U.K. to End Zero Risk for EU State Debt on No-Deal Brexit

(Bloomberg) -- Banks in the U.K. may face an unexpected hit to their finances from British regulators if there’s no Brexit deal, further quashing hopes that they can carry on with business as usual.

The Treasury in London said banks won’t be able to treat debt issued by European Union governments as risk-free once the nation withdraws from the bloc. That will push up the cost of trading bonds and derivatives from the City because those activities will absorb more capital. The change was disclosed Aug. 21 as the government set out out how it plans to take European banking law into British legislation.

The City of London is already fighting to ensure it retains its rank as Europe’s pre-eminent financial hub, even as firms based there lose the passporting rights that currently give them wide-ranging access to the bloc’s internal market. And, while banks in London will have to review and potentially restructure holdings of government debt, British lenders would find themselves similarly penalized by the EU because mutual recognition rules would no longer apply.

“It’s a bizarre decision,” said Owen Callan, a Dublin-based analyst at Investec Plc, adding that some market-making would become “prohibitively expensive to do out of London.”

Leaving the EU means banks from the bloc with U.K. operations will “be subject to an additional layer of U.K.-led supervision” because Bank of England supervisors from the Prudential Regulation Authority will view them as standalone companies, according to the statutory instrument. The change was reported earlier by Global Capital.

While any change to risk weights will depend on whether the two sides can reach a deal, Brexit will mean new rules on liquidity. Currently, the U.K. operations of EU-based banks can rely on liquidity held in parent companies elsewhere in the EU because both countries are members of the bloc. That will change when the U.K. withdraws and local requirements come into force.

“It remains to be seen what liquidity requirements the PRA will impose on EU banks operating in London,” said Etay Katz, a partner at Allen & Overy LLP in London. “In a worst-case scenario this could be very penal.”

The Treasury said on Thursday it will bring forward legislation to give regulators a “general transitional tool, ” allowing them to phase in post-Brexit regulatory requirements for financial firms where they are the result of the U.K.’s withdrawal from the bloc.

“This will give firms the necessary time to adjust, and avoid cliff-edges at the point of exit,” it said in advice to companies on preparing for a no-deal exit.

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