Brexit is top of mind, of course, for most of our banking clients in Europe and, indeed, across the globe. Given the current situation, there remains confusion, with many unanswered questions. Banks are working on a number of potential and alternate outcomes, depending on how it all unfolds.
While it looks unlikely to happen, the prospect of a “no deal” still hangs in the air. The impact of this would be immense on various parts of the global banking system, and in particular some of the financial institutions operating in the UK. Consequently, a number of recent announcements attempt to mitigate the affect that a “no deal” might have.
For example, the European Central Bank and the Bank of England announced that, if the UK leaves the European Union (EU) in a “no deal” scenario, UK-based derivative contracts would not have a legal basis, which could result in settlement contagion. Regulators have been working behind the scenes to assess and mitigate such systemic risks, with that particular example addressed through a cooperation and transition arrangement. Note, however, that systemic remedies are only temporary, pending negotiation of the future trading relationship between the UK and the rest of Europe during the transition period.
Preparing for what lies ahead
Meanwhile individual banks have analyzed the high-level impact of Brexit in all its forms and taken initial steps to create contingency plans and mitigate known issues, including the following:
- Set up the required legal entities to maintain operations in Europe
- Clarify and resolve membership of European banking bodies and clearing and settlement organizations
- Relocate European headquarters
- Review the legal basis of trading contracts
- Relocate and repatriate systems and operations to ensure continuity of business operations
However, this is as about as far as they can go for now, without any indication of what will happen next.
Whether Brexit is a “deal” or “no deal,” there is little foresight on the future. Review the entire withdrawal agreement as it stands currently, and you will see there is nothing in there about banking—zero. In the document outlining the basis of the UK’s future relationship with the European Union, there is only a passing reference to the financial industry, along the lines of “we will seek to have a close, open and harmonious” future together. This is in the realm of “known unknowns” and means there is little to no clarity at all for the banking industry. .
For example, currently, a German asset manager can sell products in the UK through the EU passport arrangement, and, as a contingency, may have already set up a UK legal entity to enable it to continue to sell in the future. However, it has no idea if its products will comply with potentially new UK rules post transition. While it may have done enough to cope with a “no deal,” it cannot act on anything post-transition day. .
Another example is London’s role in clearing many European originated or European denominated contracts. Presently, many of these contracts cannot be cleared in Europe as the capability does not exist, so temporary arrangements have been set up to allow a type of regulatory equivalency to allow banks to clear in London even in the event of a hard UK exit. .
In two years’ time, however, that arrangement will expire and, presumably, Europe will have its own clearing facilities. Banks might have to change their business processes once those facilities and regulations come into play. As of yet, we have no idea what these are. It is reasonable to suggest that there will be new clearinghouses set up, say in Frankfurt, which may mean the end of London dominance and a ripple effect on banks’ businesses, processes and systems. .
London has a huge asset management business that serves domestic, European and global clients and intermediaries. This business drives many of the banking services in the city. As a result, it might be that London will not suffer from Brexit as long as asset managers stay there. However, if they leave, the consequences could be huge. Presently, there is no real reason why they would leave, and no one is predicting a big asset manager defection, but if prohibitive measures or new arrangements get introduced as a result of the post-transition agreement then, of course, it may be easier to move operations to Europe. It just depends on the barriers. .
So, all in all, while some of the big issues have been temporarily fixed to prevent major systemic risks and financial meltdown (in the event of a “no deal”), effectively it will be another 18 months of hard negotiation before we see what the new rules may be for the banking industry in the UK. Based on the time it has taken to negotiate the withdrawal agreement, it is anyone’s guess on whether all of those negotiations will be completed within the transition period. .
Regardless of the outcome, there will be substantial differences in Brexit’s impact on specific categories of banks, as well as specific banks within those categories. If you are a small UK domestic bank, for example, Brexit will probably have relatively little impact. However, for major European banks or, indeed, those from the U.S., Canada and so on, the impact could be huge to continue to operate within the UK. .
The reason why foreign banks are in the UK in the first place will determine the nature of the Brexit effect. For example, it may make sound business sense for a Japanese bank in the UK that is looking to serve Japanese corporates in Europe to move its headquarters to Europe. However, a global U.S bank in London may serve not only U.S. corporates in the UK and Europe but also may use London, for example, to trade Renminbi. Will the UK be a Renminbi trading hub in five years’ time? Will the UK be a successful offshore center for the rest of Europe? We cannot be sure. Depending on the answer to those questions, the U.S. bank may or may not relocate. Some strategic aspects are just completely unknown at this time. .
Given the uncertainty, it would be wise for banks to start looking at the possible effects of Brexit on a business-by-business and system-by-system basis. Specific regulations (GDPR, SEPA), trading, tariffs, tax implications and staff location are just a few areas to consider. For example, the UK may become a ‘third country’ with respect to SEPA, and how will the UK adopt PSD2? Could there be a return of card surcharging? Could the cost of correspondent banking and payments increase for UK businesses, as UK providers will no longer have direct access to central payments infrastructures in Europe? .
CGI has helped banks respond to critical market changes for 40 years and can help you navigate the potential impact of Brexit. Regardless of the outcome, the pressure on banks to make sure their systems and processes are fit for purpose will be immense, and they will need to work quickly. Employing agile approaches, new technology and automation techniques will be the best way to go. .
Feel free to contact me to discuss the potential implications of Brexit further. .