United Kingdom

Conduct risk exposures likely for financial institutions during post-Brexit ‘grace period’.

Hard, soft or medium; whatever the outcome of Brexit negotiations, the warnings from financial services regulators have been getting louder by the day.

Losing the current European Union passporting regime will create a trading environment in which cross border rules will be hard to enforce.

Financial Conduct Authority Chief Executive Andrew Bailey’s evidence to the Treasury Select Committee demonstrates[1] the extent of the challenge, with more than 5000+ UK registered firms holding at least one passport and more than 8000 authorised in other EU states using their pass port to do business in the UK.

The question for risk managers in the finance sector is, what sensible precautions can be taken amidst such uncertainty?

Edward Smerdon, Managing Partner at Sedgwick, Detert, Moran and Arnold LLP says that Bailey’s warning should be taken seriously with conduct risk a likely exposure issue. He says “as the FCA has confirmed, it will be very complicated policing all of these new agreements and there will be mistakes made by financial services companies as they navigate a new closed system. As a result, they could get investigated which will certainly trigger FI and D&O policies.”

Worse still, says Ed, is the prospect of opportunists taking advantage of a post-Brexit grace period, to exploit regulatory loopholes. “Given the amount of law-making required, I expect there will be a transitionary period post Brexit where, for example contracts written just before could be allowed through. Regulators are going to have to be somewhat more relaxed during the first two years or so post Brexit but could this encourage people to exploit the situation, knowing that they may be subject to less scrutiny?

"After all" he adds "Explotioning differences in rules is how financial services makes money, the vast Majority of the time perfectly legally. The question is, could we open a window of opportunity for mistakes to be made or worse still, crimes to be committed, while oversight holds back?”

Increasing risk

David Nayler, Executive Director and Head of Aon’s Financial and Professional Services Legal and Claims Practice says unfortunately the nature of the principles-based approach to the regulation of FI institutions, means that often a company only knows with hindsight what a regulatory approach to a particular issue or working practice would be.

“It is hard enough to stay on the right side of the line when you know where that line probably is, but when that line is even more uncertain (as it will be during any transition) the risks increase.”

This is likely to lead to a greater number of both internal and external investigations into working practices examining issues with the additional benefit of hindsight, adds David:

“As a result of this, increased claims and defence costs / pre-investigation pre-claim costs are much more likely.”

Enforcing judgments after Brexit

On a separate note from passporting, David has particular concern for financial services companies who may be in the midst of a claim which straddles the Brexit period. “On a high level view, the judgments of a UK Court are enforceable across the EU as part of the membership package. The same applies to EU judgments into the UK. Any cross EU-border judgment an insured secures will be harder and more costly to enforce post- Brexit unless this issue is dealt with in the Brexit negotiations.”

This is likely to impact European insureds who have a long tail liability policy that has a dispute running through the Brexit period as they may start out pre-Brexit being able to enforce their local court judgment across the EU-border against the insurer, but lose that automatic right during the lifetime of the claim.

“New purchasers are considering arbitration clauses instead of Court clauses so as to be able to rely on unaffected international treaties on the enforceability of arbitration awards,” says David. “However, many on the buy-side of insurance see the arbitration process as biased against insureds, and there is a concern that not having an attractive option to obtain finality in a cross border insurance coverage dispute will mean that insurance premiums begin to avoid the London market in favour of more certainty with local insurance markets.”

Aon UK Limited is authorised and regulated by the Financial Conduct Authority.

GBC FPS CF 0001.

[1] Source: Treasury Select Committee, 20 July 2016

For more information Contact

Edward Smerdon
Managing Partner,
Sedgwick, Detert,
Moran and Arnold LLP
+44 (0)20 7398 8927
edward.smerdon@sedgwicklaw.com

David Nayler
Head of F&PS Legal &
Claims Practice,
Aon UK Ltd
+44 (0)20 7086 1353
david.nayler@aon.co.uk