‘Fog in Channel’ – The Disconnect between England and France

The rest of that phrase, from a long ago Times headline, reads “- Continent Cut Off.” It succinctly summarizes the past, present and probably future state of relations between two of Europe’s oldest nation states – England and France.

Although they have been closely linked for over a thousand years, they have never been exactly friends. The English still remember William the Conqueror’s victory in 1066, which imposed French rule and language on the country for over 200 years. The French still remember the ravages of the 100 Years War, when William’s descendants sought to rule France.

However, a few minor skirmishes excepted, the two countries have had peaceful, if not always friendly, relations since Napoleon’s final defeat at Waterloo in 1815. They’ve been allies in two world wars. Their rivalry has been kept alive mainly in the economic and social spheres.

The current global financial crisis has once more underlined the differences between the two countries, mainly over how much additional financial regulation is needed to reign in the ungoverned transactions that triggered the crisis. While the arguments are focused on the banking sector, the insurance industry has also been drawn into the debate.

There is a fundamental difference in philosophy as to what “regulations” – of any kind – are supposed to do. France, with its long history of central control, imposes a more stringent and intrusive type of oversight on business activity than the more free market oriented English. France describes U.S. and British businesses as being the “Anglo-Saxon” model – a somewhat patronizing circumlocution that reminds the French how lucky they are to have their government looking out for their interests. Oddly enough, no one in the UK or the U.S. describes the French system as the “Visigothic” model.

The latest “hot spot” in this ongoing debate surfaced with the appointment of French politician Michel Barnier to the European Commission (EC) in the key post as overseer of interior markets for the European Union, which includes financial regulation. As a former Minister of Agriculture (France receives billions of dollars a year in farm subsidies from the EU), he is known to be a strong supporter of toughened financial regulation. France’s outspoken President, Nicolas Sarkozy called Barnier’s appointment a “victory over the Anglo-Saxons.”

Although most English politicians would agree that some additional regulation of the financial community is necessary, they are also worried that too much restriction on financial transactions, or the adoption of plans to tax some of them, would drive business away from the City of London. The square mile area is far and away Europe’s largest financial marketplace, and, as Lloyd’s Chairman Lord Peter Levene pointed out, “UK financial services account for about 8 per cent of national output and contribute some 14 per cent of total tax revenues in this country.”

The City’s insurance community, which contributes a goodly portion of those revenues, is caught in the middle. On one end you have Lord Turner, the Chairman of the Financial Services Authority (FSA), which regulates both banking and insurance, calling some of the City’s financial transactions “socially useless,” and urging that they be stopped or taxed. On the other hand you have people like Lord Levene, pointing out that, while the global recession is serious, and the banking sector made serious errors, which should be addressed, “it is certainly not a reason for politicians and policymakers to start undermining the UK financial sector – which is one of this country’s great national assets.”

Actually, the City is now predominantly an insurance center, as most banks have moved to Canary Wharf. Why, those working there wonder, has their industry become part of the debate? As a good many spokespeople for the insurance industry have explained – insurance isn’t banking, it doesn’t have the same business model and it doesn’t pose the threats to the global economy that the highly leveraged banks do. Moreover, although insurers lost some capital during the initial stages of the economic crisis, claims were paid, and, with one notable exception, no companies went under and very few, mainly life insurers, had to rely on state aid.

Thomas Hess, Swiss Re’s chief economist and head of global research, speaking at the reinsurer’s economic review conference in London on Tuesday, singled out four essential differences between banking and insurance, as follows:
1) Contract characteristics – Insurance only pays for an insurable interest when a claim is made; capital market contracts are paid whether or not the counterparty has a loss.
2) Liquidity risk – insurance is “pre-funded” by premium payments, with some difference in life insurance; many of the liabilities of banks – deposits, savings accounts and commercial paper – are short term.
3) Contagion risk – very little between insurers, but interbank markets make banks vulnerable.
4) Unwinding of global groups – due to the long duration of liabilities, insurance regulators can unwind and liquidate insurers in an orderly manner; however, a run on a bank requires very quick action.

But he admitted that the industry needs to work a lot harder to convince the politicians to separate regulations for insurers from the banks. There is real concern among Europe’s insurers that recently announced proposals to include higher capital requirements in the impending Solvency II regulations, which are scheduled to go into force in 2012, will unduly restrict the insurance industry’s operating capabilities.

The London market has an additional concern besides Solvency II. The EC, which now features Mr. Barnier, has been pushing regulations for the subscription market that would alter many of its established business practices, notably that the following market obtains the same premiums as the lead underwriter.

These proposals directly affect London, where the world’s only successful (for over 300 years) subscription market, including Lloyd’s, operates. Others have tried to duplicate it, notably in New York and Frankfurt, without success. The arguments – pro and con – are complex, as is the market itself. Most of the City’s insurance community justify the way the subscription market works by pointing out that it covers mainly large and highly complex risks at suitable premium rates. They are also convinced that the EC doesn’t understand this, which makes dialogue difficult.

At week’s end both French and English politicians seemed to realize that the current economic crisis requires them to work together, rather than creating new hurdles. President Sarkozy and Barnier are both planning trips to the UK to discuss regulation, and have assured their London interlocutors that they don’t want to destroy the City’s financial underpinnings. Britain’s Chancellor of the Exchequer, Alistair Darling has gone on record in favor of Europe-wide financial regulations – as long as it doesn’t threaten the UK’s financial services industry.

As in the past, these two old rivals both need one another. It’s a prickly relationship, but for Europe and the global financial community, the fact the two countries are, for the moment, committed to reaching compromises is a good sign.

Topics Legislation Europe Market London