RegulationNov 20 2014

Toward Solvency II

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The last few weeks have seen flurries of activity by both the PRA and the FCA as they ready themselves for Solvency II.

In October the FCA released the response to the FSA’s consultation paper (CP) 12/13, focusing on the changes necessary to the COBS rules when Solvency II comes into force. At the same time the PRA issued a complementary note on the prudential regulation of with-profits business under the Solvency II directive.

This links to the earlier PRA supervisory statement (SS) 1/14, which clarified that each with-profits fund is likely to be considered ring-fenced under Solvency II. The PRA followed this with a consultation paper on the processes for firms to apply for some of the key approvals under Solvency II.

These are the latest in what will be a fairly steady stream of statements and consultations by the regulators – the PRA especially – over the next few months, and CP23/14 notes that a further communication from the PRA on transitional measures for technical provisions and the risk-free interest rate as well as the volatility adjustment will emerge later this month.

Feedback statement (FS) 14/1 – conduct of business rule changes

The FCA has issued a feedback statement (FS) in order to give advance notice of how the conduct of business (COBS) rules for with-profits business (COBS 20) and unit-linked business (COBS 21) are likely to be developed. This will give firms time to put processes in place to ensure that they are compliant when the final rules expected early in 2015 come into force on 1 January 2016.

The FCA is continuing to amend and update the existing rulebooks to bring them into line with Solvency II. The main changes are in respect of with-profits business in COBS 20 and unit-linked business in COBS 21, but there are also consequential changes required in SUP, GENPRU and INSPRU.

Highlights

Some of the key changes are highlighted below

COBS 20: With-profits business

• Distributions of surplus – These are only permitted when there is a surplus after allowing for the regulatory duty to treat customers fairly

• Governance – Here firms will potentially have new requirements:

to identify and account for each separately identifiable with-profits sub-fund,

to include full details of any support arrangements in the PPFM, and

for the terms of reference of the with-profits committee – or the advisory arrangement – to include consideration of the treatment of with-profits sub-funds and the support arrangements.

COBS 21: Unit-linked business

A small number of changes and clarifications are proposed in FS 14/1 in respect of the management and conduct of unit-linked business. These include:

• Revisions to permitted links are proposed to cover:

approved money market instruments, and

permitted derivative contracts.

• Rules for stock lending in respect of unit-linked funds:

requirement regarding counterparties,

risk and rewards for unit-linked policyholders, and

collateral arrangements.

• Treatment of reinsurance arrangements for unit-linked business.

Consultation paper 22/14 – with-profits insurance business

The PRA’s consultation paper (CP) 22/14 covers those aspects of the management of with-profits business in COBS 20 which fall under its remit, and these tie in very closely with the material in the FCA’s FS 14/1.

The PRA proposes to delete the existing COBS 20 rules for which it has responsibility, and implement rules in its PRA rulebook for three specific areas: assets in the with-profits fund, distribution strategies and support arrangements.

The new rules are expected to clarify and codify practices to which the PRA already expects firms to adhere in the current regulatory regime. In summary, the new rules require firms carrying on with-profits business:

• to have sufficient assets in each with-profits fund to meet the with-profits liabilities;

• to ensure distribution strategies are affordable and sustainable; and

• to document any support arrangements including any restrictions as to their use.

The PRA has also included some useful definitions relevant to with-profits business.

Consultation paper 23/14 – Solvency II approvals

CP 23/14 seeks views from the industry on the PRA’s proposed approach to applications for certain Solvency II approvals. In particular the PRA is keen for firms which might apply for more than one approval to consider the dependency between the applications and to have contingency plans in place. This is of particular relevance for firms applying for approval in a number of areas such as internal model, matching adjustment and undertaking specific parameters.

Firms can formally submit applications for approvals for Solvency II from 1 April 2015, after the Solvency II rules have been transposed into national legislation. Firms should already be talking to their usual supervisory contact about their likely applications.

For internal model firms, the CP brings unwelcome news in that the PRA proposes to use the EIOPA-developed application template rather than PRA’s self-assessment template, which has been in use for some time. While it is to be expected that EIOPA will lean heavily on the PRA template, the need to transpose and amend the information will be viewed as an unnecessary overhead for hard-pressed internal model firms. The PRA has repeatedly pointed out that internal model approval is binary: either it is good enough and meets the required standards or it is not. Firms should have a contingency plan for the possibility of failing to gain approval and discuss it with their usual supervisors.

On the matching adjustment the PRA has produced a checklist to assist firms when submitting their applications. These are intended to help firms to submit the necessary information and to avoid unnecessary delays from incomplete submissions. The PRA recommends these checklists are submitted at the same time as the application. To further assist firms, the PRA is running a pre-application process for matching adjustment approvals from 1 December 2014 to 6 January 2015. Feedback on the pre-application process will be given to all firms no later than 31 March 2015.

There are a number of other approvals discussed in the document including USPs, a single-group own risk and solvency assessment, and dispensation from providing certain information in the (public) solvency and financial condition report. Firms should consider whether any of these may be of relevance for their circumstances, and review the checklists the PRA has prepared.

The PRA has outlined the approvals timetable and the processes involved in the diagram [below/this page].

Concluding thoughts

There are a number of new requirements and new processes proposed in these documents. While none of the proposals regarding with-profits business feels controversial, firms will have some additional work to ensure that they understand and can comply with the proposed new rules. The changes in COBS 21 in respect of permitted links may offer new opportunities, while the stock lending requirements may necessitate a review of existing arrangements.

The application process – and pre-application process – for some very important approvals for firms remains very challenging both in terms of the information required and the timeframes in which it must be prepared. Firms must now look at their contingency plans and make sure they have considered how they will deal with the rejection of any – or even all – of their applications. This is a serious exercise.

Firms have an opportunity to provide feedback on CP 22/14 until 14 January 2015, on CP23/14 until 9 January 2015, and also on FS 14/1 as soon as possible.

Peter Gatenby is a partner of Mazars LLP

Key points

The PRA and the FCA are busy readying themselves for Solvency II.

The FCA is continuing to amend and update the existing rulebooks to bring them into line with Solvency II.

Firms will have some additional work to ensure that they understand and can comply with the proposed new rules.