22 February 2022

FT: Why post-Brexit race in financial regulation is a bad strategy

There is only one sort of race in the regulation of financial services: to the bottom.

That’s worth remembering in the UK’s sudden hurry to overhaul European financial rules as part of a broader push to show the benefits of the glorious freedom gained by leaving the EU. No sooner had newly-anointed minister for Brexit opportunities, Jacob Rees-Mogg, expressed concern about the slow progress in producing changes to the Solvency II rules for insurance companies, than there came a promise of “slashing of red tape” from the Treasury.

The insurance framework was “ripe for reform”, to use Rees-Mogg’s words, as evidenced by the fact that Europe is also changing the rules. And it is more restrictive than in some markets such as Australia. But the implication that it is important that Britain go further and faster than its nearest neighbours is a concern. For a start, the hurry for change glosses over the complexities of what is, after all, insurance regulation. There were two big areas for reform.

Everyone broadly agreed that the risk margin, effectively an extra capital buffer, has been too volatile and too high in a low-interest rate environment. A promised cut of 60-70 per cent looks close to the industry’s hopes. The more contentious area (and more significant in the UK annuity market) is the matching adjustment, which allows writers of long-term business to match predictable investment cash flows against their liabilities.

The resulting capital benefit is huge: at the end of 2020, it meant an improvement to the sector’s solvency position of £81bn against a total capital requirement of £116bn, according to the Bank of England. There seems to be more flexibility on offer to enable a wider range of long-term investments, in politically-appealing areas like infrastructure or green energy, to qualify for the matching adjustment. But the regulator had raised concerns that the calculation of what risk should be retained by insurers, or the fundamental spread, was incorrect in Solvency II.

That was a view for which the industry says it has seen no evidence. Ultimately, the sector will want to be assured that overall the UK reforms, like those in Europe, will release capital and if so, how much. Shrouded in the insurance wonkery here is a pretty typical tension over capital requirements. Experts may be out of favour in post-Brexit Britain. But let’s agree they remain useful in the world of insurance regulation and that this was a debate worth having given the implications for policyholder protection.

So why the rush? Europe published its proposals last year. But a few months at this stage makes little difference except in the fevered minds of politicians seeking a Brexit dividend....

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