To Brexit or Not to Brexit

Too much has been said lately about the Brexit and the consequences that will follow on to the UK financial markets. Given that the capital London is the 2nd largest city in European Union and the 4th largest city in Europe and is considered as a global financial center. Naturally,

Brexit will be a top issue in a country historically known as center of excellence for insurance and reinsurance including its famous Lloyd’s market,

which is the world’s specialist insurance and reinsurance market with more than 50 leading insurance companies and over 200 registered Lloyd’s brokers. In general, UK is regarded as well as the first largest market in term of long term savings in the world and the largest in the EU. In 2014, UK insurers contributed to around 213 billion pounds to GDP whilst employing 334,000 in the industry. This effectively constitutes an essential part to the UK’s economic strength knowing that investments reached around 1.9 trillion pounds in the same period.

 A historical glimpse of the UK-EU membership, going back to 1975 and two years only after joining the EU, UK held a referendum in June to gauge support for the country’s continued membership in the EU. The majority voted “yes” with around 67% of the votes agreeing to maintain partnership. 41 years later,

the winds of change reversed the previous referendum with the June referendum 2016 voting for the UK’S independence from the EU with 52% of the population,

majority age 40s and above, agreeing to the withdrawal. Withdrawal negotiations will start once the UK files a written notice to the committee and invokes accordingly the Article 50 of the Lisbon Treaty.

 The Brexit and its implication on insurance is a long story.

The British divorce from the EU could have an influence on the UK’s economy and specifically its insurance sector as London could be facing a potentially damaging test:

 “Can its ability to attract international talent and wealth survive a hard Brexit.” The major reason is that UK would see itself losing the single market membership that each member of the EU enjoys and which removes the sale and service barriers between the countries.

 There are some major benefits of being part of the EU, the substantial one is to allow the UK insurers to write business in EU member states, a total of 28 countries, without local capital regulatory requirements. Thus, allowing access to a single market through what is referred to as past-porting rights.

The relevance of a pass porting system in the insurance sector means that the underwriters are able to conduct business throughout the EU while being regulated and supervised by the Prudential Authority

(PRA), which is the UK financial regulator.

 Underwriters accordingly are not required to localize funds or to report to any local regulators in any state member they are operating in.

However, if Brexit does indeed happen, the UK insurers may have to make changes to their group structures to be able to have a presence in both the UK and the European Economic Area.

They will have therefore to set up subsidiaries in the EEA and vice versa.

 Another major benefit, would be the encouragement of foreign investments considering that London’s financial services industry is an attractive destination for global investment capital, most of which originating from outside the UK and especially from EU. The UK has been a preferred option for investment for many reasons: namely UK’s legal system, central location and the English language for business affairs. Another importance reason for attracting capital is particularly the access to a single market.

Moreover, the London insurance marketplace enjoys the benefits from the treaties and trade agreements that the EU had negotiated since its formation with countries around the world,

to date. There have been deals with 55 countries and the EU is planning to complete deals with another 87 countries. The consequences of making such deals is to open up countries and to allow as well foreign insurers to operate within the trading partner countries.

In view of the Brexit vote, the UK and Europe are now entering a period of great uncertainty.

As discussed previously, the major impact of cutting ties with the EU will oblige the insurance firms to open EU branches to be able to write business in their respective territories and this will undoubtedly result in significant resource and cost issues. Another major impact would be on regulation as the EU drives that regulatory environment and not being part of the EU will give more discretion to domestic authorities. For example, the UK could opt to pursue Solvency II and the risk would be within the UK only with no regulatory influence whatsoever on or from the EU.

On the contrary, some would argue that the withdrawal of the UK from EU could let the country be a more attractive destination for business. A prime example is Switzerland which is a financially stable country and not a member of the EU.

UK could be as well liberated from the Solvency II stringent requirement which will eliminate excess costs.

 It should be mentioned however that the status of London as a global insurance leader is at risk following Brexit. According to John Nelson, the boss of Lloyd’s of London and the Chairman of the specialist insurance market “The company will quit the city if it is not given guarantees about its access European markets, and added that the group wants more clarity from the government about what assurances ministers will seek during Brexit negotiations”.

At the moment, insurance firms trading at Lloyd’s can sell to the rest of the single market without restrictions,

however Nelson said, “if this were no longer the case, or even if the arrangement was subject to a prolonged period of uncertainty, the market would have to consider “contingency plans” and won’t be Lloyd’s losing out, it will be the UK, he warned”. On the other hand, the French Insurance Association insisted the European authorities to take a hard line with the UK during the withdrawal negotiations and has requested the European Insurance and Occupational Pensions Authority (EIOPA) to move to Paris after the process is finished. Bernard Spitz, president of France’s insurer association FFA, stated that” European negotiators should make sure British insurers will not gain a competitive advantage by opting out of European regulations and that some are engaged into maintaining the attractiveness of the city of London. But that is not acceptable for Europe’s insurance or reinsurance sectors.”
 
Therefore, the Brexit could result in lost business for the London insurance and reinsurance market unless the government negotiated a continuity of pass porting rights and formulated various options to minimize its impact. During such negotiations, the UK should agree on what would be the post Brexit relationship.

 There are three realistic potential relationships between UK and EU post withdrawal: either the Norwegian Model, or the Swiss Model and the Free Trade Agreement.

For the first model, known as well as the EEA membership, there is a full access to the single market as a member of the EEA. For example, Norway is obliged to implement all single market rules however does not have any influence over them. Norway is requested to accept the free movement of persons and is required to contribute towards the EU budget. Secondly, the Swiss Model or Bilateral Agreement, the one adopted by Switzerland, which has around one hundred bilateral agreements with the EU that give access to the single market for goods but not most of the services. Switzerland makes contributions to the EU budget and is subject to the free movement of persons. Finally, the Free Trade Area Arrangement, this option provides for a single bilateral free trade agreement.

 Though the first option could give the UK insurance market the pass porting and access needed to single market it could provide few advantages for the UK, as the EU legislation will bind the UK however the UK would not have any influence on it. As for the second model, if UK would opt this model, it will not automatically have to implement new EU legislation with agreements negotiated case by case. As for the third model if adopted, the UK would no longer have to implement all EU rules and pay into the EU budget however under this model, one single bilateral agreement would not give financial services firms the benefit of the EU passport bearing in mind that the negotiation process is lengthy.

 Despite what has been mentioned above, the Brexit could on the contrary give the UK a greater influence as an independent country making their own parliament and shape their own destiny as a world power. It should be mentioned as well that

the Brexit could influence and lead other EU members to hold their own referendums.

This could be the beginning of the end for the European Project.