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Brexit clouds threaten to derail sunshine

Posted November 2, 2016

By David Worsfold

Forget the sunshine headlines, the Brexit storm clouds are gathering.

The positive economic news since the shock vote to leave the European Union on 23 June is in danger of masking the harsh reality of Brexit, especially for the insurance industry and its already beleaguered investment professionals.

There is a collective sigh of relief that the economy hasn’t suddenly followed Sterling over the cliff edge. There may be some among those who fought to remain in the EU who wish it had – just to prove their dire warnings right – but most will be thankful the economy is coping well so far.

This is a double-edged sword, however.

It looks as if the UK economy is more resilient than feared. Most financial institutions will be grateful for that. The severe economic disruption feared and predicted by many commentators is not going to hit us like a whirlwind.

But it does not mean we aren’t still in for a sustained period of uncertainty. It would be naïve of anyone, even those wanting the UK to get out of the EU as quickly as possible, to believe it will be all economic plain sailing. That economic resilience actually makes the thing the City now fears the most more likely to happen – a hard Brexit.

Most senior figures still talk with a touching optimism of their hopes for a soft Brexit with access to the single market and, in particular, an extensive portfolio of passporting rights. Its wish list doesn’t stop there. It also wants to be able to employ people from Europe without any complicated, potentially highly restrictive new rules on who can come to work in the UK.

While they may publicly urge the case for a soft Brexit, they are planning and lobbying on the basis of the increasingly harsh reality that we could be heading for exactly the opposite – a hard Brexit – with a rollercoaster ride of crippling uncertainty in prospect between now and the UK’s final bow as a member of the European Union in March 2019.

The positive economic news – growth sustained, multi-national giants like Nissan still investing and so on – will encourage the Brexiters to shun the pleas to do deals to retain access to the single market, especially if it jeopardises their most cherished objectives of controlling entry to the UK and not paying into the EU coffers. The economic resilience is encouraging the anti-EU lobby to believe it can push through a hard Brexit without fearing the hideous consequences once threatened. Quite simply, many of them no longer believe there is much downside.

This has left the insurance industry feeling increasingly nervous according to Huw Evans, director general of the Association of British Insurers: “Most are seeking to build an understanding of what will happen in what order, what it means for them and what it means for the wider policy landscape”.

Huw Evans, Director General, ABI

Huw Evans, Director General, ABI

He said understanding the various potential outcomes was important and that insurers needed to keep pushing for the outcome that would be best for them: “I don’t think a soft Brexit is out of the question. Until something is settled, nothing is settled. I think it is important not to give up too early”.

Despite this obligatory optimism, he didn’t underestimate the challenge of making the case for a continuing access to the single market: “We are dealing with 27 partners who don’t want us to go and don’t want anyone else to try and leave. The worse case scenario is a very attritional set of negotiations that sought to create difficulties and divisions that don’t exist”.

Evans agreed that for some firms, the decisions would have to be made sooner rather than later: “The key group are those members whose commercial structures are most impacted because they use passporting to access their markets. But all the members are impacted as they are affected by European regulations in a wide range of areas such as Solvency II, data protection and wider public policy issues. These are issues that affect all our members regardless of whether they do business in the European Union.”

If the prospect of a soft Brexit is rapidly fading, then the fall back position for the industry is to create some realism about the need for effective transitional arrangements to be put in place. There fear is that without these there will be huge policy and regulatory vacuums as the UK finally walks through the exit door in March 2019.

“The point about having transitional arrangements is something ministers already understand. It is in the interests of both sides not to close off important trading relationships abruptly”, says Evans.

“These need to be agreed early in the process as firms are already taking key decisions”.

Among those key decisions is where to set up shop, says Paul Merrey, a partner in the Global Strategy Group at KPMG.

Those insurers and brokers with strong EU business flows are not hanging around waiting for clarity on the government’s negotiation position as this will take months to emerge, warns Merrey.

“What we are seeing is that those insurers who have no option, ie no legal entity elsewhere, are looking to establish one. We are hearing of queues of enquiries to local regulators, especially in Dublin, Malta and Luxembourg. These are domiciles which have a reputation for flexibility and are already acting as a hub.”

The uncertainty surrounding Brexit has been amplified by the volatility in the foreign exchange markets with insurers with large dollar earnings in particular vulnerable to the crash in the value of the pound. It has also hit those property and casualty insurers with substantial long-term claims reserves denominated in dollars with those outstanding liabilities suddenly looking significantly larger than they did before 23 June. This, in turn, puts further pressure on insurers’ investment portfolios as they are being asked to match liabilities that have ballooned in recent months.

The economic sun still may be shining at the moment but the Brexit storm clouds are looming up fast.

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