Pru’s Hong Kong move

August 16 2019 by Nick Ferguson

Prudential is set to come under the supervision of Hong Kong’s regulator before the end of this year, chief executive Mike Wells said this week as he announced the company’s first-half results.

Between a new Brexit-loving prime minister in the UK, Trump’s trade war with China and the turmoil in Hong Kong, the Pru has lost a fifth of its market value since the start of July.

All three issues come with significant uncertainty, particularly for the company’s outlook in Asia, but Wells says that the situation in Hong Kong is not yet affecting business.

“We did not see an impact in our July sales, which maintained their positive growth trajectory, but of course, we’re monitoring developments on a daily basis,” he told analysts at an investor presentation on Wednesday. “The earnings dynamic of a strongly compounding revenue base here immunises our business for many potential short-term sales fluctuations.”

The strength of the company’s growth in Asia is one of the main reasons for demerging the more mature UK business — Asia operating profit for the first half of the year was up 14% and new business profit was up 10% — but regulation is also another driver.

Far from having to raise new funds from investors, the move to Hong Kong’s regulator should free up capital as the company says goodbye to the UK’s Prudential Regulation Authority.

“Assuming completion of the demerger in quarter four, this is the last occasion on which Prudential plc will report on a Solvency II basis,” said CFO Mark FitzPatrick.

Investors have long been asking the company to split the two businesses so the Asia operations could compete with local competitors on a level regulatory playing field, and the company provided more clarity this week about how its solvency position will change going forward.

After the demerger, said FitzPatrick, the company has agreed a new supervision framework with the Hong Kong Insurance Authority that will be known as the Local Capital Summation Method (LCSM) — until Hong Kong finalises its new group-wide supervisory standard, which is not expected to come in to force until the second half of 2020 at the earliest.

“The LCSM approach really is what it says, a summation of the available capital and required local capital of each business for regulated entities and IFRS net assets with adjustments for non-regulated entities,” he said. “When we talk about Solvency II, the thing that truly bites is the underlying capital level in terms of the underlying businesses, especially around Asia. And, effectively, the LCSM gives us a more direct route across on that particular piece.”

Also, around £3.4 billion (US$4.1 billion) of subordinated debt will be included in the capital calculations in Hong Kong.

On this basis, the demerged group’s solvency surplus at the end of June would be £7.7 billion with a cover ratio of 340%, compared to its current Solvency II surplus of 232%.

The protesters in Hong Kong have legitimate concerns about China’s Communist Party pressing for changes to the city’s rule of law, but most businesses are focusing their energy in the other direction — pressing for changes to the law in China that will give them more access to business opportunities on the mainland.

For insurers such as Prudential, those changes are starting to happen, with China easing restrictions on foreign companies owning controlling stakes. And this of course is another important driver of its decision to switch to Hong Kong’s regulator.

However, regulation was only one of the hurdles the Pru has faced in growing its presence in China.

“The second hurdle was the appetite of our partner to sell a proportion of that business to us,” said Nic Nicandrou, chief executive of the Pru’s Asia business, referring to the company’s long-standing 50:50 joint venture with Citic. “The timing which full ownership will now be allowed has in fact been brought forward by the Chinese government, but there is no change in the relationship we have with Citic at this moment.”

Even without a bigger stake, Nicandrou forecasts continued strong profit growth from the Chinese business. But with under Hong Kong supervision and rules that may soon allow it to own 100% of a business on the mainland, it will doubtless be keen to leverage the growth opportunity in the future.

Clarification: the original article stated that Prudential’s headquarters were moving to Hong Kong. Prudential’s current plans are to remain in London after the demerger.


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