House of Commons - Regulatory Reform

Select Committee on Regulatory Reform Sixth Report

4 What the draft Order proposes

11. The background to and detailed reasoning for the proposed reforms are set out in paragraphs 2.13 to 2.19 of the ED, and this report does not rehearse the reasoning behind the reforms where to do so would merely reiterate the facts and arguments already set out at length in that document. The eight proposed reforms are:

i. Relaxing the rules on appointments of the Chairman and Deputy Chairman of the Council

ii. Relaxing the rules on elections to the Council

iii. Removing the requirement for the Governor of the Bank of England to approve the Council's nominated members

iv. Abolishing the Committee

v. Reforming the rules on delegation by the Council

vi. Relaxing the rules on disciplinary committees

vii. Removing the restriction that access to the Lloyd's market must involve a Lloyd's broker

viii. Repealing the provisions that required divestment of interests between brokers and managing agents.

12. The reforms were proposed by Lloyd's itself and are designed to improve governance and competitiveness. Additionally, there is a wish to overcome deficiencies in the current mechanism for safeguarding against conflicts of interest; namely, the divestment provisions in the 1982 Act which forced the divestment of managing agents from brokers and thereafter their continued separation. That mechanism can be circumvented by complex ownership arrangements which are able to mask common ownership.

Consultation and EGM

13. Consultation on the proposals took place between 7 March and 30 May 2008. The consultation can be found at:

www.hm-treasury.gov.uk/consultations_and_legislation/lloydsact/consult_lloyds_act.cfm.

All Lloyd's members were contacted, together with 258 other individuals and organisations including all Lloyd's brokers and managing agents.[15] There were 69 responses. The ED contains a table summarising the consultation responses, which is reproduced here.

Proposal Number of Responses For Unsure Against

1 Relax rules on appointments of
Chairman/Deputy Chairmen of Council
41 93% 2% 5%

2 Relax rules on elections to Council 44 89% 4% 7%

3 Remove the requirement for Governor
of the Bank of England to approve
Council's nominated members
41 98% - 2%

4 Remove the Committee 41 95% - 5%

5 Reform delegation rules 43 95% - 5%

6 Relax rules on disciplinary committees 41 95% - 5%

7 Remove restriction on market access
concerning Lloyd's brokers
48 79% 4% 17%

8 Repeal the divestment provision 45 89% 2% 9%

14. It is also noteworthy that, at an extraordinary general meeting of Lloyd's members on 21 May 2008, the then draft LRO[16] was approved on the basis of 99.14% of the capacity-weighted membership.[17] The turnout was 51.77%.

15. The ED explains that the proposed market reforms attracted most comment, although the first two proposed governance reforms also caused considerable reaction. Twelve respondents raised objections to the proposals. Six of those objections concerned proposal 7 only. It is noteworthy that only proposal 7 attracted opposition from more than 10% of the respondents, and that the other reforms attracted nearly 90% support or greater. Three respondents objected that the LRO would be an inappropriate use of the powers under the LRRA because the LRO would make significant amendments to a local Act that was introduced into Parliament following extensive consultation with Lloyd's members and after full discussion in Parliament.

16. In light of the above, we believe that the proposals have been the subject of adequate consultation. For the reasons stated hereafter, we further believe that the proposals have taken proper account of the consultation. We therefore believe that proceeding by means of an LRO is appropriate in this instance. Amendment of local Acts is expressly contemplated by section 1 of the LRRA. Parliament can revisit the position in due course by way of further debate, order or statute, should it be necessary.

The Proposals

PROPOSAL 1: RELAX THE SECTION 4 1982 ACT REQUIREMENT FOR THE CHAIRMAN AND DEPUTY CHAIRMEN TO BE ELECTED FROM THE WORKING MEMBERS ON THE COUNCIL

17. The ED explains that the original justification for this requirement seems to have been the view that "experience of working in the Lloyd's market was essential for effective leadership at Lloyd's."[18] However, the introduction of corporate capital in 1994 and the phasing out of individual membership since 2003 mean that the pool of working members is shrinking (from 4,209 in 1982 to 956 in 2008, of whom 553 were non-underwriting members.) It is correct that modern corporate governance views external experience as being valuable, and it is clearly important that a body with the profile of Lloyd's should be able to employ leadership of high calibre. We agree that there should be the capacity to recruit the Chairman and Deputy Chairmen from a broader pool of candidates than is currently permitted without the need for outside candidates to spend time as working members in order to qualify (as has already happened) and concur with the view that the current situation constitutes an administrative burden.

18. In order to ensure that there remains a broad basis of support for a proposed Chairman or Deputy Chairmen, the draft LRO provides that their election should henceforth take place by special resolution.[19] It further provides that, if the Chairman is not a working member, at least one Deputy Chairman must be a working member. We believe that those provisions provide adequate safeguards, and therefore agree that the proposal meets the requirements of the LRRA relating to fair balance, necessary protections and preservation of rights.

PROPOSAL 2: REMOVE THE TERM OF OFFICE RESTRICTIONS ON ELECTIONS TO THE COUNCIL

19. As explained in paragraph 8 above, working members on the Council other than the Chairman and Deputy Chairmen cannot currently serve consecutive terms. The 1982 Act is silent on service of consecutive terms by external and nominated members, so the position in relation to them is governed by the byelaws, which state that external members can be re-elected for a further three-year term after an initial such term. Thereafter, there must be a gap of a year. Nominated members can remain on the Council indefinitely, subject to re-election. Records of the working members who have served on the Council show that many have been re-elected onto the Council as soon as their one-year break was completed. It seems to us that the need to deal with such re-appointments creates an administrative burden without providing an adequate safeguard against excessive tenure of office.

20. The proposal would remove the current statutory restriction and allow Lloyd's to determine its own rules on terms of office in accordance with good governance practice including as set out in the Combined Code on Corporate Governance.[20] Lloyd's has confirmed that it will establish relevant byelaws, including for a maximum period of office of nine years for all Council members other than the CEO.[21] In light of that, we agree that the proposal is an improvement on the existing position and meets the requirements of the LRRA already mentioned in relation to Proposal 1.

PROPOSAL 3: REMOVE THE REQUIREMENT FOR APPROVAL OF NOMINATED MEMBERS OF THE COUNCIL FROM THE GOVERNOR OF THE BANK OF ENGLAND

21. This requirement of the 1982 Act predates the supervision of Lloyd's by the Financial Services Authority (FSA). The FSA now has an obligation to approve all Council Members, and the Bank of England supports removal of the requirement. Given the requirement for the FSA to approve nominated members, and the support of the Bank of England for a revised procedure, it seems to us that the proposal would remove a burden and would meet the criteria of the LRRA mentioned above in relation to Proposal 1.

PROPOSAL 4: REMOVE THE PROVISIONS ESTABLISHING THE COMMITTEE OF LLOYD'S

22. As explained in paragraphs 4.48 and 4.49 of the ED, the Committee (which under the 1982 Act can consist only of working members) has to all intents and purposes become redundant, with the executive functions of the Council being now exercised largely by way of other bodies—notably the Franchise Board, which unlike the Committee can take advantage of external expertise and on which the representation of working members could always be boosted if that were felt appropriate. We agree that a statutory requirement to continue the existence of a body that has been superseded creates a burden. It seems to us that this proposal removes that burden and meets the requirements of the LRRA mentioned in relation to Proposal 1.

PROPOSAL 5: REFORM THE DELEGATION RULES

23. Section 6(5) of the 1982 Act currently restricts the extent to which the Council can delegate certain of its powers such that delegation other than to the Chairman, the Deputy Chairmen and the Committee is not permitted. The redundant nature of the Committee makes this provision something of an anachronism, and the restrictions on delegation powers make it necessary to rely unduly on the agency powers in section 6(7),[22] which has been a cause of litigation owing to the uncertain nature of agency powers. Consequently, there is a desire to extend the scope for delegation along the same broad lines as are permitted in relation to companies by the Department for Business, Enterprise and Regulatory Reform's recommended model company articles—subject always to maintaining the provision in the 1982 Act that requires delegation to be approved by Council special resolution, and maintaining the current position in relation to the Council's reserved powers.[23] It seems to us that this proposal would reduce burdens by reducing the scope for ambiguities in relation to delegation arrangements and by making the delegation powers less restrictive. Subject to the continued requirement for delegation to be approved by special resolution of the Council, we consider that the proposal meets the relevant requirements of the LRRA.

PROPOSAL 6: RELAX THE RULES ON MEMBERSHIP OF THE DISCIPLINARY COMMITTEE

24. Section 7(1) of the 1982 Act currently requires the majority of members of a disciplinary committee to be members of Lloyd's, with the objective of ensuring an appropriate level of knowledge of the market and an element of peer review. However, following the introduction of corporate membership, the current arrangements fail to address the situation of directors of Lloyd's corporate members—who are subject to the disciplinary procedures, but who generally are not themselves members of Lloyd's. It appears that there have also been practical difficulties in finding the requisite number of members to sit on disciplinary committees. The proposal would remove the current restriction and replace it with a requirement that the disciplinary tribunal consist of at least one working member, corporate member director, FSA-approved underwriting agent employee or FSA-approved Lloyd's broker employee, or someone who has retired from one of those occupations.

25. Whilst we agree that the current requirements appear to operate as a burden, the nature of this proposal makes it important to consider whether a necessary protection or important rights and freedoms would be affected. In consultation, 41 respondents commented on the proposal, of whom 39 were in favour and two objected. The main objection was from a member who preferred the existing arrangements on the basis of the importance of continued judgment by peers. Another respondent questioned whether a narrower list of peer members would be preferable, with greater scope for two working members to sit on the panel.

26. In light of the protection afforded by the proposed replacement provisions, and given the support in consultation, we conclude that the proposal meets the requirements of the LRRA, although we recommend that there be a review of the revised rule on membership of a disciplinary committee in due course.

PROPOSAL 7: REMOVE THE RESTRICTION THAT REQUIRES LLOYD'S MANAGING AGENTS GENERALLY TO ACCEPT AND PLACE BUSINESS ONLY FROM OR THROUGH A LLOYD'S BROKER

27. Under the 1982 Act, Lloyd's brokers are defined as partnerships or bodies corporate permitted by the Council to broke insurance business at Lloyd's. The Act currently permits underwriters to accept or place business only from or through such Lloyd's brokers or such other persons as the Council may by byelaw permit.[24]

28. In practice, the Council already uses the byelaw exemption to permit business to be channelled through other routes, such as (for commercial life and commercial motor insurance) through brokers regulated by the FSA or which have a guarantee from a Lloyd's broker, so the restriction is not absolute. The ED gives the following principal further reasons for the proposal. First, the restriction is unique to Lloyd's and therefore is not faced by Lloyd's competitor insurance markets, with the result that Lloyd's is placed at a competitive disadvantage. Having a freer and more extensive range of brokers would, it is argued, allow greater scope for pursuing new business. Secondly, the Insurance Mediation Directive ("IMD")[25] now subjects all EU insurance brokers to regulation by their home regulator—the FSA in the case of the UK. Although Lloyd's has streamlined its process for registering brokers in light of the IMD, the 1982 Act restriction perpetuates the need for full registration, which imposes an administrative burden.

29. The proposal is that the value added by specialist Lloyd's brokers should be recognised through continuation of the designation "Lloyd's broker", and that Lloyd's should have express power to regulate on standards for intermediation with the Lloyd's market by brokers other than Lloyd's brokers, thereby maintaining standards across the whole range of brokers who deal with Lloyd's. Subject to consultation on appropriate byelaws, all such brokers will be required to show, inter alia, that they are properly regulated under the IMD or equivalent standards outside of the EU and have adequate professional indemnity insurance.

30. In consultation, eight out of 48 respondents objected to the proposal, and a further two expressed reservations. Initial objections from Lloyd's brokers were founded on concerns about potentially lower standards applying to their competitors. Following those objections, Lloyd's confirmed its intention to require the application of the same standards to all brokers across the board. as a result of which the body representing Lloyd's brokers, the London Market Insurance Brokers Committee, withdrew its objections, although some individual objections remained. These are spelled out in paragraphs 5.37 to 5.46 of the ED. In particular, there were concerns that the estimates of cost savings contained in the initial impact assessment did not withstand scrutiny. As a result, the impact assessment was changed, and no longer attempts to quantify such savings. We pursued this point in our correspondence with the Treasury,[26] whose response was based on qualitative arguments derived from general theory of competition as well as, perhaps more importantly, feedback from discussion with brokers.

31. It seems clear that the proposal could affect the interests of current designated Lloyd's brokers by subjecting them to greater competition. However, we do not believe that a monopoly right (particularly one that, in any case, is already limited) is a right or freedom that can reasonably be expected to exist in perpetuity. Our view is that, notwithstanding the lack of agreed quantified benefits, the opening of the market to greater competition is broadly to be welcomed as being in the public interest and in the interest of development of that market, that the proposal strikes a fair balance with those potentially adversely affected and that it would remove a burden. We agree that it would be inappropriate to use the existing byelaw exemption to neutralise the restriction in the 1982 Act entirely, and we therefore agree that a change in legislation seems necessary to effect the reform. We note that the effects of the LRO will all be reviewed after five years.[27] Given those considerations, we agree that the proposal is appropriate.

PROPOSAL 8: REPEAL THE "DIVESTMENT" PROVISIONS

32. The divestment provisions were the most extensively debated provisions of the 1982 Act, and evidence and submissions on them took up considerable time at the Committee stage of the 1982 Bill. They required Lloyd's brokers and managing agents to divest their interests in each other with the aim of preventing conflicts of interests. Such conflicts include those arising from situations such as brokers placing business with a managing agent who is preferred over another not on the basis of advantage to the policyholder but because of a connection with the broker. They also include conflicts arising from a managing agent placing business with a capital provider for reasons of association with a broker rather than in the fair interests of that capital provider.

33. The provisions are now believed to be obsolete for two principal reasons. First, they are structure-based rather than effects-based and do not prohibit all associations, which means that they are vulnerable to circumvention and complex to administer. Secondly, since 1982 the FSA has promulgated conflicts of interest principles with full and specific applicability to Lloyd's.

34. The proposal would therefore remove the divestment provisions, but add a requirement of additional disclosure upon managing agents. Managing agents will be required by a combination of byelaws and amendments to Accounting Regulations[28] to set out, in syndicate business plans, the parameters under which they will conduct business with associated brokers, to identify any associations with brokers, and to report regularly both to Lloyd's and to syndicate members the proportion of business with associated brokers.

35. In consultation, 40 respondents were in favour, one expressed reservations, and four were against. We note the objections that were made to the adequacy of FSA control, but we note also the inadequacy of the current regulatory provisions and the proposal for additional disclosure. As noted in paragraph 32, it is correct that the divestment provisions were the subject of extensive debate at the time of the 1982 Act. However, they are clearly no longer an ideal solution. The proposed regime has attracted a large majority of support and would appear to have substantial merit, and the impact assessment notes that the effectiveness of the new disclosure mechanism will be the subject of continuing review by the FSA, as well as being re-examined at the time of the five-year review of the LRO. We suggest that the FSA set a date for an active review of the effectiveness of the new measures after an appropriate period of implementation.

36. We agree that the proposal removes a burden and, given the additional regulatory supervision that will be put in place to require disclosure alongside existing safeguards, we believe that the proposal meets the LRRA requirements in relation to necessary protections, rights and freedoms, although in the light of concerns about financial regulatory matters we strongly recommend an early review of the effectiveness of the new regime.

OTHER PROPOSALS

37. There were several additional proposals for other reform from consultation respondents and by way of other submissions, including a proposal to remove Lloyd's immunity from liability in damages under section 14 of the 1982 Act. While acknowledging that these additional proposals might merit further consideration, we do not believe that they need hinder progress of this particular draft Order.

15 Managing agents are the administrators of Lloyd's syndicates Back

16 The principal difference between the draft LRO that was circulated on consultation and the LRO as laid is that the former envisaged a statutory nine-year cap on the Chairman's term of office; but see paragraph 20 Back

17 That is, capital capacity Back

18 ED paragraph 4.4 Back

19 See footnote 8 Back

20 http://www.frc.org.uk/CORPORATE/COMBINEDCODE.CFM Back

21 See ED paragraph 4.36 Back

22 Section 6(7) confirms the power of the Council and the Committee to act by persons, committees, sub-committees and other bodies whose members may include persons who are not members of Lloyd's, and through employees, but this is an agency power rather than a delegation power. Back

23 See section 6(5) and the subsections to which that refers Back

24 See section 8(3) of the 1982 Act Back