Financial Services

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Mr. Breed: Will the Minister confirm whether the rules will be different for subsidiaries where the group holding company is located outside the Community?
Kitty Ussher: The provisions only refer to situations where the subsidiaries are within the EU. There are other ways of dealing with companies that exist across other borders.
Mr. Breed: I fear that, although we may know quite a lot about the subsidiaries, those may be relying on the capital adequacy of the group. However, if the group is outside the Community, our ability to understand and know how strong that particular group is could be a major impediment to supervising the subsidiaries properly.
Kitty Ussher: The hon. Gentleman is correct. That is a challenge for regulators across the whole financial services sector throughout the whole world right now. Detailed arrangements are in place, often on an ad hoc basis and sometimes through other mechanisms, to ensure that there is adequate communication between different regulators in respect of firms, whether in insurance or broadly in the banking sector, or even in the wholesale markets.
Just to clarify what I have said before, to come under the scope of this directive, the parent company needs to be in the EU.
Mr. Hoban: This is interesting, because a lot of non-EU groups operate in the EU. Would it be possible for a non-EU group to arrange itself so that it has an EU-based holding company for all its European insurance businesses and for that company to be regulated on a group basis rather than on a solo basis per territory?
Kitty Ussher: Yes, it would, but that is not anything to worry about, because the regulatory requirement would ensure that they had sufficient capital to deal with all the subsidiaries in the EU. So as far as the policy holder is concerned, there should be no difference.
Mr. Hoban: I am not worried; I just want to ensure that that was the answer. Groups such as the Prudential—I plucked it from the air, and there are others—have significant non-EU insurance activities, so how will its EU activities be segregated out? How will its capital be assessed when a proportion of its activities are outside the EU?
Kitty Ussher: My presumption is that the relevant regulatory framework will be the one in the country where the company operates. For example, if it has five or six subsidiaries in the EU, they will have to be regulated in the way that the “Solvency II” directive requires. If they have other operations elsewhere, there will presumably be arrangements between the host regulator and the parent group regulator to ensure that the necessary regulatory requirements are adhered to, but that will depend on the regime in each country. We are discussing what happens in the EU.
Mr. Hoban: So, if an insurer has an operation in, for example, Singapore, it will meet its regulatory capital requirements there, and presumably the subsidiary’s capital would not count towards its capital for the SCR.
Kitty Ussher: The hon. Gentleman is entirely right. The parent company in the EU must meet the one-in-200 requirement for operations that take place in the EU.
The Chairman: Unless I am mistaken, that brings us to the end of questions. I call the Minister to move the motion.
Motion made, and Question proposed,
That this Committee takes note of EU Document No. 6996/08 relating to Financial Services, amended draft Directive on the Taking up and pursuit of the Business of Insurance and Reinsurance: Solvency II (Recast).—[Kitty Ussher.]
5.7 pm
Mr. Hoban: I am grateful to the Minister for her forbearance during detailed and technical questions. Our aim is not just to tease out information, but to support the Minister by identifying some of our concerns about “Solvency II”, and to encourage her in her negotiations with her European counterparts. The directive is important, and will start to bring prudential regulation into line with the way in which international groups manage their activities. Insurance groups are increasingly sophisticated in the way in which they manage their risk from the capital side of their business. If the benefits are to be realised, there must be a close fit between that side and their prudential supervision.
It seems that the directive has been designed to encourage and reward better risk management, regardless of a company’s size, and, hopefully, should enhance consumer market confidence in the soundness of insurance companies. We welcome the fact that it is possible to manage solvency on an EU-wide basis, taking account of capital use within the EU as a whole. I hope that the directive will lead to a level playing field for insurers throughout Europe, and reward those who manage risk carefully, enable optimal capital allocation, and streamline group supervision.
I want to discuss in a little more detail some issues that we did not probe during questions. First, the minimum capital requirement is an outstanding issue to be settled in the next round of negotiations. I understand that the closer it is to the solo solvency capital requirement for each territory, the less benefit will be gained in the ability to manage solvency on an EU-wide basis. I gather that the simulations of quantitative impact study 3 came up with a range of answers where the minimum capital requirement was either less than zero, which seems absurd, or greater than the solvency capital requirement. Clearly, further thought is required.
Will the Minister outline the Government’s position on what the minimum capital requirement should be? Some member states want the MCR to be calculated on a stand-alone basis, so that it could be audited, and be separate from the SCR. The Association of British Insurers has suggested that the MCR should be risk-weighted using the value-at-risk method. It indicated that the best way to achieve that is to set the MCR as a proportion of the solo SCR—the SCR applying to companies acting in that jurisdiction on a stand-alone basis. It suggested that 33 per cent. of the SCR will be an appropriate level at which to set the MCR. Will the Minister explain the Government’s thinking on that? Clearly it is an important issue to resolve, given that it will have an impact on how effective the directive is in creating a level playing field and yielding some of the benefits for which we would hope from a strong group regime.
My second issue concerns the supervisory regime and the colleges. I have read the Government’s consultation paper on the role of colleges, and I recognise that, as I indicated in my questions, if we do not get the group supervision right, we will not fully benefit form “Solvency II”. Clearly a strong lead regulator will strengthen group supervision, thus realising the goals of EU-wide solvency calculations. The Government made a very strong and important point in their consultation document: given the open nature of financial markets in the UK, the FSA will act as a local regulator in a significant number of incidences, which strengthens the argument in favour of a strong lead regulator—that demonstrates that on this we do not speak with a vested interested. Will the Minister give us her assessment of where she thinks that the balance of opinion lies on that relationship? We have mentioned that industry is broadly supportive of a strong lead regulator, but it might be helpful to have another discussion on that.
I have a broader point about supervisory colleges. In this case, an EU-wide college will be set up to deal with a particular regulatory issue—prudential supervision—but clearly, as the Minister indicated, the concept of such colleges could be applied to international financial institutions. Will she elaborate on the Government’s broader policy on supervisory colleges in terms of their membership and powers? As we touched in our discussion on solvency relating to non-EU groups and EU groups with non-EU activities, clearly a number of EU groups have significant non-EU activities. Is the Government’s view that colleges should be inclusive and open to all significant regulators of financial institutions, or does she believe that there is pressure within the EU for them to cover EU regulators only? Given the open nature of the UK financial services sector, an inclusive college would be better than an exclusively EU one. What powers does the Minister expect those colleges to have? There has been some debate about whether they will open up the opportunity for a supranational regulator. I understand that the Government do not think that there should be such a regulator, but I question whether some would use colleges as a way of re-opening that debate.
In the question and answer session, we did not touch on the fungibility of capital. Clearly the proposal will work only if it is possible to transfer capital around EU group companies. Have the discussions on “Solvency II” dealt sufficiently with the fungibility of capital and the ability to transfer direct capital to subsidiaries at risk of breaching their solvency margins. As my hon. Friend the Member for Hammersmith and Fulham alluded to when he talked about Basel II, over recent months, we have seen the tension between liquidity and solvency in the banking sector—we have seen banks that are solvent, but not necessarily liquid. A parallel can be drawn here: an EU-wide institution might be meeting its SCR, but the nature of the underlying assets might impair its ability to move its capital around the group.
5.15 pm
Those are the only comments that I have to make on this directive.
Kitty Ussher: Those are useful issues; I am grateful to the hon. Gentleman for raising them.
On the MCR, I am aware of the proposal of the Association of British Insurers, which we are certainly comfortable with. As the hon. Gentleman has said—indeed, I think that I said it earlier, too—the key is that there is a connection between the SCR and the MCR to allow a sort of ladder of supervisory intervention and to ensure that the MCR really is a base beyond which we do not go.
So we have been supportive of setting the MCR as a percentage of the SCR. Realpolitik suggests that other member states may be unlikely to support that idea, but we think that a corridor approach is an acceptable alternative to ensure that the MCR is fully driven by risk, which is the most important factor, and has a link to the SCR.
Mr. Hoban: Just to be clear, in terms of the corridor approach, is the Minister thinking about setting, say, a floor and a ceiling as to the percentage of SCR that the MCR could be?
Kitty Ussher: Exactly. There would be a cap on the MCR as a percentage of the SCR, yes.
Mr. Hoban: Will it be clear, in looking at the MCR, that it should be calculated, as far as possible, on a consistent basis with the SCR in terms of treatment of different types of assets, and things like that, so that we do not end up with businesses having to run two parallel calculations and suddenly a percentage is applied at the end to ensure that the business is within that corridor?
Kitty Ussher: The hon. Gentleman and I are violently agreeing on this point; the answer is yes. We will try to negotiate something that is as near as possible to a sensible basis with that idea in the back of our minds.
On the point of a strong lead regulator, we have already had an exchange on that issue in an earlier part of this debate. We think that such a regulator is in the interests of our industry and policyholders across the EU, so I take the hon. Gentleman’s point on that issue, which, I think, is broadly shared by the industry and is certainly held by our industry.
On colleges, there is nothing to be lost from having regulators from all the relevant jurisdictions working together effectively. I have not seen the specific proposals, but I can see no reason why, if there were a regulator outside the EU, that regulator should not be involved, if it were seen as being important for them to be involved or necessary for them to discharge their duties. Of course, we must bear in mind that, at the end of the day, these are informal arrangements for co-ordination, and it is the regulatory background in the EU or in each member state that is appropriate.
The hon. Gentleman asked whether a move along the road to greater use of colleges would inexorably lead to an argument for a single regulator or a greater degree of harmonisation in that regard. I do not think so at all. In fact, one could argue the opposite point that if we can have good co-ordination, obviously we do not need legislative solutions. That is certainly the line that the Government take.
In an earlier part of the debate, the hon. Gentleman rightly pressed me on how the level 2 measures will be implemented and how those decisions will be taken. It may help to point out that when drafting the level 2 implementing measures, the Commission will, of course, do so on the basis of advice from the Committee of European Insurance and Occupational Pensions Supervisors. The measures will have to be agreed by EU Finance Ministries, and they will be subject to scrutiny by the European Parliament.
The Commission will conduct an impact assessment at that point, and we in the UK will do one as well. We hope to proceed step by step on the basis of evidence only, which is the most effective way to implement the high-level agreement. That will at least increase the chances of a solution that works in the interests of the industry, I presume.
The hon. Gentleman asked specifically about surplus funds, which, as he rightly said, are dealt with differently in other European countries. We suspect that the countries that allow with-profit life insurance policies will require some kind of compromise during the course of the negotiations, but, obviously, we will continue to push our point. There is no way that the surplus funds arrangements that exist in some other countries could be used in the UK, because they simply would not comply with the FSA’s conduct of business rules. The important thing is to ensure that other member states get what they need, but that there is no disadvantage to us, and that negotiations move as far as possible in our direction so that our industry is not left behind.
Mr. Hoban: Does the Minister expect that if a compromise were reached—I believe that it could create an uneven playing field between the UK and, say, German insurers—the tier 2 measures on disclosure would require those companies reliant on surplus funds to meet their capital requirement and to disclose it fully and properly?
Kitty Ussher: I am happy to look at that, but the important point is that German companies, for example, work in that way already. It is always intellectually unsatisfactory that one cannot create a single market in every way, if we think that it would be in the interests of British business to do so, but, if we were forced to concede a compromise in that area, the situation would be no worse. It could end up being more advantageous to British business than was previously the case. I always think that transparency is a good idea, but I will have to write to the hon. Gentleman with details on that matter.
The hon. Gentleman was right to say that fungibility of capital is a key issue. Groups already move capital between legal entities, so, to a degree, that currently exists. The key is to set appropriate regulatory requirements to determine whether capital is truly fungible, especially between legal entities in different member states. Of course, surplus funds cannot be used to provide group support—we would not concede on that important point. For example, one cannot move assets backing a with-profits policy around the group. I hope that that will allay any remaining concerns.
Unless there are further interventions, I believe that I have answered all the points that have been raised. I am grateful for this opportunity to put on record the Government’s position on the directive.
Question put and agreed to.
That this Committee takes note of EU Document No. 6996/08 relating to Financial Services, amended draft directive on the taking up and pursuit of the business of Insurance and Reinsurance: Solvency II (recast).
Committee rose at twenty-three minutes past Five o’clock.
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