INSURANCE SOLVENCY II AND DIVIDENDS ON ORDINARY SHARES. The requirement

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Amberlynn Newman
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1 SOLVENCY II AND DIVIDENDS ON ORDINARY SHARES From January 2016, dividends declared on an insurer s ordinary shares must be cancellable on a breach of the Solvency Capital Requirement (SCR) at any time up until payment if they are to qualify as Tier 1 own funds. What does this mean in practice and how have different jurisdictions interpreted the requirement? The requirement The Level 2 Delegated Regulation (which is directly applicable to all insurers) states that, for ordinary shares to qualify as Tier 1 capital: the legal or contractual arrangements governing the terms of the ordinary shares, or national legislation, must allow for the cancellation of distributions if there is non-compliance with the SCR or the distribution would lead to such non-compliance. In many jurisdictions this requirement is potentially problematic as, once declared or approved by the shareholders at a general meeting, a dividend becomes a debt owed by the company which cannot be withdrawn. It is possible that an unforeseen event might occur between declaration and payment which causes SCR non-compliance. Therefore, unless steps are taken to modify the position, ordinary shares issued in those jurisdictions would not qualify as Tier 1 capital under Solvency II as the terms would not allow for cancellation of distributions at any time. In a number of jurisdictions the proposed solution is for dividends to be declared conditionally, as discussed in the table below. As a matter of company law, there does not appear to be any bar to dividends being declared conditionally in these jurisdictions. In other jurisdictions the relevant company law position would need to be confirmed before adopting this approach, to ensure that it is a workable solution. Other jurisdictions have addressed the issue through the granting of additional powers to supervisory authorities. This is also discussed in the table below.

The requirement The Level 2 Delegated Regulation (which is directly applicable to all insurers) states that, for ordinary shares to qualify as Tier 1 capital: the legal or contractual arrangements

2 Position in different jurisdictions Country Steps taken? Comment France Germany Ireland The Autorité de contrôle prudentiel et de résolution (ACPR) is entitled to prevent the payment of a dividend where the solvency or liquidity of an insurer or the interests of its clients, insured parties, members or beneficiaries are or are likely to be compromised. A new (2015) provision in the German insurance Supervision Act (VAG) allows the German regulator (BaFin) to prohibit the payment of a dividend if the solvency requirements are not met or threaten to be not met anymore within the near future. No public guidance has been given by the Central Bank of Ireland. There is a risk an action by the ACPR to this effect could be challenged before the French Constitutional Council (FCC). The FCC has already declared the forced transfer of an insurance portfolio under the same provision of the French insurance code to be an unconstitutional deprivation of property. A dividend validly adopted by the shareholders meeting is a debt. Pursuant to the wording of the new provision of the VAG, the payment of a dividend nevertheless can be prohibited even after adoption of the respective shareholders resolution. A dividend declared by a general meeting is a debt. Best practice would therefore be for insurers to amend their articles of association to provide that dividends can be cancelled for a breach or prospective breach of the SCR. PAGE 2

interests of its clients, insured parties, members or beneficiaries are or are likely to be compromised.

3 Country Steps taken? Comment Italy Spain In accordance with the requirements of the Delegated Regulation, a new provision has been added to the Italian Insurance Code whereby distributions of own funds (including dividends) are temporarily suspended if the insurer is not compliant with the SCR or the MCR. This also applies after the distribution resolution is passed but not after the distribution is carried out. Thus far, no specific guidelines have been issued by Istituto per la Vigilanza sulle Assicurazioni (IVASS). No public guidance has been given by the Dirección General de Seguros y Fondos de Pensiones (DGFSP). This provision is particularly innovative for the Italian legal framework, in that until now the cancellation/suspension of dividends attached to ordinary shares after a shareholders meeting has approved the distribution, by either the company s directors or the regulator, has never been permitted. This provision achieves a twofold objective: all existing ordinary shares of Italian insurance companies are automatically transformed into tier 1 instruments, without the need to amend the articles of association; and the insurer s management body is obliged to maintain an up-to-date picture of the insurer s capital requirements. A validly passed shareholder declaration for the payment of a dividend cannot be challenged. Therefore, it is advisable for dividends to be declared conditionally or for insurers to amend their byelaws to contemplate conditionality on any distribution. PAGE 3

dividends) are temporarily suspended if the insurer is not compliant with the SCR or the MCR.

4 Country Steps taken? Comment PAGE 4 The Netherlands United Kingdom No public guidance has been given by the Dutch Central Bank. A requirement was introduced in the Financial Markets Supervision Act in 2014 for an insurer to obtain a declaration of no objection from the regulator if it intends to pay a dividend while its SCR is not met or it is foreseeable that it would not be met within the next 12 months. However, this does not appear to be sufficient to satisfy the requirements of the Delegated Regulation. The Prudential Regulation Authority has given guidance proposing that insurers declare final dividends on a conditional basis as a means to ensure that the Tier 1 requirements are met. Payment of the dividend should be conditional on the SCR not having been breached before payment and payment of the dividend not causing an SCR breach. A dividend declared by a general meeting is a debt. Therefore, insurers will need to declare their dividends conditionally or arrange for them to be paid immediately after declaration. Interim dividends are only cancellable in very specific situations in The Netherlands and should therefore be treated in the same way as final dividends. A dividend declared by a general meeting is a debt so insurers should follow the approach proposed by the PRA or take alternative steps to allow dividends to be cancelled up until payment. Alternative approaches would be embedding conditionality into the articles or adopting a practice of paying only interim dividends.

is not met or it is foreseeable that it would not be met within the next 12 months. However, this does not appear to be sufficient to satisfy the requirements of the Delegated Regulation.

5 Issues Directors duties A decision to cancel a dividend after declaration will need to be made by the directors. The relevant provision in the articles or the wording of the resolution will need to give the directors the power to cancel the dividend and the discretion to decide when it should be cancelled. To mitigate the risk of any liability arising in connection with the cancellation, in some jurisdictions it may be beneficial to use broad wording in the articles or resolution allowing the directors complete discretion over the cancellation and to state explicitly that no liability will arise in respect of any cancellation. The accompanying notes to the resolution amending the articles or declaring the dividend can explain that the intention is only to use the ability to cancel where there is a breach or prospective breach of the SCR. Cross border groups Insurers which are part of pan-european insurance groups will need to pay particular attention to any regional variations in approach to this requirement. In principle the group supervisor could revisit the question of whether an insurer within the group has satisfied the requirement for dividends to be cancellable. Where groups include non-eea insurers the position of those undertakings will also need to be considered if group solvency is assessed based on the accounting-consolidation method, or if the undertaking is in a non-equivalent jurisdiction, the third country insurer s own funds will need to be assessed based on the Solvency II rules, including the need for dividends on ordinary shares to be cancellable. PAGE 5 Grandfathering Another, temporary, solution to the issue might be to rely on the grandfathering regime under Solvency II. If no new share capital was issued after 18 January 2015 (when the Level 2 Delegated Regulation came into force), it will qualify to be treated as Tier 1 capital up until 1 January However, no more than 20% of total Tier 1 own funds can be made up of grandfathered own funds and subordinated liabilities and this is therefore unlikely to be a practical approach. If ordinary shares have been issued after 18 January 2015 the fungible nature of ordinary share capital means that relying on grandfathering may be difficult or even impossible. Published to provide general information and not as legal advice. For further information, please use the contacts on the following page or contact your usual adviser at A&L Goodbody, BonelliErede, Bredin Prat, De Brauw Blackstone Westbroek, Hengeler Mueller, Slaughter and May or Uría Menéndez.

To mitigate the risk of any liability arising in connection with the cancellation, in some jurisdictions it may be beneficial to use broad wording in the articles or resolution allowing the directors

6 James Grennan Tel: jgrennan@algoodbody.com Stefano Micheli Tel: stefano.micheli@belex.com Olivier Saba Tel: oliviersaba@bredinprat.com Daniëlle Pos Tel: danielle.pos@debrauw.com Daniel Wilm Tel: +49 (0) daniel.wilm@hengeler.com Oliver Wareham Tel: +44 (0) oliver.wareham@slaughterandmay.com PAGE 6 Guillermo San Pedro Tel: guillermo.sanpedro@uria.com

com Daniëlle Pos Tel: +31 20 577 1508 E-mail: danielle.pos@debrauw.com Daniel Wilm Tel: +49 (0)211 8304 128 E-mail: daniel.

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