John Larkin discusses the position of Dublin as a financial centre within the European Union.
Who knows what changes our forefathers had to prepare themselves for as they faced the new millennium in 999! Unlike today, it probably was not the topic of conversation on everyone's lips. However, like today, there would have been a very international flavour to Irish affairs back then. For a start, many of Ireland's monks were establishing monasteries in Germany, France and Spain (under a freedom of establishment directive no doubt!).
Back in 999 Dublin was just a small village. It had recently been founded by some Northern European neighbours, affectionately known as Vikings, and the Irish financial services industry was getting under way as silver coins were minted for the first time in Dublin.
Today as the Irish financial services industry approaches the new millennium, the changes which it faces seem much more dramatic by comparison - a new currency, a new tax regime, the prospect of a single financial regulator and continuing progress on the integration of a single European market for insurance.
Almost since the outset, Ireland had been a supporter of the concept of a single European currency - this support was unwavering even when it became apparent that our neighbours in the UK would not be participating at the launch. There is no doubt that the decision is the right one, particularly for the Irish financial services industry, and in some respects the United Kingdom's hesitation may be Ireland's opportunity. Although it is still early days, international financial markets seem to be well disposed to the Euro, and this should see mobile investment projects gravitating towards financial centres within euroland.
In the lead into the launch of the euro, many insurance and reinsurance companies based in the International Financial Services (IFSC) in Dublin invested substantial resources in developing a proactive strategic approach to the euro, designing new products, information systems and distribution channels. (See page 35 for one company's approach.) They can expect to reap the rewards of their investment as the euro brings greater price transparencies and European insurance markets continue to open up.
Many sceptics were predicting the decline of the Irish financial services industry in 2006 following the termination of the 10% IFSC tax rate. A “sudden jerk” increase in tax rates of over 30% would certainly have put a strain on some businesses located there. However, the agreement reached last summer between the Irish Tanaiste (deputy prime minister), Mary Harney and EU competition commissioner, Karel van Miret, means that domestic tax rates on trading income will decrease gradually so that by 2003 the standard tax rate will be 12.5%.
As far as the IFSC is concerned, the key provisions of the van Miret/Harney agreement are as follows:
• a 10% corporation tax rate will continue to apply to all IFSC trading income until 31 December 2005 to companies which have been approved to operate in the IFSC on or before 31 July 1998;
• companies approved to operate in the IFSC after 31 July and before 31 December 1999 will be eligible for the 10% corporation tax rate until 31 December 2002;• a 12.5% corporation tax rate will apply to all trading income (including IFSC related) from 1 January 2006 in the case of IFSC companies approved to operate in the IFSC on or before 31 July 1998. In other cases the 12.5% corporation tax rate will apply from 1 January 2003;
• the cut-off date for new IFSC projects has been brought forward by one year to 31 December 1999. Any project established after that date will be subject to the standard corporation tax rate then prevailing, which rates will be reducing on the basis set out above;
• the number of new IFSC projects which can be established in 1999 will be limited to a quota of 67 (same quota as applied to IFSC projects established in 1998). However, the quota does not apply to certain types of IFSC companies including captive insurance/reinsurance companies.
The existence of the quota has prompted some companies (non-life insurance and reinsurance companies in particular) who might otherwise have established operations in the IFSC to examine more closely the opportunities presented by establishing their operations outside of the IFSC.
While the 10% tax rate has undoubtedly been a key factor in attracting businesses to the IFSC, other advantages of locating a financial services business in Ireland have not been exclusively tax based. Factors such as EU membership, euro participation, responsive yet responsible regulatory system, a flexible labour pool and convenient time zones are equally available to financial services activities establishing outside the IFSC.
Single financial services regulator
Plans for a new super regulator for the Irish financial services industry are expected to emerge shortly. The new regulator will become responsible for the supervision of all financial services companies in Ireland. The concept has government support and an implementation group has been established to furnish proposals on the role, scope and functions of the new authority. As part of this exercise, the implementation group has carried out a comparative review of the financial services regulators in a number of jurisdictions and the expectation is that it will recommend a “best of breeds” structure for Ireland, based on this review. The group is conscious of the need to avoid over regulation and to recommend a framework that will properly balance the needs of the Irish financial services industry and the end user.
As the financial services industry becomes more sophisticated, the current regulatory system could become rather cumbersome with a number of different regulators having a network of interwoven responsibilities. Assuming the proposals are implemented, the likelihood is that responsibility for the supervision of insurance companies (both life and non-life) will move from the Department of Enterprise, Trade and Employment to the new regulator. The position of reinsurance companies, which are currently subject to minimal regulation, is also likely to be reviewed.
Single market initiatives
Draft European Commission interpretative communication
Generally speaking, the European insurance market is well harmonised so that insurance companies (both life and non-life) authorised in one EU member state can carry on business anywhere else in the EU either under establishment rules (operating branches or agencies in other member states) or under the rules on freedom to provide services. However, there have been instances of divergence between theory and practice where it is apparent that the regulators in some EU member states have interpreted key provisions of the relevant directives (the third life and non-life directives) in a narrow, some would say protectionist, way.Two issues were causing most difficulty. The first was that regulators in different member states were putting varying interpretations on what activities ought to be categorised as the “provision of services” and what amounted to “establishment”. The general rule of thumb is that provision of services is distinguished from establishment by its temporary character, while establishment pre-supposes a lasting presence in the host member state. However, some national regulators were forcing insurance companies to comply with the more onerous branch obligations when the activities being carried on were more akin to the provision of services.
Secondly, the third life and non-life directives each recognised that where an insurance undertaking regulated in one member state carried on business in another member state, it must comply with the local laws of general application to all insurance companies necessary to ensure compliance with professional rules and the protection of the purchaser of the products (known as “general good” requirements). However, the regulations in some host member states were obliging insurance companies to comply with local laws which seemed to go beyond the general good.
To address these difficulties the European Commission issued a draft interpretative communication in October 1997. This set out the interpretation that the commission intended to follow on these issues. The final version of this interpretative communication is likely to be issued in May 1999 and this final version will reflect not only the views of the European Parliament but also the views of the industry which was invited to submit its observations on the draft paper during 1998.
Even as a draft document, the interpretative communication has helped to harmonise the views of regulators in different member states on these key issues. Moreover, it is clear that the commission will be prepared, where it is notified that a member state is adopting rules which are inconsistent with its interpretative communication, to take proceedings before the European Court of Justice for a breach of community law.
The issue of the interpretative communication and the robust position which the European Commission is prepared to take on these issues have been welcomed by insurance companies operating in the IFSC, many of which have been established as a hub operation to penetrate key European markets. This development will make that task that much easier.
The EU Commission adopted this new directive (EC 98/78) late last year. It must be implemented by member states before 5 June 2000 and will become effective in respect of accounting periods commencing after 31 December 2000. The key features of the directive are:
• it contains detailed provisions for the calculation of an adjusted solvency margin of insurance companies within a group. While it allows for an insurance company to take into account the resources of its parent, it specifically prohibits the double use of capital by insurance companies within a group company;• intergroup transactions will become subject to a greater degree of scrutiny by regulatory authorities;
• insurance companies within a group will have to make available additional information to regulatory authorities for supplementary supervision purposes. The directive also envisages greater sharing of information and a greater level of co-operation between regulators in different member states.The Department of Enterprise, Trade & Employment is currently undertaking preparatory work so that Ireland will implement the directive on schedule.
The Irish financial services industry faces the changes of the new millennium confident in its ability to convert the challenges which it will present into opportunities. The industry generally, and the insurance sector in particular, has developed impressively over the last 12 years and all the indicators suggest that this growth is set to continue well into the new millennium.
John Larkin is a partner specialising in financial services with William Fry, solicitors, Dublin. Tel: 353 (0) 1 639 5225; e.mail: email@example.com