In this episode of “The Standard Formula,” host Robert Chaplin is joined by colleague Olivier Peeters to guide listeners through the U.K.’s change-in-control regime for insurers and insurance brokers, and highlight important changes that regulators are putting forth.
In this episode of “The Standard Formula” podcast, which focuses on Solvency II developments, Skadden partner Rob Chaplin is joined by colleague Olivier Peeters to discuss the U.K.'s change in control regime for insurers and insurance brokers.
Rob and Olivier delve into the concept of a “controller” as defined in the U.K. Financial Services and Markets Act 2000 and the obligations that the U.K. regime imposes on controllers looking to acquire a regulated firm.
More specifically, they discuss the controller application process required for regulatory approval before closing a transaction, the assessment of applications to determine whether the incoming controllers are fit to control the business of a regulated firm and the obligations of controllers. They also discuss a recently released consultation paper by the Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA) proposing that the existing European Union guidelines on changing control approvals be replaced by U.K.-specific rules and guidance.
- What Is a Controller? A controller holds 10% or more of the shares in a regulated firm, 10% or more of the voting power, or holds shares or voting power in the firm that allows them to exercise significant influence over the firm's management. This role is key to any M&A transaction involving a target that requires regulatory approval, including U.K. insurance companies or brokers.
- Obtaining Regulatory Approval. After a controller analysis is performed, an incoming controller must notify the appropriate regulator and then obtain approval before closing, which includes submitting an application to the relevant regulator, filling in a standard PRA or FCA form and providing necessary supporting documentation.
- Understanding the New PRA and FCA Consultation Paper. The consultation paper proposes that the existing European Union guidelines on changing control approvals, which were retained post-Brexit, be replaced by U.K.-specific rules and guidance, tailored to the U.K. market and the U.K.'s regulatory approach post-Brexit. New information requirements are included for private equity funds, hedge funds, sovereign wealth funds, investment firms and crypto asset businesses. There is also revised guidance on the significant influence threshold, and when a decision to acquire control has been made that would trigger a regulatory approval requirement.
From Skadden, the Standard Formula is a Solvency II podcast for UK and European insurance professionals. Join us as Skadden partner Robert Chaplin leads conversations with industry practitioners, and explores Solvency II two developments that matter to you.
Rob Chaplin (00:18):
Welcome back to the Standard Formula Podcast. Today we’ll be talking about the UK’s change in control regime for insurers and insurance brokers. The UK regulators are making important changes to the regime, and we’ll also cover this. I’m joined by my colleague, Olivier Peters, who’ll be discussing this topic with me. Olivier, please run us through what we mean when we talk about a controller.
Olivier Peeters (00:45):
Thanks, Rob. It’s great to be here to discuss this topic. The concept of a controller is key to any merger or acquisition, or M&A transaction, involving a target which is a regulated entity, or a target group, which has a regulated subsidiary.
In this context, in the UK, when we say regulated, we mean regulated by either the Prudential Regulation Authority, the PRA, or the financial conduct authority, the FCA.
Usually, when a buyer enters into an agreement to acquire a target, absent any other mandatory conditions, it is free to complete the acquisition at a time that the parties agree. This could even be immediately on signing of the purchase agreement. But when you’re buying an insurance company, or an insurance broker in the UK, you will always need regulatory approval to complete the acquisition.
In fact, it’s a criminal offense to complete the acquisition without regulatory approval. As a result of this, insurance M&A transaction documentation is always structured to have what we call a split signing and closing. Closing is then made conditional on the necessary regulatory approvals being obtained. Let’s now look at the tests for whether someone is a controller. Over to you, Rob.
Rob Chaplin (02:08):
Thanks, Olivier. A controller is defined in the UK Financial Services and Markets Act 2000 as amended. If a person or entity meets one of three tests, it qualifies as a controller. First, if they hold 10% or more of the shares in a regulated firm. Or, if they hold 10% or more of the voting power in the firm. Or, if they hold shares or voting power in the firm, which allows them to exercise significant influence over the firm’s management.
A person may also be an indirect controller. This would be the case where it satisfies one of the three tests. Because of shares or voting power, it holds an apparent undertaking of the regulated firm. A parent undertaking is defined by reference to the UK Companies Act 2006, and includes a company which holds the majority of the voting rights in a subsidiary.
This is a key point, that should be identified in the due diligence phase of an acquisition. Although in most cases, buyers will be aware that they’re acquiring a regulated group. This may not be immediately obvious, where an otherwise innocuous corporate group contains a regulated subsidiary.
Let’s now talk about some of the obligations that the UK regime imposes on controllers. Olivier, why don’t you start with the obligations of someone who is looking to acquire control of a regulated firm in an M&A context?
Olivier Peeters (03:44):
Of course. A person looking to acquire control has an obligation to notify the appropriate regulator when it decides to acquire control of a regulated firm. In an M&A context, this would usually be around the time that a definitive share purchase agreement is signed. We usually see this take the form of a warmup communication, like a short courtesy letter to the regulator.
Ultimately, the timing of the formal notification, which is required once a decision is made regarding the acquisition, is of course assessed on a case by case basis. Let’s now talk about the process for obtaining regulatory approval. Over to you, Rob.
Rob Chaplin (04:26):
Thanks, Olivier. A prospective controller must obtain the regulator’s approval before closing the transaction. This requires each incoming controller to submit an application to the relevant regulator. Each controller has to fill in a standard PRA or FCA form, which asks for corporate details, information on the acquisition, and also contains a fitness and propriety questionnaire.
The application also requires a range of supporting documentation, such as annual accounts for corporate entities, details and CVs or resumes of each director, as well as a business plan describing the buyer’s go forward plans for the regulated firm.
Because the definition of controller captures entities at all levels of a buyer’s corporate structure, it is usually necessary to prepare an application for each company in the buyer’s holding structure. This begins at the level of the acquisition vehicle, and goes up the corporate chain to capture all intermediate holding companies up to the top holding company in the buyer’s group.
Depending on the buyer’s ownership structure, the buyer’s, shareholders, and investors may also be controllers, up to their beneficial owners. This is why we perform a controller analysis as one of the first steps in any buy-side representation. Once the application is submitted, the regulator usually has 60 working days to decide on the application, although they may stop the clock once by asking for additional information.
It’s important to remember that the 60-day period only starts once the regulator considers the application to be complete. In more complex scenarios, we often make use of the PRAs and FCAs informal pre-application procedure. This allows us to obtain feedback on a draft application. It’s not unusual to interact with the regulator for some time before obtaining a confirmation of completeness.
The regulator will then assess the application to determine whether the incoming controllers are fit and proper to control the business of a regulated firm.
It will look at the identity and history of the buyer, and its directors and shareholders, as well as its track record in the financial services industry. It will also assess the buyer’s business plan. The regulator may choose to approve or deny the application. An approval can also be made subject to specific conditions or undertakings from the buyer. These tools are used to address a particular concern that the regulator identifies as part of its assessment. But a controller’s obligations do not end when it completes an acquisition. Olivier, why don’t you run us through controller’s ongoing obligations after closing?
Olivier Peeters (07:17):
Thanks, Rob. Controller’s post-closing obligations can be broken down into two categories. The first is where the controller later considers increasing or decreasing its stake in the regulated firm. For most insurers, the PRA grants its approval on the basis of controller bans. These bans relate to the percentage of shares, or voting rights, a particular controller holds in the regulated firm.
The bans are 10 to 20%, 20 to 30%, 30 to 50%, and 50% plus. An investor would need approval before moving up a controller band, although this process would be significantly simpler than the initial approval process. There’s no requirement to obtain approval before decreasing or disposing of a stake, although, of course, the buyer may need its own approvals.
There is, however, an obligation to notify the regulator if you drop down a controller band, for example, if you go from 25 to 15%. Certain firms, such as insurance brokers, have a single 20% controller band, which simplifies things considerably. This means a buyer would only need approval if they intend to cross that 20% threshold. And once crossed, they can increase their stake without needing further approvals.
The second category are indirect regulatory obligations of controllers. Unlike regulated firms themselves, controllers are not directly subject to PRA or FCA regulation. Of course, if regulatory approval was given subject to conditions or undertakings from the controllers, controllers may have direct obligations to the regulators. In that case, controllers will need to ensure that any conditions to the approval are satisfied, within the timeframe agreed with the regulator.
They will also need to be ready to comply with and perform the terms of any undertakings given if called upon to do so by the regulator. Even in situations where controllers do not owe direct obligations to regulators, they need to be mindful of their role and status, as regulators have a range of powers that indirectly affect controllers.
For example, if the financial performance of a regulated firm deteriorates, regulators may impose a dividend blocker on the regulated firm, which prevents controllers from benefiting from their investment. Regulators may also call upon controllers to contribute additional capital into regulated firms if their financial situation requires it. And in very serious cases, the PRA and the FCA have the power to apply for court order, forcing the controller to sell their shareholding.
Rob, there are two other key concepts we haven’t yet discussed, acting in concert and significant influence. Why don’t you run us through the first?
Rob Chaplin (10:21):
Thanks, Olivier. Acting in concert is a concept that allows the regulator to aggregate two separate shareholdings or voting rights for control purposes.
Two or more people are considered to be acting in concert once they take the decision to exercise their rights in accordance with an agreement between them. This could be by signing a formal shareholder’s agreement, but any agreement to vote or not vote shares in any way may satisfy the definition. The concept of significant influence is another way for a person or entity to become a controller, even if they do not meet the applicable shareholding or voting thresholds.
If a person holds any shares or voting power in a regulated firm or its parent, and as a result of this can exercise significant influence over the management of the regulated firm, it is a controller and requires regulatory approval. These rights could come from a shareholder’s agreement, a contract with a regulated firm or a group entity, or a more informal arrangement.
Olivier Peeters (11:32):
Rob, we haven’t talked about the recent consultation paper that was released by the PRA and the FCA yet. Let’s spend a few minutes on that.
Rob Chaplin (11:41):
Yes, thanks, Olivier. The PRA and the FCA have released a consultation paper that proposes that the existing European Union guidelines on changing control approvals, which were retained post Brexit, will be replaced by UK specific rules and guidance. These changes are said to be tailored to the UK market and the UK’s regulatory approach post Brexit.
In summary, there are new information requirements for private equity, or PE funds, hedge funds, sovereign wealth funds, investment firms, and crypto asset businesses. There is also revised guidance on the significant influence threshold, and when a decision to acquire control has been made that would trigger a regulatory approval requirement, which is specific to PE and other fund structures.
The new regime will be implemented through a new PRA supervisory statement, a new FCA guidance, drafts of which are appended to the consultation paper. Let’s go through the proposals for key controller concepts. First up is the decision to acquire.
The regulators have clarified the established guidance to determine when a person has decided to acquire, increase, or dispose of control. Recall that this is the time at which an obligation to notify the regulators arises. Relevant factors for the assessment include whether a proposed buyer was aware, or should have been aware, of the acquisition or the transaction giving rise to it, and whether the acquirer had the ability to influence, object to, or prevent the proposed acquisition.
This means that limited partners, or LPs in fund structures, may be included as controllers. LPs might previously have argued that the general partner or manager of the fund makes any decision to acquire, and not the LPs, which may have obviated the need for the LPs to obtain pre-approval. But the regulators have made it very clear that they expect there to be a finding of a decision to acquire control in almost all circumstances, as almost always, the acquirer will have taken or omitted to take certain action, which would’ve contributed to the circumstances leading to an acquisition or a control threshold being crossed.
The only examples that regulators give of an instance where there is no decision to acquire, is the involuntary crossing of a threshold, as a result of a repurchase of shares by another person, which reduces the overall share count, thereby increasing the percentage shareholding of the remaining shareholders.
This is a very narrow illustration which may indicate a hardening of the approach to acquisitions by fund structures and the treatment of LPs. Next up is the concept of significant influence, which is developed for a list of UK specific examples that regulators have encountered, regarding, for instance, board seed rights, regular transactional interactions, and contractual or other veto rights relating to the regulated target firm. These are listed as examples, which potentially amount to control based on significant influence.
Going forward, close analysis of governance and other rights would likely have to be carried out, as well as early engagement with the regulator, to determine whether there is significant influence. This approach has the potential to introduce a level of discretion and uncertainty in controller assessments. Olivier, please run us through the additional information requirements on certain types of entities in the consultation paper.
Olivier Peeters (15:31):
Of course, Rob. The proposed additional requirements would apply to five types of entities. First, private equity, hedge funds, and sovereign wealth funds. Ownership at 20% or more of a regulated firm by a PE or hedge fund will likely trigger a requirement to provide regulators with various additional information.
This includes a detailed description of the performance of previous acquisitions in financial institutions, details relating to the investment policy, and any restrictions on investment, including investment monitoring, investment rationale, and the exit strategy, as well as the framework for investment decisions and details of the decision-making individuals, as well as the anti-money laundering procedures and framework of the proposed controller.
In addition, sovereign wealth fund owners would be required to detail the government department defining the fund’s investment policy and the department’s influence on the day-to-day operations of the fund, as well as on the regulated target firm, details of the investment policy and restrictions on investment, and details of the decision-making individuals. This is significantly more comprehensive of a burden than the current general practice of the UK regulators.
Second, investment managers. For investment firms, the FCA may require additional financial information where the acquisition might result in or add to a consolidated UK investment group, such as group forecasts or management accounts, and proof of an ability to satisfy the capital and liquidity standards applicable.
Third are crypto asset businesses. The FCA will likely engage relevant stakeholders to assist with their controller assessment, which may lead to additional information being required for the assessment.
Fourth, holding companies. If the transaction results in a buyer becoming a parent financial holding company, or a parent mixed financial holding company in the UK, of a consolidated group containing a UK bank or certain large investment firms, the company must complete an application for a PRA approval or exemption. Fifth and last are cases of multiple authorized firms.
The regulators expect that a transaction leading to control of more than one regulated entity will require additional information on potential conflicts of interest. This shows that the regulators intend to adopt a process which is more sensitive to the specifics of a given transaction, For example, if the buyer is already regulated by an equivalent regulator in another jurisdiction.
The FCA has also indicated that it would vary the intensity of its assessment and the information requirements in accordance with the nature, scale, and complexity of the proposed transaction. Examples of this would be intragroup transactions, where the regulator will apply a reduced information requirement, and focus on the transaction’s effect on the internal group structure, but also transactions where the proposed controller is already known to the FCA based on up-to-date information, where the FCA may be satisfied with assessing only the corporate entity at the top of the control chain.
If there is a change in the nature of a controller, like a controller moving up a band, the assessment may be limited to changes that have occurred since the most recent assessment, or to propose changes affecting the regulated firm.
Rob Chaplin (19:09):
That’s an excellent note to end on, Olivier. Thank you to our listeners for joining us. We hope you will continue to tune in for future episodes. If you have any questions or comments on any of the topics we spoke about today, or insurance regulation in general, do please feel free to contact us. Thank you, and we hope you’ll join us next time.
Thank you for joining us on the Standard Formula. If you enjoyed this conversation, be sure to subscribe in your favorite podcast app so you don’t miss any future episodes. Additional information about Skadden can be found at skadden.com.
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