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TRANSCRIPT
November 2013
RISK MATTERSHighlighting topical issues for insurance sector participantsCMS Cameron McKenna Insurance Sector Group
CMS_LawTax_Negative_28-100.eps
Contents
3 Introduction Stephen Netherway, Head of CMS UK Insurance Sector, introduces this edition of ‘Risk Matters’
4 The FCA’s thematic review into insurance brokers’ conflicts of interest Guest feature from Christopher Galyer, Jardine Lloyd Thompson Group Plc
6 Pan-European Product Development
8 Internal pricing of reinsurance It is big and it is clever
10 How smart are EU sanctions rules? How insurers are learning to deal with an ever stricter regime
12 Third party litigation funding What’s the deal for funded Claimant parties? Is it a new litigation driver?
14 To IPO or not to IPO Are the public markets open to the insurance sector?
16 Pension transfer exercises Enhanced value or hidden risk?
18 Employment law update Let’s talk about collective consultation
20 Solvency II update Progress at last and a firm date?
CMS named as ‘Best Firm for Corporate Advice in Europe’ 2013CMS was named ‘best firm for corporate advice in Europe’ in the recent Reactions’ Insurance and Reinsurance Legal Survey 2013.
CMS was named the ‘go-to’ firm for companies seeking corporate advice in Europe. Reactions noted that CMS’ knowledge of the European market allows it to “stand out as a specialist partner for insurers and reinsurers looking to gain further insight into legal issues that affect the UK and the EU,” with clients praising CMS’ knowledge of the “way the industry works” and ability to “help [the client] to shortcut decision-making.”
2 | Risk Matters: November 2013
Introduction
Stephen Netherway
Partner
Head of CMS UK Insurance
Sector Group
T +44 (0)20 7367 3015
Ed Foss
Partner
Head of Insurance and
Reinsurance Group
T +44 (0)20 7367 2313
Welcome to the Autumn 2013 edition of Risk Matters; your guide to the latest themes and issues affecting domestic and international insurance markets.
In any dynamic industry, pinpointing trends of enduring significance can be like reading station signs from a high speed train. Nevertheless, our authors have craned their necks with sufficient suppleness to earmark several essential topics.
Our guest feature follows matters of domestic regulation, with Christopher Galyer, Head of Legal at broker Jardine Lloyd Thompson Group Plc. Christopher provides a unique perspective on the Financial Conduct Authority’s thematic review into insurance brokers’ conflicts of interest.
Meanwhile, Tim Ingham’s detailed look at the practical challenges for insurers around pan-European product development delivers the latest guidance on how to bring standardisation into your continental portfolio.
Consultant Nick Foster-Taylor switches attention to the captive markets around the globe for whom the spectre of a probe by some tax authorities into internal pricing of reinsurance looms large.
Also scaling the controversial issues of today are Partner Caroline Hobson and Senior Associate John Markham. Both have been heavily involved with matters in relation to sanctions recently and with pressure on corporates and their insurers from the long arm of US legislation, John and Caroline explain that companies would be wrong to discount the European Union’s rules as having no bite. With these rules restricting the ability for insurers to do business in certain jurisdictions, this article provides a few helpful tips on how to spot sanctions issues before they arise.
Returning to UK-specific issues, since the implementation of Lord Justice Jackson’s civil justice reforms litigation funding has been at the top of the agenda. Here, we reveal the outcome of the recent CMS CMCK case of Harcus Sinclair v Buttonwood Legal Capital, and consider its implications for funded parties and those who may have harboured suspicions that litigation funding would prompt an increase in speculative claims.
We also have a range of articles focusing on corporate matters covering pension concerns and whether conditions are right for an IPO . First, CMS Partner Helen Johnson explains the choices available to insurance companies and brokers looking to take their business public; next, Associate Alaina Wadsworth looks into the increasingly controversial topic of pensions transfer exercises.
Few can have failed to notice further delay in confirmation of Solvency II’s implementation. Needless to say the news failed to surprise, however CMS CMCK Partner Mike Munro extracts some important elements on which to focus; notably potentially good news on the approach to long term guarantee products.
And finally, with merger and acquisition activity gathering pace across the insurance sector, employment specialist Sarah Ozanne looks at the recent government consultation on transferring employees under “TUPE” regulations.
We hope you find this edition of Risk Matters a helpful compendium of pertinent issues and welcome any feedback you would care to give.
CMS recently named a ‘Top 20 Global Elite Law Firm Brand’ in Acritas’ Sharplegal 2013 Global Elite Brand Index.
The index is based on feedback from the world’s biggest companies ranking the world’s top law firms.
3
The FCA’s thematic review into insurance brokers’ conflicts of interest
Earlier this year, as part of its ever increasing focus on the insurance market, the Financial Conduct Authority (FCA) announced a thematic review into how general insurance brokers handle potential conflicts of interest.
The thematic review will be looking into whether insurer/broker relationships lead, or could lead, to the broker improperly performing its duties or taking steps contrary to the insured’s interests.
It is not for the first time that the financial regulator has decided to shine a light on the relationships that brokers have with insurers. Although the Financial Services Authority’s 2008 statement on “transparency, disclosure and conflicts of interest in the commercial insurance market” led to formal industry guidance in March 2009 and investigations concluded that, despite there being numerous potential conflicts, the market works and, generally speaking, brokers are not taking advantage of them, the FCA has, quite properly, now decided to revisit the issue.
While the conclusions of the FCA’s current thematic review have yet to be reached, providing brokers have properly established and implemented conflict procedures, there should not be any immediate need to be overly concerned. Indeed, at least in part, there is a sense that the FCA is seeking to understand more about how the insurance market works. It is more complicated than the broker simply offering a placement and claims service to the client. The workings of the market depend on there being an inter-
relationship between brokers, insurers and clients. That relationship needs to be open and properly understood by all three parties and, of course, the regulator.
The broker offering has diversified from pure ‘vanilla’ insurance broking into a broader business model under which brokers are moving into product design, administration, market analysis and underwriting to maximise revenues in an ever pressured financial environment. It is precisely this diversification that the FCA intends to look at in its thematic review. Indeed, Simon Green, Head of General Insurance and Protection at the FCA, has advised that the review will focus specifically on profit-share arrangements and volume-based commissions. As well as looking into payment flows, the FCA will also be reviewing claims handling and management.
Initially, the spotlight of the thematic review will be on insurance relating to small and medium sized enterprises and micro businesses, but thematic reviews can expand and develop over time and the outcomes of the review are likely to be relevant to all insurance brokers. It would be unwise of a broker to assume that the thematic review does not, and cannot, apply to them.
In particular, senior management should ensure that they set the tone from the top and that the strategy aligns with good customer outcomes. In doing so, they should bear in mind that the thematic review is focussing on a forward looking approach with regulation based on sound judgement rather than box ticking. Further, the FCA will be looking at whether the culture is right, not just whether there are suitable structures in place.
Christopher Galyer,Head of Legal, Jardine Lloyd Thompson Group Plc
4 | Risk Matters: November 2013
The key will be how well the FCA judges that brokers, from senior management all the way down, recognise and manage the conflicts that they face. Where the FCA judges that brokers have failed to do so, they can expect fines, the requirement to change their processes and controls and, following recent FCA proposals to name firms under investigation, potential naming and shaming. Those brokers that have carefully considered the issues, monitored them and handled them appropriately should not find themselves in that position. Indeed, such brokers will share the regulator’s desire to preserve and maintain the integrity of the insurance market, which is central to the City and the economy as a whole.
For now at least, it seems that the FCA’s spotlight will be well and truly focused on insurance brokers. The findings of the review are currently expected to be published in the last quarter of 2013.
‘ Initially, the spotlight of the thematic review will be on insurance relating to small and medium sized enterprises and micro businesses, but thematic reviews can expand and develop over time and the outcomes of the review are likely to be relevant to all insurance brokers.
‘
5
Pan-European product development
Tim Ingham
Partner
T +44 (0)20 7367 2990
With many insurers seeking to capitalise on their European presence by developing standardised products, challenges can arise in adapting them between jurisdictions; one size does not easily fit all.
In our experience, the issues tend to be more numerous when taking a policy developed in London for use in the continental European markets. For instance, simply undertaking a direct translation of the policy wording is not the solution; the legal concepts and styles of product and regulatory requirements mean that this is simply not a viable option. That said, using a translation can help identify underwriting intent; but it should be just that, a guide to what was intended rather than a suitable policy wording in another jurisdiction.
For example, in Germany, the structure of insurance products is totally different from that of the UK and a policy developed in London will often require a complete redraft for use in the German market. Likewise, in Italy, additional documents are required to comply with Italian regulation. For example, insurance companies need to prepare an information dossier that must contain certain information (which varies by policy type) and needs to be provided to the policyholder. Such documents will need to be produced.
Indeed, as some legal concepts are entirely different. Certain provisions of a policy that work in one jurisdiction do not in others. For example, in many civil law jurisdictions, the concept of subrogation is simply not recognised; a standard subrogation clause will be of no value as the concept may be meaningless under local law. Instead, those jurisdictions have the concept of an assignment of rights. This can lead to various complications on recovery actions, where insurers seek to recover sums paid out by claiming in their own name (having taken an assignment of rights) but where the insured has their own uninsured losses. In addition, the priority on recovery can be different to the English law position.
Similarly, the legal position on misrepresentation/non-disclosure, warranties, conditions precedent and simple conditions can be very different. In many parts of continental Europe, the concepts of warranties and conditions precedent are simply not recognised. Instead, it is all about contractual terms that need to specify the consequences of breach, without which there is no sanction. Likewise the tests for, and consequences of misrepresentation and non-disclosure can be very different to English law concepts, leaving insurers having to pay claims. In some jurisdictions, the questions on the proposal form produced by insurers can even limit the information that the proposed insured has to disclose. These issues need to be factored into policy drafting.
6 | Risk Matters: November 2013
These are not the only issues that can arise where insurers need to think carefully about how the differences in legal and regulatory structures impact on the development of products across the European region. Awareness of these differences and issues, combined with a structured approach to product development, can help enormously in ensuring the successful roll-out of a standardised product across Europe.
CMS can assist in ensuring a smooth roll-out of pan-European products through our sector approach across offices in Europe (and beyond). We are experienced in drafting and advising on such multi-jurisdictional products and we can assist insurers operating on a multi-jurisdictional basis. For further reading, see our publications ‘10 things every insurer should know’ and ‘Insurance defence’.
‘ Awareness of these differences and issues, combined with a structured approach to product development, can help enormously in ensuring the successful roll-out of a standardised product across Europe.
‘
7
Internal pricing of reinsuranceIt is big and it is clever
Nick Foster-Taylor
Consultant
T +44 (0)20 7367 2123
Financial institutions are currently under intense scrutiny regarding perceived shifting of profits to low-tax jurisdictions, and nowhere is this more apparent than for captive insurance companies.
Cross-border transactions which have long been a fundamental component of tax-efficient operational structures are in the spotlight, although tax authorities frequently struggle to understand the highly complicated process of attributing actuarial and commercial values to internal reinsurance contracts; key elements to the transfer pricing process of determining internal prices between group companies.
Despite the complexities, the sheer volume of cash flow under internal treaties and the potential for tax grab via relatively minor adjustments means that we are seeing a significant increase in aggressive tax audits.
Recent government and public outrage over what are branded ‘immorally’ low payments of corporation tax by multinationals is having a considerable effect on how groups structure and price their internal business relationships.
The ‘Action Plan on Base Erosion and Profit Shifting’ report (BEPS), published by the OECD in July 2013, now comes with unequivocal G20 endorsement, and a 15 point shopping list which promises to address concerns
over the transparency of global tax arrangements, with recommendations for a coordinated multilateral approach to international taxation standards arriving by the end of 2015.
The position is exacerbated with increasing adoption of tax ‘blacklists’ by various jurisdictions, most recently France, where transactions with ‘non-cooperative’ jurisdictions are subject to potentially onerous controls in transfer pricing and withholding tax, combined with severe penalties for non-compliance. Of particular note here is that these ‘tax-haven’ lists often include Bermuda, Jersey and the British Virgin Islands, traditional long-term homes for the insurance industry.
So what of captive insurers. There was concern in industry circles when the first iteration of the BEPS analysis, issued in early 2013, specifically held up captive insurance activity as a ‘key pressure area’ in relation to tax avoidance, lumping internal reinsurance contracts with aggressive tax-driven hybrid financial and debt instruments. However the concept of ‘artificiality’ is the crux here: location of business activity is key to profit allocation, and the primary issue addressed in the BEPS analysis is preventing the shift of profits to legal entities in locations where in reality there is little or no material business activity. Given both the tangible substance of insurance captives and the proactive commercial role that they play both for related parties and in the wider market as a whole, to consider that captive reinsurance
8 | Risk Matters: November 2013
transactions involving, say, Bermuda represent prima facie tax avoidance structures is simply not realistic.
What is clear from the ongoing BEPS work is that related party financial transactions will inevitably come under the microscope, and the quantum of business carried out by captives is making them an obvious target for transfer pricing audits. It is also apparent that the technical approach needed to price internal reinsurance treaties is far from simple, and this is all the more important given the generally widespread application of standardised internal treaties used across multiple jurisdictions.
Simply lifting terms, conditions and pricing from external 3rd party reinsurance contracts and applying these verbatim for internal purposes will no longer suffice: in practice the variations in relative financial standings of the counterparties to a reinsurance transaction mean that traditional transfer pricing methods such as testing quota shares and commissions against an apparently identical 3rd party comparable uncontrolled price are often inappropriate. Now more than ever insurers need to review and if necessary change the terms and conditions of internal treaties to meet current transfer pricing standards before the almost inevitable knock of the tax inspector.
‘ Recent government and public outrage over what are branded ‘immorally’ low payments of corporation tax by multinationals is having a considerable effect on how groups structure and price their internal business relationships.
‘
9
How smart are EU sanctions rules?How insurers are learning to deal with an ever stricter regime
Caroline Hobson
Partner
T +44 (0)20 7367 2056
John Markham
Senior Associate
T +44 (0)20 7367 3109
Rules imposing sanctions in relation to trade with named countries usually originate in a common political agenda, reflected in UN Security Council Resolutions and implemented separately by the US, the EU and other states globally.
Despite the shared origin, the detail of the rules vary between regimes, with US rules generally perceived to be more robust than most. The reinsurance industry can testify to this, given the series of letters issued by the New York Department of Financial Services in June and July this year to global reinsurers, claiming the industry had traded illegally with Iran when writing business in New York and claiming jurisdiction whatever the domicile of the alleged infringer.
The scope of the EU rulesHowever, it is wrong to discount the EU rules, which are enforced in practice at the national level, as having no bite. EU legislation is catching up and many aspects of the current EU regime are a significant challenge for the insurance (and reinsurance) industry.
The basis of a typical EU sanctions regime is an asset freeze where funds and economic resources of designated individuals or institutions are frozen. In
addition, the provision of funds or economic resources directly or indirectly to, or for the benefit of, the designated parties is prohibited. Similarly to the US approach, EU regimes cast the net wide in terms of jurisdictional reach:
— any act anywhere in the world by an EU national may be caught;
— any act in the territory of the EU, its airspace or its waters may be caught; and
— any act anywhere in the world by an EU national any act which facilitates the contravention by others of these rules is itself a breach under the UK rules.
These rules could easily restrict insurance business. Any provision of insurance, reinsurance or broker services to any designated party is prohibited, whatever the nature of the underlying product or activity. In addition, the provision of insurance to a party itself in breach of the rules may count as “facilitation” of a breach under the UK rules (and under similar rules in other states).
How to spot sanctions issues in insurance businessUntil recent years, it was not anticipated that authorities would take action against the insurance industry. The expectation was instead that they would focus enforcement action against companies directly trading with a prohibited state. This has changed, as insurance
10 | Risk Matters: November 2013
companies have woken up to their potential exposure due to the identity or business of their customers and due to a widely held belief that targeting insurance may be an effective enforcement tool for the authorities, since all import business needs insurance.
Insurers have begun to implement a range of essential compliance management procedures:
— Appropriate termination clauses in insurance contracts, e.g. triggered on discovery of a link to a prohibited regime or activity.
— Due diligence on insureds and other customers, including more and more sophisticated screening processes to identify any link to inappropriate activity.
— Training and internal guidance notes.
— Engaging with government departments where the reality of an arguable breach is not clear (the finer points of the rules can be surprisingly ambiguous).
Governments often claim that sanctions policy is “smart”, meaning that it is targeted at the key institutions of politically unfriendly regimes and that it allows other trade with those regimes to continue. At the same time, there is a common perception that the reach of sanctions is too broad, catching many institutions and forms of business in a scatter-gun fashion. In recent months, an Iranian bank has even won the first stage of an appeal in the European Courts to be struck off the list.
Sanctions may not therefore always be so smart. However, they are here to stay for now and the procedures highlighted here are an increasing part of essential legal compliance.
‘ Governments often claim that sanctions policy is “smart”, meaning that it is targeted at the key institutions of politically unfriendly regimes and that it allows other trade with those regimes to continue.
‘
11
Stephen Netherway
Partner
T +44 (0)20 7367 3015
Litigation Funding has become a lucrative market in England and Wales. Alongside the Jackson Reforms and the tightening of Legal Aid, litigation funders are at the forefront of options for those pursuing a claim in court.
While there is no specific statutory regulation governing litigation funding, the London-based Association of Litigation Funders, has seen its membership grow to fourteen since founded in November 2011.
Investors are keen on the UK market as the Courts in England and Wales move relatively quickly, are of good repute and appeals are only permitted on substantive points. Not only this but there is a considerable wealth of competent legal advisors matched with a number of businesses (specifically SMEs) who have significant claims but do not necessarily have the cash flow to fund them or are looking for alternative ways to fund such cases.
It is, however, a relatively new and growing way of funding claimants and the Courts have begun to be involved in reviewing that relationship.
In September, orders restricting publication of a judgment in a dispute between a funder and a funded party were lifted. This was a case in which this firm acted for the successful (funder) party. The case
focussed on the rights and obligations between the funder and funded party and the issue of whether, and in what circumstances the funder Buttonwood Legal Capital Limited (BLC) was entitled to terminate its funding of a commercial court action brought by the Third and Fourth Defendants (collectively AREF).
It was held that BLC was entitled to terminate its funding arrangements and that it had validly done so. This case itself concerned monies held in an escrow account as part of a litigation funding agreement (the Agreement) under which monies were loaned by BLC to AREF to pursue a claim against First Rand Bank in the Commercial Court. That litigation concerned a claim by AREF against First Rand Bank for their alleged withdrawal as a “cornerstone investor” in one of AREF’s investment projects.
The key question for the court was whether the Agreement had been validly terminated in January 2013 pursuant to a clause in the Agreement permitting unilateral termination where “in the reasonable opinion of the Lender the prospects of success are less than 60%”.
Further issues arose, if BLC were entitled to terminate the Agreement, as to BLC’s liability, if any, as funder, to pay fee requests made of it both before and after the termination, and also whether provision of a sum by way of security for costs in the First Rand proceedings was still a liability of BLC.
Nick Moore
Associate
T +44 (0)20 7367 3230
Third party litigation fundingWhat’s the deal for funded Claimant parties? Is it a new litigation driver?
12 | Risk Matters: November 2013
— A condition of funding under the Agreement was that the prospects of success of the underlying funded case continued to exceed 60%. Initially at the outset of funding in 2011 a short counsel’s opinion was submitted, described as a ‘preliminary view’ so as to ‘enable potential backers to decide whether to put up sufficient funds’. More formal advice was anticipated to be provided to the funders as the case progressed.
— In 2012, BLC repeatedly requested provision of an updated counsel’s merits advice in respect of the underlying proceedings. BLC did not receive what they had repeatedly requested and eventually, in November 2012, gave notice to AREF’s solicitors that they would seek their own independent counsel’s review of the prospects of success of the funded case.
— In the period November 2012 to January 2013, the counsel instructed by BLC received a number of papers and requests for further information that were relayed to AREF’s solicitors. Not all of these requests were responded to by AREF’s solicitors. A draft and then a final opinion were issued by BLC’s independent counsel, which stated, on the available evidence, the prospects of success were less than the minimum threshold allowed for in the Agreement.
— BLC considered the ongoing funding issue in light of this advice and ultimately decided to terminate the Agreement. That decision was communicated to AREF’s solicitors immediately afterwards on 8th January 2013.
It was argued by AREF that the opinion arrived at by BLC was not ‘reasonable’ as they had not had sight of all relevant materials. The judge held that whilst there may have been further information that could have been made available by AREF to BLC, and in spite of BLC’s requests for any and all materials to be made available to their counsel, this information was not disclosed in a timely manner, or at all. On that basis, it was held the opinion arrived at by BLC’s counsel, and BLC’s termination based upon that opinion, was reasonable. A claim that BLC was estopped from terminating the agreement was also dismissed.
Accordingly it was held that all relevant monies in the escrow account be returned to BLC and no further sums were due or payable at all to AREF.
This is the first reported case to consider termination of third party litigation funding agreements since the arrival of the new Jackson regime, which came into force on the 1st April 2013. This Judgment not only confirms that courts will enforce the terms of commercial third party funding agreements between the relevant parties, but also underscores that a funded party and their solicitors should be fully cogniscent, not only of their respective rights but also of their obligations under the funding agreement. Parties should understand and observe a funder’s right of continuing review and should work to keep a funder apprised of developments in the funded case.
One further topical issue for those who insure parties and are defendants to claims brought, is whether a new wave of litigation funding in the UK will promote an increase in litigation generally. In the UK, as most are aware, adverse cost consequences follow from failure to win court hearings. The absence or availability of litigation funding does not affect that position. Litigation funders are commercial people who wish to partner good claims; this case is a good reminder that litigation funding is a commercial business. If speculative claims are brought, claims will be dismissed and adverse cost consequences will follow- so in the UK at least there is no incentive to foster claims that may have no substantive merit. Third party funding may be a new source of funding that fills a void post the Jackson reforms but there is no reason to believe that it will, per se, generate an increase in litigation where there is no merits base for that litigation.
Stephen Netherway (Partner) and Nick Moore (Associate) acted for the successful funder, Buttonwood Legal Capital.
Further reading: [2013] EWHC 1193 (Ch)
‘ Governments often claim that sanctions policy is “smart”, meaning that it is targeted at the key institutions of politically unfriendly regimes and that it allows other trade with those regimes to continue.
‘13
Helen Johnson
Partner
T +44 (0)20 7367 3339
Initial Public Offerings are generating headlines once again. The recent announcements of the planned IPOs of Twitter and Royal Mail, following the $104 billion IPO of Facebook last year, indicate renewed appetite in the public markets – and this extends to the insurance sector, as shown by the IPOs of Esure and Partnership Assurance in March and June this year, and of Direct Line last October.
Secondary fundraisings, by companies already listed, also seem to be on the up. The Austrian insurer, Uniqa, announced in September that it plans to raise around €750 million, which will be the biggest deal on the Vienna Stock Exchange since 2011; and Lancashire Holdings announced a £131 million secondary fundraising to part-fund the acquisition of Cathedral Capital. With other established brokers and insurers reportedly considering going public in the next couple of years how difficult is it to pull off an IPO?
In a market showing signs that equity investors are returning, an IPO on either the Main Market of the London Stock Exchange or the Alternative Investment Market can enable liquidity in a company’s shares, and provide increased visibility for the company to raise capital and fund business growth.
Smaller insurers or brokers may initially look to AIM rather than the Main Market, as the admission criteriaare less stringent, making AIM suitable for a growing business that might find compliance with Main Market rules too demanding and expensive. Despite this suggestion many AIM-listed companies voluntarily match some of the corporate governance and other standards of the Main Market.
Movement from AIM onto the Main Market is also a distinct possibility, as exemplified by a business closely connected to the UK Insurance market. Outsourcing and technology provider Quindell Portfolio, has grown substantially from its contracts within the insurance industry to an extent that it now plans a full listing on the Main Market, having recently appointed non-executive directors to support this process.
The Main Market is more attractive to institutional investors and is more likely to achieve improved liquidity and visibility. Lancashire Holdings, which moved from AIM to the Main Market in 2009, stated, “The directors believe that a move to the Official List will improve the company’s profile in the insurance market and increase public awareness of Lancashire”.
IPO processThere are two levels of listing on the Main Market: premium and standard. Nearly all UK companies elect for premium listing; with notable companies such as Amlin, Aviva and JLT all having a premium listing.
Nick Kuria
Associate
T +44 (0)20 7367 2023
To IPO or not to IPOAre the public markets open to the insurance sector?
14 | Risk Matters: November 2013
In order to be eligible for admission to AIM a company must appoint a nominated adviser and, for the Main Market, a sponsor. In each case the adviser is responsible for assessing the company and deciding whether it is suitable for admission. The adviser will also advise and guide the company on its responsibilities under the AIM Rules/Listing Rules.
The eligibility criteria are simpler for AIM. If the company has not traded independently and been revenue-earning for the previous two years, the directors and substantial shareholders will be required to lock up their shares for two years. Whilst there is no “free-float” requirement, the company is unlikely to be admitted if less than 10% of the shares are in public hands.
It is more difficult to list on the Main Market as a company normally needs to have a three-year trading record and a minimum market capitalisation of £700,000. In addition, at least 25% of the shares need to be in public hands. The company will have to publish a prospectus, setting out prescribed information on the company, and submit it to the Financial Conduct Authority (acting as UK Listing Authority) for approval, which often extends the timetable. The prospectus will include financial information and details of material contracts.
In the case of AIM, depending on the amount of money being raised and the number of persons being offered shares, a prospectus might be required; but some applicants need only publish an admission document, for which the prescribed contents requirements are less comprehensive.
In each case the documents will need to be verified to make sure all the information is correct and not misleading. Following a pre-admission announcement, the securities are either admitted to trading on AIM, or an application is made to the UKLA for admission of the shares to the Official List and to the LSE for the securities to be traded on the Main Market.
Once admitted, the company becomes subject to continuing obligations prescribed by the Listing Rules and Disclosure and Transparency Rules for companies on
the Main Market, or by the AIM Rules for AIM companies. Main Market companies have more onerous continuing obligations than AIM companies, including the requirement to obtain shareholder consent for certain transactions. Shareholders in UK companies on AIM must comply with the same disclosure regime for holdings of 3% and above as applies to shareholders in Main Market companies.
Secondary fundraisingsOnce listed, companies on both markets have two main means of raising cash: a pre-emptive basis, being a rights issue or open offer, or a non pre-emptive basis, being a placing, vendor placing or a cash box placing. Rights issues and open offers are generally used for larger fundraisings and involve offers of new shares to existing shareholders pro rata to their shareholdings, and in the case of a rights issue they can trade any rights they do not take up. On the Main Market, a prospectus will be required.
In a placing, the company offers shares to a specific group of usually institutional investors, and can normally issue around 5% of the share capital at up to a 5% discount on a non-pre-emptive basis without having to obtain shareholder approval. A cash box placing (invariably of under 10%) avoids pre-emption rights by using an offshore Newco as a conduit. A vendor placing is also sometimes used when a company wishes to raise finance to fund an acquisition. The need for a prospectus (in the case of Main Market companies) can often be avoided.
How difficult are the markets for the insurance sector?While the insurance sector could attract investors looking for stable dividend income, it may struggle to attract investors who are looking for capital appreciation and growth. However, the UK insurance sector has had a strong start to the year and the market is expected to continue to thrive as low volatility and high yields attract investors. Taking all things into account, with so much activity in the public markets, if companies in the insurance sector are considering an IPO, now might not be a bad time to start preparing.
‘ The eligibility criteria are simpler for AIM. If the company has not traded independently and been revenue-earning for the previous two years, the directors and substantial shareholders will be required to lock up their shares for two years.
‘
15
Stephen Netherway
Partner
T +44 (0)20 7367 3015
With some estimates putting UK defined benefit (DB) pension schemes’ combined deficit at over £700 billion, enhanced transfer value exercises (ETVs) are an attractive risk-management tool for employers.
By incentivising DB scheme members to use their statutory right to transfer their pension rights from one scheme to another, employers have been able to reduce scheme liabilities, deficits and long-term risk. Members opting to take part in ETVs receive the enhancement to their transfer payment and can, in theory, benefit from greater flexibility and the removal of the risk of employer insolvency from their pension.
Since ETVs first appeared in 2005, tens of thousands of members have been offered the opportunity to take part (including 70,000 in 2011/12 alone). However, concerns have mounted about the fairness of ETVs and they have come under increased scrutiny.
Although employers have no power to compel members to accept an ETV, there is potential for them to exert undue influence particularly in cases where members may not have received proper advice about the transfer or where they have insufficient knowledge to act in their own best interests.
In many cases, particularly where employers have offered an immediate cash incentive to take part in an ETV (a practice that is now prohibited by the code of conduct – see below), members might not have realised the potentially significant difference in value between a ‘guaranteed’ DB pension and a defined contribution one funded by their transfer.
As yet, regulatory action on ETVs has been limited. Most notable has been the introduction of a voluntary code of conduct, agreed with contributors from across the industry. Although formally this code only has ‘moral’ weight, its voluntary status is deceptive. This is neatly illustrated by the amendment of the upcoming Pensions Bill 2013/14 to include a provision allowing the government to give the code of conduct statutory force without further primary legislation.
While government and regulators appear content with the current situation, their hands-off approach may not continue. The possibility that ETVs, like PPI insurance, might become subject to significant negative media attention cannot be discounted. This could lead to far more active intervention. Even though regulatory bodies (other than The Pensions Regulator) have not shown to date a great deal of interest in the issue and the government seems to view it as ‘solved’, increased media prominence could lead to a crackdown, perhaps by the FCA or possibly through direct government action. Coming hand in hand with this is the possibility of mass legal action on the part of transferees.
Alaina Wadsworth
Associate
T +44 (0)20 7367 2772
Pension transfer exercises Enhanced Value or Hidden Risk?
16 | Risk Matters: November 2013
Is this a real risk? Futurology is fraught with difficulty; however, there is clearly significant potential for members to be worse off as a result of taking part in ETVs, particularly if inaccurate assumptions are made about their potential investment returns.
Insurers and IFAs might have reason to be dubious of the prospects of success of any suit against them. No member is or has been obliged to transfer their benefits out of a DB scheme and, in fact, participants in ETVs by definition received more than the immediate cash equivalent of their share of scheme assets. However, with the benefit of hindsight it becomes much easier to criticise professional advisors and, in the face of serious reductions in the value of their pensions, transferees could see considerable value in pursuing insured professionals and consequently, deep-pocketed insurers.
‘ It is therefore questionable whether the IFAs could truly be independent. Instead, they might merely provide disgruntled former-members with an insured target for legal action.
‘
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Sarah Ozanne
Partner
T +44 (0)20 7367 2650
On 5 September the Government published its response to the consultation on changes to the Transfer of Employment (Protection of Employment) Regulations (TUPE), clearly indicating how TUPE will change.
Some of the proposed changes to TUPE, together with amendments introduced earlier in the year to the rules on collective redundancy consultation, reflect significant changes in the area of collective consultation which all employers should understand. In this article we take a look at the changes and assess how worried employers should be about getting it wrong.
Redundancy consultation changesThe requirement to collective consult in a redundancy situation is set out in section 188 of the Trade Union Labour Relations (Consolidation) Act 1992 (TULR(C)A). The obligation is triggered when an employer is proposing to dismiss as redundant 20 or more employees at one establishment within a 90-day period or less. It is important to remember that a redundancy for the purposes of TULR(C)A has a wider definition than the general definition under the Employment Rights Act 1996 (ERA). In ERA redundancy means a disappearing role, disappearing workplace or that the employer requires fewer employees to undertake work. By contrast redundancy under TULR(C)A is a dismissal
where the reason does not relate to the individual employee. It can therefore include changes to terms and conditions of employment through a process of dismissal and re-engagement.
TULR(C)A was amended as of 6th April this year so that where an employer is proposing to dismiss 100 or more employees at one establishment within a 90-day period or less the minimum consultation period has been reduced from 90 to 45 days before the first dismissal takes effect. Similarly the timeframe for lodging an HR1 form with the Secretary of State was also reduced from 90 to 45 days before the first dismissal takes effect. The consultation period, and timeframe for submission of the HR1 form, in circumstances where an employer is proposing to make more than 20 but less than 100 employees redundant remain unchanged at 30 days.
In addition to reducing the timeframe for consultation the Government has legislated on how fixed term employees should be treated for the purposes of calculating employee numbers for collective consultation purposes, an issue on which there has been some confusion amongst employers. The position is now clear that employees on fixed term contracts “which have reached their agreed termination point” are excluded for the purposes of calculating the number of dismissals for collective redundancy consultation purposes. However, employers should note that employees who are on fixed term contracts which have not reached
Employment update Let’s talk about collective consultation
18 | Risk Matters: November 2013
their natural termination but who are made redundant should be included. To help employers Acas has published a non-statutory Code of Practice on managing collective redundancies which provides useful checklists and worked examples.
One area of TULR(C)A which wasn’t addressed in the April changes was the reference to ‘one establishment’ in respect of collective consultation. It has been recognised that TULR(C)A is not consistent with the European Directive from which it derives but courts have traditionally held that it is not possible to interpret TULR(C)A purposively to ensure compatibility with the Directive. However, in the recent case of USDAW v Ethel Austin Ltd (in administration) & another UKEAT/0547/12 concerning Woolworths, the EAT held that the wording ‘at one establishment’ should be disregarded. The impact of this is that any employer who proposes to dismiss 20 or more employees from its business(es), regardless of the location of those employees, will trigger collective consultation obligations. The Secretary of State, who didn’t participate in the EAT case - because it stated that it had nothing useful to add - has been granted the right of appeal to challenge the decision in the Court of Appeal. The date of the Court of Appeal hearing is not yet known but interested employer parties hope that it is sooner rather than later.
TUPE ChangesAs mentioned earlier in this article, changes are also proposed to TUPE from January 2014, some aspects of which will affect collective consultation requirements. One change is that consultation by a transferee with transferring employees pre-transfer will be able to count towards collective consultation for redundancy requirements as long as (i) the transferor and transferee can agree and (ii) the transferee has carried out meaningful consultation. To date many transferors and transferees have co-ordinated on employee consultation on a TUPE transfer but there has been no formal recognition of such consultation and no notable case law on the issue. It should however be noted that the
transferee will remain responsible for any failings in such co-ordinated consultation and guidance is awaited on issues such as when such pre-transfer consultation should start and how meaningful it can be.
A minor but perhaps useful proposal is that the Government is going to issue guidance on what is ‘reasonable’ time for how long an employer has to allow for employees to elect employee representatives before it can inform directly with employees. In addition, micro-businesses of 10 employees or less will be permitted to inform and consult directly with transferring employees where there is no trade union or existing employee representatives.
When it goes wrongOne key area where the approach to TULR(C)A and TUPE coincide is in relation to awards of compensation when employers get it wrong. If a tribunal finds a failure to consult under TULR(C)A or TUPE well founded then it must make a declaration and it may also make an award of ‘appropriate compensation’ up to a maximum of 90 days/13 weeks actual pay per employee. In both instances the award is intended to penalise the employer, not to compensate the employees. There is also the risk of double recovery if an employer has failed both in relation to TUPE and TULR(C)A in respect of the same circumstances. Although an award of compensation can be high some recent cases have given employers the hope of mitigating the amount of award made to some extent. Of particular relevance to the tribunal is to what extent the employer has considered its obligations to its employees, including obtaining relevant legal advice, and whether it has tried to comply. However, employers shouldn’t get their hopes up too much as evidenced by the recent case of AEI Cables v GMB UKEAT/0375/12. In that case, even though the reason for substantially failing to consult was the risk that the directors would be accused of unlawful trading, the tribunal only reduced the award of compensation from 90 to 60 days.
‘ A minor but perhaps useful proposal is that the Government is going to issue guidance on what is ‘reasonable’ time for how long an employer has to allow for employees to elect employee representatives before it can inform directly with employees.
‘19
Mike Munro
Partner
T +44 (0)20 7367 3314
Richard Ham
Consultant
T +44 (0)20 7367 3592
On 2 October 2013, the delay to the Solvency II implementation date, which has long appeared inevitable, at last became official.
Through a statement by Commissioner Michel Barnier, the European Commission announced that it had put forward a draft Directive postponing the Solvency II application date to 1 January 2016.
Whether that proves achievable remains to be seen, but the statement emphasises that the new date has been announced in the light of assurances from the European Council and Parliament that further changes will not be required.
It seems, therefore, that the date is firm although agreement of the Omnibus II Directive remains a key next step. And, as reported in previous editions of Risk Matters, that in turn requires that the current impasse over the package of measures relating to the treatment of insurance products (such as annuities) containing long-term guarantees (the LTG package) is overcome.
Here, too, encouraging signs.
In June of this year, EIOPA issued a detailed report (the EIOPA Report) setting out its findings and associated advice, which included a number of recommendations
in respect of elements of the LTG package. The EC has welcomed the EIOPA Report (described by Commissioner Barnier as “excellent”) and believes its recommendations provide a “sound basis for achieving a speedy political agreement on Omnibus II”. Industry reaction, in contrast, has been more lukewarm. But what are the key elements and recommendations?
Background to the LTG Package – a reminderBy way of reminder, the LTG package is primarily concerned with the basis on which insurers’ liabilities in respect of products with long-term guarantees (LTG products) are to be calculated under Solvency II, taking account of the basic principle that both assets and liabilities should be valued on a market consistent basis.
More specifically, a central issue is whether, and in what circumstances, adjustments/additions can be made to the discount rate used for liability calculations, bearing in mind that, broadly speaking, insurers issuing LTG products:
— will generally seek to hold assets (such as government or corporate bonds) which, in terms of duration and cashflows, are closely matched to the associated LTG liabilities; and
— will typically expect to hold matched assets to maturity, such that, regardless of fluctuations in market values from time to time, the value of those assets should (absent default) trend towards and, ultimately, match that of the relevant liabilities.
Lisa Brown
Senior Associate
T +44 (0)20 7367 3705
Solvency II updateProgress at last and a firm date?
20 | Risk Matters: November 2013
Under Solvency II, the starting position is that the discount rate should be the appropriate risk free rate. But unless adjustments to the risk free rate are permitted to allow liability valuations to move in line with fluctuations in the market value of assets which result from (potentially temporary) movements in spreads, Solvency II would expose (re)insurers of LTG products to significant “artificial” volatility in their capital positions.
The elements of the LTG package are, accordingly, directed towards avoiding potentially unnecessary and damaging capital volatility – and to introducing transitional measures to mitigate the impact that immediate adoption of Solvency II might otherwise have for affected insurers.
Undoubtedly it’s a technical area – but from both a political and regulatory perspective the concern is clear. Get the technical rules wrong, and a regime intended to promote stability and to protect consumers / policyholders might have rather the opposite effect – and adversely impact the availability of LTG products for future policyholders. Combine that with concerns about Solvency II’s impact on the European growth agenda, and the product has been political stalement.
EIOPA’s Recommendations – Selected highlightsAs the EIOPA Report describes, the range of measures which together will comprise the LTG package fall into three broad categories, being:
— those applicable only in exceptional financial market circumstances/crises;
— those applicable to relevant long-term business for a transitional period; and
— those which will be permanently applicable (such as the “matching adjustment”).
EIOPA’s analysis in relation to each potential measure is detailed and considers a broad range of factors including (for example) the potential impacts on
policyholder protection, effective and efficient supervision, financial stability and the prevention of systemic risks, insurance and reinsurance undertakings’ solvency positions and on long-term investments.
A full review of EIOPA’s recommendations in the various categories is beyond the scope of this article, but certain recommendations for changes to proposed elements of the LTG package are particularly worth noting.
Exceptional circumstances: Volatility balancer/adjustment not CCPThe LTG package assessed by EIOPA incorporated a proposed counter-cyclical premium (or CCP), which would operate as an addition to the risk-free rate if the CCP measure was “triggered” as a result of exceptional financial market conditions.
It was envisaged that the “triggering” of a CCP would be a matter for the discretion of relevant national supervisory authorities. However, the EIOPA Report notes that “the announcement of a CCP, and thus the implicit recognition that markets are in a temporary and exceptional stressed situation is a particularly delicate issue, especially when the distress is linked to government bonds” and that “the triggering may result in a self-fulfilling prophecy, thus causing problems that the measure intended to prevent in the first place.”
Accordingly, EIOPA has recommended that the CCP be replaced with an alternative measure, likely to be known as the “Volatility Adjustment” and which would be:
— designed to deal in a predictable and permanent way with the unintended consequences of volatility;
— applicable to all insurance business except unit-linked (and unless the business applies the matching adjustment); and
— calculated as an adjustment to the relevant risk-free rate.
21
Permanent measures: “Classical” Matching AdjustmentPerhaps the key “permanent” measure is the “classical” Matching Adjustment (MA), designed to operate as an adjustment to the discount rate for valuing relevant liabilities, such that the “market value of the liability” tracks changes to the value of matched assets (to the extent not attributable to default or downgrade costs).
The MA is described by EIOPA as “the most effective tool within the tested LTG package with regards to mitigating short-term volatility from the Solvency II balance sheets of portfolios eligible for the measure”. Accordingly, a central question is as to eligibility – given that the MA can be used only for asset and liability portfolios in respect of which relevant conditions are met.
The precise detail of those conditions remains subject to further development, but it is worth noting that:
— EIOPA has recommended that the MA should be applicable to all business which meets the relevant criteria (and so include reinsurance and relevant non-life business), and should not exclude cross-border business; and
— Whilst the principle that “ring-fencing” of the matched business/assets is viewed as key, to ensure that matched assets are not “exposed to the risk of forced sale as a result of being required to support other, less predictable liabilities”, EIOPA has stressed that “the concept and application of ring-fencing in the context of the MA needs further elaboration and clarification” (acknowledging that “ring-fencing needs to be workable in practice”).
No Extended Matching AdjustmentFinally, the LTG package considered by EIOPA had included an additional adjustment, referred to as the Extended Matching Adjustment (EMA), which would potentially have applied in respect of “portfolios of unpredictable insurance obligations” – such that the relevant assets would potentially be at risk of forced sale if the relevant liability cash flows were discontinued or accelerated.
Citing “major concerns with regards to policyholder protection, competition and supervisability”, EIOPA has recommended that the EMA be removed from the LTG package.
ConclusionWork and consultation on the LTG package remains ongoing, and the trilogue party discussions have recommenced.
At a high level, the proposed approach to LTG products, such as annuities, may be moving towards a more palatable position. However, whilst earlier concerns as to whether the Solvency II regime would provide for an “illiquidity premium” at all have receded, the devil remains in the detail – and the initial reaction of “Insurance Europe” points to “significant concerns that the measures proposed would not work as intended.”
In short, don’t hold your breath for an early vote on Omnibus II – but, longer term, 1 January 2016 now looks to be the date when Solvency II finally comes into force.
‘ In short, don’t hold your breath for an early vote on Omnibus II – but, longer term, 1 January 2016 now looks to be the date when Solvency II finally comes into force.
‘22 | Risk Matters: November 2013
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