The heavy-weight set of European insurance regulations known as Solvency II will soon be active. This article looks at some of the issues facing the industry.

As regular readers will know, insurance is – or ought to be – a part of any effective wealth management toolkit. Whether it is about protecting valuable assets against loss, or providing the structures through which assets can be protected (as in private placement products), insurance has a potentially valuable role to play although the fine print needs to be carefully understood. In the European Union, meanwhile, the insurance sector faces the Solvency II regime, which takes effect from January next year. The regime is designed to make the sector more robust. Whether the regulations have that desired outcome is, as chroniclers of rule-making know, another matter, however – and there are always potential side effects. 

To talk about some of the issues in this legislation is Brian Clarke, senior consultant at Citisoft, along with Jennifer Yao, supervising associate for law firm Simmons & Simmons. The editors of this publication are pleased to share these views with readers and as ever, invite readers to respond. This publication doesn’t necessarily share the views expressed.

After attending a Citisoft client reporting conference last year, the indications were that within the asset management client services community there was a lack of preparedness around Solvency II.
 
Since then, as a result of the continued indecisiveness and obfuscation around Solvency II, opportunities remain for those organisations taking a proactive stance as insurers may end up looking for asset managers that can serve them best. One key area where asset managers can be proactive is the legal perspective.
 
A central issue concerns whether the material risks arising out of the provision of data being used for Solvency II purposes can be adequately dealt with by asset managers under the provisions of standard NDAs alone. In short, this is not possible.
 
In respect of standard NDA provisions, particular consideration should be given to prohibiting the information being provided to regulators from being included on any publicly disclosed reports (e.g. the Solvency and Financial Condition Report). It may also be worth expressly acknowledging the specific provisions in Solvency II that allow for private disclosure reporting of SFCR information as a carve out to such a prohibition.
 
As regulated entities, asset managers should be mindful of the need to comply with their own regulatory obligations. This includes identifying and managing effectively the risks arising out of the impact of Solvency II on their business. This is of particular relevance in the context of divulging information to investors in Collective Investment Funds, e.g. ensuring compliance with the principle of treating customers fairly. It is important for asset managers to document their rationale for why and how (including via contractual provisions) they are in compliance with their own regulatory duties. Of particular assistance will be the distinction between treating customers fairly and identically.
 
After initial discussions with clients regarding their requirements, the next step might be to explain how much data will need to be sourced from third-party providers. The use of third-party providers can potentially have great cost and liability implications for asset managers. Asset managers should carefully consider whether the commercial benefit of using third-party providers merits their use. Furthermore they should carefully review contracts with third-party providers to ensure their terms are suitable (too often they are not).
 
What sort of warranty can an asset manager provide for data that it has no control over, or cannot even verify? The answer might be an insurance policy that underwrites the accuracy of the data. Providers may well start to move into this area of the market and this may lead to asset managers proactively marketing the fact that they provide this service as a means of differentiation. There are, however, practical considerations here. How would the insurer calculate risk? Presumably the policy would have to be with an insurer other than the client. This would seem to be a new market and premiums may start high. Who will pick up the cost?
 
Insurers that plan to use the threat of changing their asset managers if they cannot provide the data for Solvency II are going to create huge headaches for themselves, under their system of governance and their requirement to always act in the best interests of their policyholders. It is likely that insurers would adopt a ‘carrot’ rather than ‘stick’ approach with their asset managers and offer a long-term commitment in exchange for the provision of the required data. Even with this approach, some asset managers will not have the size or infrastructure to enter such a partnership.

Note: the Solvency II Services Agreement (“S2SA”), produced with the input of the participants of Simmons & Simmons LLP’s S2SA working group (of which the Investment Association is a participant), sets out a more detailed analysis of legal issues that asset managers and insurers should consider.