Brexit: Keep calm and carry on
June 30, 2016
There was a stunned hush in the office and the City on 24 June as we took in the news that the UK electorate had chosen Brexit. We have little idea what Brexit means in practise at this early stage of political negotiations, of course, despite the many blog posts and column inches that are currently being written about it. Nonetheless, the Oxbow Partners message is, broadly: keep calm, and carry on.
The reality is that there is little that companies can do about Brexit right now. Our contacts suggest that companies were prepared for the potential impact of an out vote and it is now a case of seeing how negotiations play out. (Had this type of event happened 10 years ago the insurance industry and wider financial services would be left reeling: it is good to see that the industry has learned its lesson from the 2008/9 financial crisis and embedded sound risk management practices into its day to day operations and strategic thinking.)
In the medium term, we think Brexit will impact the insurance industry in the following ways:
Cost and technology investment
With most commentators predicting an economic downturn, we see indications that companies will use Brexit as an opportunity to cut costs. For better or worse, Brexit is one of those events which will force the industry to have a look at itself and see where it can raise productivity. Expect some staffing rationalisations and some investment in technology.
Legal entity review and capital fungibility
All financial services companies are keenly focused on European passporting rules and it is possible in some scenarios that the UK will lose its “passporting” rights. Were this to happen (and assuming that rules are implemented bilaterally) we still think that it is quite possible that insurance might get a “carve back” – will it really be worth everyone’s while for European insurance entities operating branches in the UK to convert these into subsidiaries, and vice versa? We see little merit for either side. Nonetheless, many potential scenarios require companies to hold more assets locally and both investment and currency risk will increase. There might also be issues to consider about capital fungibility. Expect insurers to increase optionality by setting up entities in the EU or UK as a possible hedge against this risk over the next year.
The UK was a leading proponent of Solvency II and the PRA is viewed as one of the strongest regulators in the world. With the implementation of Solvency II only 6 months old, many of the features are being road-tested and tweaks will no doubt need to be made. The question for companies in this environment will be whether the regulatory environments will start to diverge (even though they it is difficult to envisage a scenario where they would not be equivalent) and what actions the companies need to take to meet these new requirements.
Increased need for innovation
Competitive pressures will increase under many Brexit scenarios as companies seek to grow or protect market share in a challenging economic climate. Companies will seek to diversify into new lines of business. Not only will this require careful stewardship of risk and capital considerations, but clearly the most successful players will be those who create sustainable competitive advantage. Innovation – linked with technology investment to create a flexible internal environment – is key.
Interest rates and macro-economic risk
Nobody knows how Brexit will impact the economy – will there be Boris’s “sunlit meadows” or is the recent slashing of UK growth forecasts by economists a sign of things to come? Either way, we have moved from an environment where people were slowly starting to talk about interest rate rises to one where predictions of low rates until the 2020s look likely.
A robust risk framework allowed companies to weather the Brexit shock but they should now be used in anger to allow UK and EU companies to explore the various possible structural scenarios of a post Brexit environment and get ahead of the political discussions. Companies should not just wait to see what happens between the politicians but use this negotiation time-window to understand the ramifications of each scenario and inform and engage their stakeholders.