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«Summer 2014 Review of the Balance of Competences between the United Kingdom and the European Union The Single Market: Financial Services and the Free ...»

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are not paid out in full. In the case of life insurance products the impact of market failures, such as misselling of long term insurance products, is especially high, since any resulting detriment may not become evident for many years, by which time the policy-holders will not be in a position to buy alternative products.

2.30 Risks to policy-holders are mitigated by a prudential regime and a conduct regime.

The prudential regime sets out how insurance companies should assess and mitigate the underwriting risks to which their business model exposes them, including standards relating to capital and investment. The conduct regime currently sets out how insurance products may be marketed and the standards that should apply to the provision of professional advice, although the scope of this regime is being extended to additional aspects.

2.31 Insurance companies are also major investors, including in equities and in corporate and Government bonds. The return on the insurance premia which they invest goes on to fund their obligations to policy-holders and is their major source of profit. Therefore, changes in rules on tax, accounting or prudential standards will have a significant impact on expected returns, on the costs and benefits passed on to policy-holders, on the asset classes insurers hold, and therefore on the investment finance provided to the wider economy.

2.32 The rules of the Single Market are designed to remove national obstacles to the freedom to buy and sell insurance services. This has been achieved in the prudential area by permitting insurers authorised and supervised in one country to establish a branch or provide insurance remotely on a services basis to prospective policy-holders in another Member State, without that Member State being able to impose its own authorisation or prudential requirements.

2.33 The EU’s prudential regime for insurers is contained in the Solvency II Directive. The Directive introduces a modern prudential regime based around the three pillar approach of banking regulation. The first pillar provides a standard for valuing the liabilities an insurer has to policy-holders, and the capital insurers must hold to meet the insurance, investment and other risks to which they are exposed. The second pillar is the supervisory review, which focuses on whether the capital buffer is appropriate for the risks of the insurer and its control environment. The firm may be required to hold additional capital as a result. The third pillar is greater market discipline through disclosure by insurers of key data on capital, risks and their control.

2.34 EU Directives also provide minimum conduct standards. The Directive on Insurance Mediation (IMD) establishes common standards and an authorisation regime for the sale of insurance and reinsurance across the EU by intermediaries and brokers. The revision to the IMD – IMD II – extends the scope of the regime to include the direct sales forces of insurers and imposes new requirements intended to increase consumer protection, particularly for insurance investment products.

2.35 The single market for insurance services is incomplete. While Solvency II will create a level-playing field for the movement of insurance capital and services, this is not replicated for policy-holder protection, where the lack of harmonised minimum rules mean that insurance policy-holders in the EU are subject to differing compensation rules. This is an issue for the UK which offers high standards of protection to insurance policy-holders via the Financial Services Compensation Scheme.

2.36 The EU has also sought to set minimum rules for occupational pensions. However, while the removal of obstacles to the Single Market would greatly ease the provision of occupational pensions for multinational companies and make it easier for their employees to work in different Member States and remain in the same pension scheme, achieving 30 Review of the Balance of Competences between the United Kingdom and the European Union:

The Single Market: Financial Services and the Free Movement of Capital such harmonisation is extremely difficult. This is because of the importance that tax and social and labour law plays in pension rules. The Directive on Institutions for Occupational Retirement Provision (IORP) seeks to address cross-border, prudential and governance issues in this area.


2.37 The Single Market Directives mentioned above will tend to benefit consumers by opening up national markets to competition from firms in other Member States and by ensuring core standards apply across the EU. There is some EU legislation that is specifically designed to enhance consumer welfare, in areas such as investment services, mortgages, payment services, distance contracts and a common disclosure regime for investment products.

2.38 The Mortgage Credit Directive (MCD) on credit agreements for consumers relating to residential immovable property was adopted in February 2014. This Directive aims to create an EU-wide mortgage credit market with a high level of consumer protection.

The main provisions include consumer information requirements, principle-based rules and standards for the performance of services, provisions on early repayment, and a ‘passport’ for credit intermediaries who meet the admission requirements in their home Member State.14

2.39 The Consumer Credit Directive (CCD) was designed to establish the conditions for a genuine single market in consumer credit, ensure a high level of consumer protection and improve clarity by recasting existing Directives. The CCD applies to all providers of credit to consumers, such as banks and building societies and all credit intermediaries. Member States were required to transpose the Directive into national law by June 2010.

2.40 The Directive on Payment Services (PSD) provides the legal foundation for the creation of an EU-wide single market for payments. The PSD aims to establish a modern and comprehensive set of rules applicable to all payment services in the EU. The Directive also provides the necessary legal platform for the Single Euro Payments Area (SEPA).

2.41 The Distance Marketing of Financial Services Directive covers contracts for retail financial services (banking, insurance, payment and investment services, including pension funds) that are negotiated at a distance by any means which do not require the simultaneous physical presence of the parties to the contract, for example, by telephone, fax or over the Internet. The Directive also gives the consumer a cancellation right.

2.42 A Regulation on key information documents for investment products, Packaged Retail Investment Products (PRIPs) will require the provision of a standardised Key Information Document to retail investors before they purchase specified types of investment product, based on the existing disclosure document required under the UCITS Directive.

‘Passporting’ is the right of a financial services firms incorporated in one Member State to establish a branch or provide services remotely on a services basis in another Member State (including within the EEA), solely on the basis of their authorisation and prudential supervison by their state of incorporation.

Chapter 3: Impact on the National Interest Introduction

3.1 This chapter considers the impact on the national interest of the existing balance of competences between the UK and the EU. It draws upon evidence submitted to the Call for Evidence (see Annex B) as well as reports and literature in the public domain (see Annex D). It does not, however, consider whether UK membership of the EU is in the UK’s national interest.

3.2 The chapter considers the impact on the national interest under four broad themes:

A. The impact of the financial services sector on the UK economy, and the benefits of access to the Single Market and the Free Movement of Capital – This section notes the size and importance of the financial services sector in the UK compared to other EU Member States. This includes the major contribution it makes to the economy as well as the significant risks it presents, as was highlighted during the financial crisis. There was broad consensus in evidence about the strong benefits of access to the Single Market, including the ability for firms to ‘passport’ their services across all 28 Member States. This section also examines the Free Movement of Capital’s wider role in the functioning of the Single Market, including the potential benefits and costs of open capital markets;

B. The global nature of financial services and its impact on the EU’s approach to rules and markets – This section sets out the increasingly global nature of financial services, including the international regulatory framework which has been extensively redrawn in recent years and the stronger interlinkages between the international, regional and national dimensions. As a result, international developments have had a significant influence on the EU’s approach to financial services regulation in recent years. This has not, however, prevented the EU from setting its own priorities and, in some instances, going beyond or falling short of international standards. This section also notes the strong calls in the evidence for the EU to facilitate trade for financial services firms between EU and non-EU markets and for the UK to ensure it has adequate influence in financial services at both the global and EU level;

C. The impact of euro area developments, notably the banking union, and EU-level supervision on the Single Market – This section sets out the introduction of the banking union following the euro area crisis and notes concerns in the evidence about the potential implications of this additional dimension to the Single Market and the UK.

It also considers the introduction of the new European supervisory structure; and 34 Review of the Balance of Competences between the United Kingdom and the European Union:

The Single Market: Financial Services and the Free Movement of Capital D. The EU’s approach to rule-making following the financial crisis – The shift in focus from market-opening to financial stability in the last five years has raised questions regarding the quality of the policy-making process and the resulting rules.

Although there was broad consensus about the need for EU-level rules to underpin the single market in financial services and to have a financial stability objective in the wake of the crisis, evidence from stakeholders raised significant concerns regarding the recent pace, volume and focus of EU legislation, the failure to differentiate between different financial services sectors, the lack of proportionality, and insufficient recognition of the subsidiarity principle, especially in the retail sector. Chapter Four focuses in more detail on the EU rule-making process.

A. The UK Financial Services Sector, Access to the Single Market and the Free Movement of Capital

3.3 The UK financial services sector provides a range of benefits to the UK, EU and global economy. It also presents risks and challenges, as was highlighted in the recent crisis.

There was broad consensus in the evidence that access to the Single Market provides benefits to UK financial services, although these are not felt equally by all parts of the sector and there were alternative views on the scope for the UK to operate outside the EU. The Free Movement of Capital, as protected by EU Treaty, was generally considered to provide benefits, although evidence did highlight the potential for exceptions to the free movement to act as barriers to trade.

The UK Financial Services Sector

3.4 The financial services sector is critical for the UK. It plays a key role in providing essential services to individuals and businesses and in its contributions to growth, trade, tax revenues and employment.

3.5 For individuals, the financial sector provides essential services from bank accounts and mortgages, through to car and home insurance, and to pensions. While for businesses, the sector plays a critical role in providing access to finance, products to help firms guard against risks, as well as the various constituent parts that help to ensure an efficient marketplace.

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10% 8% 6% 4% 2%

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36 Review of the Balance of Competences between the United Kingdom and the European Union:

The Single Market: Financial Services and the Free Movement of Capital

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Source: ONS, Labour Market Statistics, Workforce jobs by Region and Industry, April 2014

3.11 The Welsh Government similarly emphasised the financial services sector’s role as a significant employer and contributor to growth in Wales. Between 2002 and 2012 the number of financial services jobs in Cardiff grew by 60%.6 Citi also noted in their evidence that the ‘question of employment does not only affect the City of London... Citi itself employs a significant number of staff in Belfast’.

Based on the Summary Trade Classification definition of the financial sector.

ONS, Labour Market Statistics, Workforce Jobs by Industry (2014). See Section K of SIC 2007 for a breakdown of Financial and Insurance Activities.

Based on TheCityUK 2012 estimates: TheCityUK, Glasgow Factsheet (2013); and TheCityUK, Key Facts About

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3.13 However, while the financial sector undoubtedly brings large benefits to the UK economy, it also poses significant risks. As UK banking sector net exports grew from around £11bn in 2003 to £30bn in 2008, the aggregate balance sheet of the sector more than doubled in size from £3.5tn to £7.3tn.8 The recent financial crisis demonstrated the significant damage that a failure in the banking sector can inflict on both the wider economy and public finances, with billions of pounds of tax-payers’ money put at risk. The assets of the UK banking sector are currently around 492% of UK GDP, with banking assets in Scotland alone totalling around 1254% of Scotland’s GDP.9

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