The Plan to Avert Banking Chaos In a No-Deal Brexit

(Bloomberg) -- U.K. Prime Minister Theresa May is still trying to negotiate a Brexit deal with the European Union that can get through the British Parliament. But as March 29, or Brexit day, approaches, Britain’s financial industry and its regulators have also been preparing for a sudden exit from the EU without an accord or transition period -- a so-called no-deal Brexit. Here’s the good news: The U.K. and EU have been rolling out contingency plans to smooth the business of banking and securities trading and avoid a financial catastrophe.

1. Why is Brexit such a perilous issue for banks?

Because longstanding working relationships between the City of London financial district and firms on the European continent were built on the rights and privileges inherent in both sides being part of the same jurisdiction. Initial hopes that British firms might maintain full access to the EU through so-called passporting rights, or through a sweeping agreement between regulators, came to nothing, leaving banks and other financial-services companies needing to take a range of smaller measures to be ready for the upcoming divorce.

2. What steps have been taken?

U.K. banks and insurers are getting EU licenses and shifting some operations to one of the bloc’s other 27 countries to ensure they can continue doing business the morning after the U.K. leaves. Five of the largest banks looking to serve continental European customers intend to move 750 billion euros ($846 billion) of balance-sheet assets to Frankfurt, according to people familiar with the matter. That ensures the new operations are sufficiently funded and in line with demands from supervisors such as the European Central Bank. People have been moving too: Initial estimates that 20,000 financial services jobs might have to relocate have turned out to be too high, though some large banks are still moving several hundred positions. Banks are taking a wait-and-see approach before moving more staff.

3. What have regulators done to help?

EU officials in Brussels arranged for the bloc’s firms to be able to continue using critical London-based market infrastructure even if there’s a no-deal Brexit. This includes access to the London Stock Exchange Group Plc’s clearing unit, the most important clearinghouse for the multitrillion-dollar interest-rate swaps market, as well as central securities depositories, which settle trades in equities. (Ireland has relied on a U.K.-based firm called Crest to settle trades since the 1990s.) U.K. officials have spent the last year laying out a system of temporary permissions for firms wishing to do business in Britain. The U.K. Financial Conduct Authority and EU market regulator struck a deal on how they’ll cooperatively oversee mutual and hedge funds, which means trillions of dollars worth of EU-authorized investment funds can remain under management of traders in London. That cooperation agreement was a big relief to the fund industry, which has major operations in Ireland and Luxembourg.

4. What’s still to be worked out?

Industry groups are pressing Brussels to allow European firms to continue buying and selling stocks and derivatives on U.K. trading venues, as they do now, no matter what happens with Brexit. The industry wants the same type of broad arrangement for trading venues as clearinghouses have received, to avoid breaking up pools of liquidity. The EU commission has however limited itself to measures needed to safeguard financial stability, while ruling out that it will resolve any economic problems arising from Brexit. The European Securities and Markets Authority has meanwhile said it’s looking into the issue with a view to avoiding disruption “as far as possible,” signaling that some surgical measures may still be possible.

5. What happens to existing contracts between U.K. and EU firms?

They won’t necessarily become invalid the day after Brexit; the problem is the activity needed to service them. Some so-called life cycle events, such as extending the maturity of a trade, could require an EU license -- which U.K. firms are about to lose. Coming up with a fix is a matter for national governments, and there’s been no shortage of activity. Countries including France, Germany, the Netherlands and Sweden have taken steps to grant temporary licenses to U.K. firms or otherwise make sure that contracts aren’t disrupted. The industry has raised some concerns over the patchwork of differing approaches. The EU commission is meanwhile trying to make sure that all countries are aware of the challenges.

6. Is there a problem with debt sold by EU banks?

EU banks have often turned to London’s deep capital market to sell debt, or at least issued securities under English law because it was universally accepted by international buyers. They also did so when selling bonds that can be used when they run into trouble, which is a regulatory requirement to protect taxpayers from paying for future bank failures. Without any steps by authorities, a big chunk of banks’ issuance could cease to be counted toward these requirements. In the worst case, firms would be forced to re-issue the debt under different conditions. The authority responsible for banks in the euro area has signaled that it may grant firms more time to fulfill their requirements if they face a shortfall because of Brexit.

7. Can data still flow between the U.K. and the EU?

Not necessarily. Under the EU’s new data-protection rules, firms can’t simply send personal information outside the bloc. Regulators have warned banks to check where the data they handle is stored and to take “mitigating actions” if needed. The commission in Brussels has said that the bloc’s framework provides plenty of tools to deal with cross-border data flows, and that it doesn’t plan to issue the kind of broad “adequacy decision” that British lawmakers have called for before the Brexit deadline, which would recognize the British rules as equivalent.

8. What could a no-deal Brexit mean for capital requirements?

In theory at least, an EU bank’s exposure to a non-EU country such as post-Brexit U.K. requires more capital behind it. In a similar vein, the U.K. government has warned British firms that they may no longer be allowed to treat EU sovereign debt as risk-free if there is no Brexit deal. Both sides could decide that exposures in each others’ jurisdiction don’t present increased risk, which would extend the status quo. In the EU, this step also would fall to the European Commission, which has in the past issued such equivalence decisions for countries including Brazil, China and Saudi Arabia. U.K. regulators say they will proceed slowly with any change to firms’ capital ratios, because it could have a big impact.

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