Hogan Lovells discusses how to future-proof transactions before the implementation of Solvency II
The uncertainty over the timetable for the implementation of the Solvency II poses a challenge to insurers that are involved in negotiating commercial transactions. Where the potential consequences of non-compliance with Solvency II give rise to specific or general concerns for transaction parties, there are a number of ways these may be addressed in the documents.
For example a firm’s capital requirements are likely to be higher under Solvency II. If a firm is unable to comply with its Solvency Capital Requirement (SCR) or its Minimum Capital Requirement (MCR) the regulator will implement supervisory measures aimed at restoring the firm’s capital position.
A simple way for a counterparty to ensure it is not prejudiced by an insurer falling below the SCR is to use this as a trigger for a termination event. However, an insurer who has fallen just below the SCR may still be well capitalised, and so may be unwilling to agree that a termination event would occur in that scenario. If the MCR is considered too low a threshold the parties could compromise on a trigger point expressed as a percentage of the SCR.
Alternatively, there could be provision for a grace period while the regulator is still actively supervising the insurer with a view to recovering its capital position. Termination would then be triggered if more serious intervention was required.
It is likely that Solvency II will impose stricter standards regarding collateral including the proposed requirement that secured assets “can only be changed or substituted with the consent of the [insurer]”. Many existing floating charge arrangements which have been entered into to secure reinsurance exposures in favour of insurers have permitted the reinsurer to buy and sell the secured assets without requiring express consent from the insurer. It appears that this practice will not be able to continue once Solvency II has been implemented. A requirement to obtain consent may create practical difficulties for managing the secured assets efficiently, which would be in neither party’s interests.
This problem can be addressed through the inclusion of a clause under which the insurer has an obligation to give its consent to a transaction if certain defined conditions are satisfied. The clause will normally limit how often the insurer can be asked for consent, and the length of time within which the consent must be given. This will not infringe the Solvency II requirement, as ultimately the insurer retains control of the transactions affecting the secured assets.
Since the Solvency II arrangements have not yet been implemented, some counterparties are resisting such clauses. A possible compromise position is to include a clause providing that no consent is normally required for transactions involving the secured assets (the traditional approach) but that consent will in future be required (subject to an obligation on the insurer to give it as described in the previous paragraph) if the continued absence of a requirement for consent would have a material capital impact on the insurer.
It is impossible to identify all of the specific problems that implementation of Solvency II may create. Parties may, therefore, wish to adopt a ‘catch-all’ type clause that requires them to renegotiate the agreement so that it has the same effect once Solvency II is implemented.
Good faith obligation
One possibility is a general good faith obligation to negotiate amendments once Solvency II is in force, or immediately prior to its implementation. However, there is no power for either party to require amendments to be made, and such a clause would be unlikely even to form the basis of a damages claim in the event of non-compliance.
The clause can be strengthened firstly by providing that either party can terminate the transaction on pre-agreed terms if it is not satisfied with the amendments. This will not always be suitable, as both parties may depend on the continuing existence of the agreement. However, if termination is a palatable option then it will at least provide some negotiating leverage for the party seeking the amendments. Alternatively, either party may refer the matter to an expert who will be able to specify certain amendments that will then be deemed to be made to the agreement. Such a clause requires a great deal of care for it to be enforceable as a matter of law, since the power of the expert and the purpose that his amendments are to achieve must be defined precisely.
Steven McEwan is a partner and Dervla Simm is a trainee at Hogan Lovells International