July 4, 2016

The Article 50 process and planning for the possible loss of insurance passporting rights

Following the UK's decision to leave the EU, we examine some of the many uncertainties around the process by which a member state may leave the EU, and how insurers for whom rights to passport between the UK and other EEA countries are critical or important can make plans to address the considerable risk that upon Brexit (if it actually happens) those rights will be lost.

On 23 June 2016, the UK voted by a narrow margin to leave the European Union. This momentous decision has plunged Britain and Europe into a period of uncertainty that will last for some considerable time while negotiations over the terms of the 'divorce' and the future relationship between the UK and the EU take place.

We examine below some of the many uncertainties around the process by which a member state may leave the EU, and how insurers for whom rights to passport1  between the UK and other EEA countries are critical or important can make plans to address the considerable risk that upon Brexit (if it actually happens) those rights will be lost.

The Article 50 process

As a matter of strict law, the Brexit vote has no legal effect but serves as a mandate for a constitutional decision to be made that the UK should leave the EU. The question posed in the referendum made no reference to the timescale for leaving. For the time being, the UK continues to be an EU member with the full benefits and responsibilities of EU membership (except that it will not be entitled to participate on the EU side of the discussions and decisions about the terms on which it will leave).

Article 50 of the Lisbon Treaty contains the procedural requirements for withdrawal of a member state from the EU. Its key provisions relating to the triggering of the process and the timing of withdrawal are:

"1. Any Member State may decide to withdraw from the Union in accordance with its own constitutional requirements.
2. A Member State which decides to withdraw shall notify the European Council of its intention. In the light of the guidelines provided by the European Council, the Union shall negotiate and conclude an agreement with that State, setting out the arrangements for its withdrawal, taking account of the framework for its future relationship with the Union…
3. The Treaties shall cease to apply to the State in question from the date of entry into force of the withdrawal agreement or, failing that, two years after the notification referred to in paragraph 2, unless the European Council, in agreement with the Member State concerned, unanimously decides to extend this period."

In his resignation speech on 24 June, David Cameron said that the new prime minister should decide "when to trigger Article 50 and start the formal and legal process of leaving the EU", effectively suggesting that the start of the formal process for the UK's withdrawal should be deferred for at least the next two or three months.

In the immediate aftermath of the referendum, there were calls from the presidents of the EU Parliament and the European Commission for formal exit talks to start immediately. There was also some discussion in the media about whether the EU could treat as being a notification under Article 50 the discussions touching on the referendum result that have now taken place at the European Council meeting on 28 June (attended by David Cameron). However, it is now clear that the EU accepts that Article 50 will not be triggered until a new leader of the Conservative Party and prime minister has been elected.2    

Once (if) Article 50 is triggered, the UK will automatically leave the EU two years later on a 'non-agreed' basis unless by the end of that period an agreement on the arrangements for the withdrawal "taking account of the framework for [the departing member state's] future relationship with the Union" (Withdrawal Agreement) has been concluded or the other 27 member states have unanimously agreed to an extension.

Any Withdrawal Agreement will be negotiated on the EU side by the European Commission and may only be concluded once approved by the European Parliament (by a simple majority of MEPs) and then either:

  1. by the European Council acting by a qualified majority (being at least 20 of the other 27 member states representing at least 65% of their population); or
  2. by the European Council acting unanimously (followed in due course by ratification by each of the continuing 27 member states), if the terms of the future relationship between the UK and the EU (Future Relationship) are agreed at the same time – which they may not be – and involve (as must be likely) amendments to the EU Treaties and those terms are included in the Withdrawal Agreement.

What might the Future Relationship look like? Boris Johnson (now an inhabitant of the political wilderness) has asserted3  that "there will continue to be free trade, and access to the single market"; "EU citizens living in this country will have their rights fully protected, and the same goes for British citizens living in the EU… British people will still be able to go and work in the EU; to live; to travel; to study; to buy homes and to settle down"; and "the Government will be able to take back democratic control of immigration policy, with a balanced and humane points-based system to suit the needs of business and industry". These comments, in contrast to the polarised nature of many made during the course of the referendum campaign, were clearly designed to steady nerves and provide some reassurance to the many people who voted remain. But with Mr Johnson having now ruled himself out of the race to be the next Conservative leader and prime minister and until negotiations about the Future Relationship are at least reasonably well advanced, we will have little idea whether they will prove to be correct.

There are many other uncertainties:

  • We don't know when (or even if) Article 50 will be triggered.
  • Jeremy Hunt, an early possible candidate for the Conservative leadership and prime minister who has now decided to back Theresa May, has suggested that the Government should seek to negotiate a deal with the EU on our future relationship (he suggests a 'Norway plus' deal involving full access to the single market with a sensible compromise on free movement rules) and put that deal to the British people in another referendum or through the Conservative manifesto at a general election, all without first triggering Article 50. And Theresa May, now the favourite in the Conservative leadership race, has said "there should be no decision to invoke article 50 until the British negotiating strategy is agreed and clear, which means article 50 should not be invoked before the end of this year". However:
  • Angela Merkel, the German Chancellor, has said that there cannot be any informal negotiations until Article 50 is triggered (interestingly, a paper issued by the European Parliamentary Research Service in February of this year stated that "The timing of this notification is entirely in the hand of the Member State concerned, and informal discussions could take place between it and other Member States and/or EU institutions prior to the notification"); and
  • the EC president, Jean-Claude Juncker, has banned all EU officials from having any talks with the UK until it triggers Article 50.

Also, it is arguable that as a matter of domestic constitutional law, the Government will not be able to trigger Article 50 without first having been authorised to do so by an Act of Parliament. The alternative argument is that the Government may take a decision to trigger Article 50 without authority from Parliament by exercising the royal prerogative (which, among other things, has traditionally been used by the Government to enter into international treaties without Parliamentary involvement). There are deep waters here. Suffice it to say that there is a possibility that:

  • the Government may decide that it cannot trigger Article 50 unless legislation authorising it to do so is first passed by Parliament;
  • Parliament may not be prepared to pass such legislation, either until the nature of the future relationship the UK would have with the EU became at least reasonably clear or at all (bearing in mind that a majority of MPs were in favour of remaining).

 

  • We don't know whether, once (if) notification under Article 50 is given:
    • it will be possible for a Withdrawal Agreement to be concluded within the two year 'automatic exit' period; or
    • an extension to the 'automatic exit' period will be forthcoming if a Withdrawal Agreement is not concluded within two years, since the agreement of every one of the 27 other member states to such an extension would be required; or
    • the notification could be withdrawn – in practice the answer is probably "yes" if all the other members states were to agree but that otherwise the position would be unclear (since Article 50 itself is silent on the point) and would need to be decided by the European Court of Justice. 
  • And – very importantly – we don't know at this point whether the terms of the Future Relationship will be agreed at the same time as Britain leaves, or even whether the EU will be willing to start to negotiate on the Future Relationship until after Brexit occurs. The EU's Trade Commissioner, Cecilia Malmstrom, has said it won't, and the Heads of State or Government of the other 27 member states have said that any agreement about the Future Relationship "will be concluded with the UK as a third country" (notably however, this is not the same as saying that negotiations cannot begin until the UK is a third country).

Planning for the possible loss of insurance passporting rights

Unless the Future Relationship involves membership of EFTA and the EEA (or arrangements to similar effect), rights for insurers to passport between the UK and other EEA countries will be lost when (if) Brexit occurs.
If that happens:

  • UK-based insurers with branches in EEA countries (and no EEA-based insurer elsewhere within their group) who want to be able to continue to write the business they currently conduct through their EEA branches will need to have either:
    • obtained local authorisations for the branches; or
    • established (or acquired) a subsidiary in the EEA (with its own regulatory capital) in order to write EEA business on a passporting basis. Alternatively, it may be more capital-efficient for such insurers to undertake a restructuring under which the UK operation would be a branch of a new (or acquired) EEA company.
  • EEA-based insurers with branches in the UK (and no UK-based insurer elsewhere within their group) who want to continue to write the business currently conducted through their UK branches will need to have either:
    • obtained UK authorisation for those UK branches; or
    • established (or acquired) a UK subsidiary (again, with its own regulatory capital); and
  • UK-based insurers (with no EEA-based insurer elsewhere within their group) who currently write risks situated in EEA countries from the UK on a cross-border services basis and who want to continue to write such risks will in many cases need to have established locally-authorised branches or subsidiaries (or a subsidiary incorporated and authorised in another EEA country which could write risks throughout the EEA on a passporting basis) in order to do so. Again, it may be more capital-efficient for a restructuring to be undertaken under which the UK operation would be a branch of a new (or acquired) EEA company.

A further likely consequence of a Brexit that did not involve the continuation of passporting rights for the UK would be the loss of automatic mutual recognition (as between the UK and the EEA) of insurance business transfers sanctioned by UK or EEA courts or regulators, potentially making the process of reorganising books of insurance business located in insurance companies and their branches in the UK and the EEA considerably more complex (through a need for multiple applications to courts or regulators) or perhaps, in some cases, impossible.

It is also possible that following Brexit, the pan-EU cross border merger rules that enable mergers between public and private companies with limited liability in different EU member states will cease to apply as between the UK and the continuing EU.
In view of the uncertainty that will exist for some time about the nature of the UK's future relationship with the EU and the timeframes that can be involved in obtaining additional authorisations or executing reorganisations by means of insurance business transfers or cross-border mergers, it may be prudent for insurers for whom the ability to transact pan-European business is critical or important to take decisions in the relatively near future about strategic options for their post-Brexit structure on the assumption that the passporting regime will not continue once the UK leaves the EU.

  1. 1  i.e. the rights under the European insurance single market system by which a firm authorised in one EEA 'home' state may carry on business in any other EEA 'host' state on the basis of its home state authorisation, either through a branch in the host state or on a cross-border services basis 
  2. 2 In remarks following the 28 June European Council meeting, the President, Donald Tusk, said "Respecting the will of the British people, we all recognized that a process of orderly exit was in everyone's, and especially, in the UK's interest. Prime Minister Cameron undertook that the decision to trigger Article 50 of the Treaty on European Union be taken by the new leadership in Britain. Our discussions were calm and measured. Leaders understand that some time is now needed to allow the dust to settle in the UK. But they also expect the intentions of the UK government to be specified as soon as possible."
  3. 3 In an article in The Daily Telegraph on Monday 27 June