuLTIFs), EU Social Entrepreneurship Funds (EuSEFs) and EU Venture Capital Funds (EuVECAs). Once the UK has left the EU, EU legislation will no longer classify such UK exposures as EEA exposures and it is assumed they will become subject to the general third country requirements rather than the preferential treatment for EEA exposures. Similarly, the UK’s domesticated versions of EU regulation will require the UK to treat EEA exposures as exposures from any other country, thus removing preferential risk-charges for those exposures. HM Treasury is exploring possible transitional arrangements for these changes.

Transfer of functions

To ensure that the UK’s standalone Solvency II regime will work effectively, certain key functions carried out by EU institutions will need to be transferred to appropriate UK bodies. In addition to the equivalence functions covered above, the key Solvency II functions that will need transferring to the UK are:

• EIOPA’s function to produce technical information on the ‘risk free rate’ which insurance and reinsurance firms must use to value their liabilities, and which is used in calculating the Matching Adjustment and Volatility Adjustment. This function will be transferred to the PRA.

• EIOPA’s responsibility for maintenance of the correlation parameters, as set out in the Solvency II Delegated Regulation, which are used in standard formula calculations. This function will be transferred to the PRA by deeming these parameters to be a part of the PRA’s rulebook.

• The European Commission’s responsibility to publish the technical information on the risk free rate and the correlation parameters will transfer to the PRA.

• EIOPA’s responsibility for declaring an ‘exceptional adverse situation’ for the insurance market, which enables supervisors to extend the recovery period firms can use to re-establish compliance with the Solvency Capital Requirement (SCR). This function will be transferred to the Prudential Regulation Committee of the Bank of England.

Information sharing and cooperation requirements between UK and EEA regulators

In Solvency II, there are binding obligations on UK authorities to cooperate and share information with EEA authorities. These obligate the PRA to cooperate and make joint decisions with EEA supervisors through the EU college of supervisors. They also require the PRA to share specified types of supervisory information with EEA supervisors and EIOPA.

To reflect the UK’s new status when the UK leaves the EU, these obligations will be removed from UK legislation. This is appropriate given that the UK will no longer be a member of the European Union, and will ensure the UK is not obliged to share information or cooperate with the EU on a unilateral basis and with no guarantee of reciprocity. Instead, UK authorities will be required to comply with the existing domestic framework provisions for cooperation and information sharing with regulators in other countries. Indeed, it is the UK’s firm intention to maintain a high level of mutually beneficial supervisory cooperation with EU and EEA authorities.

Binding Technical Standards

Under the EU system of financial regulation, the Commission is responsible for developing legislation, except for Binding Technical Standards (BTS) which are developed and drafted by the EU Supervisory Agencies (ESAs). Across financial services regulation, the Treasury is transferring responsibility for all BTS to UK regulators. The basis on which this function is to be exercised is set out in the Financial Regulators’ Powers (Technical Standards) Statutory Instrument.

For Solvency II, all the BTS mandates currently set out in the Directive will be brought into UK law with responsibility for meeting those mandates transferred to the PRA. The PRA will have responsibility for correcting deficiencies in Solvency II BTS so that they operate effectively from day one of exit, and the PRA will then be responsible for ensuring these BTS remain fit for purpose after exit.

3.3 Relevant Rulebook and Binding Technical Standard changes

The PRA will update its Rulebook (rules made by the PRA under the Financial Services and Markets Act) and Solvency II BTS to reflect the changes introduced through this SI, and to address any deficiencies as a result of the UK leaving the EU. The PRA has confirmed its intention to consult on these changes in the Autumn.

3.4 Stakeholders

The key stakeholders are insurance and reinsurance firms regulated under Solvency II in the UK and any EEA passporting firms which will become subject to UK supervision after exit.

HM Treasury has engaged with industry bodies where possible to ensure awareness of these changes. As already noted, the intention of this SI is not to make policy changes, other than to reflect the UK’s new position outside the EU, and to smooth the transition to this position.

This SI does not include provisions that may be necessary to ensure Gibraltarian financial services firms’ continued access to UK markets in line with the UK government’s statement in March 2018, and other provisions dealing with Gibraltar more generally. Where necessary provisions covering Gibraltar will be included in future SIs.

4. Next steps

HM Treasury plans to lay this instrument before Parliament in the autumn.

5. Further information

Read HM Treasury’s approach to financial services legislation under the European Union (Withdrawal) Act 2018.

6. Enquiries

If you have queries regarding this instrument, email [email protected].