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

(Bloomberg) -- Prime Minister Boris Johnson has committed to taking the U.K. out of the European Union by Oct. 31, with or without a deal. Britain’s financial industry and its regulators have been laying the groundwork for departure without an agreement or a transition period -- a so-called no-deal Brexit. The good news: The U.K. and EU have been rolling out contingency plans to smooth the business of banking and securities trading, with the aim of averting financial chaos.

1. Why is Brexit so perilous for banks?

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 adopt a range of smaller measures to 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 or more of the bloc’s 27 other countries. That will ensure they can keep doing business the morning after Brexit. They’re also planning to move more than 1 trillion euros ($1.1 trillion) in assets into the euro area to fund the new operations, according to the European Central Bank. Early forecasts of 20,000 financial services jobs migrating to mainland Europe proved on the high side, though some large banks are shifting several hundred positions. Banks have slowed down their relocation activity since Brexit was delayed to October; the ECB is pushing them to stick to their plans.

3. What have regulators done?

EU officials arranged for the bloc’s firms to be able to continue using critical London-based market infrastructure even in the event of 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 past 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 together oversee mutual and hedge funds, which means trillions of dollars worth of EU-authorized investment funds can remain under the 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 could still cause trouble?

Industry groups have pressed Brussels to allow European firms to continue buying and selling stocks and derivatives on U.K. venues, where for many securities liquidity is strongest. Traders were dealt a blow when the European Securities and Markets Authority ruled that EU firms must trade certain equities on platforms based in the bloc and not the U.K. Initially, the rule applied even to some stocks with a primary listing in London, including AstraZeneca Plc, Rio Tinto Plc and Vodafone Group Plc, but EU regulators softened their stance under pressure from lobby groups. The U.K.’s FCA says the EU’s policy could still cause problems, as some European stocks are primarily traded in the U.K.

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

The main issue here 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. This could affect 23 trillion pounds ($25 trillion) of uncleared derivative contracts, according to the Bank of England. Finding a fix is largely a matter for national governments; France, Germany, the Netherlands and Sweden have all taken steps to grant temporary licenses to U.K. firms or make sure contracts aren’t disrupted. While the industry has raised concerns over the patchwork approach, the EU is urging countries to step up their preparations.

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

EU banks have often sold debt on London’s capital market because of its sheer depth and the acceptance of English law by international buyers. Banks also turned to London to sell bonds that can be used if they run into trouble -- a regulatory requirement to protect taxpayers from paying for future bank failures. As it stands, a big chunk of banks’ issuance could cease to count toward these requirements. In the worst case, firms would be forced to re-issue the debt. The authority responsible for banks in the euro area has signaled that it may grant firms more time to fulfill their requirements if there’s a Brexit-induced shortfall. Still, the longer the U.K.’s divorce drags on, the less of a problem this becomes, since more of the debt matures.

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.” The European Commission says 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 a post-Brexit U.K. -- requires more capital behind it. Similarly, the U.K. government has warned how British firms may no longer be allowed to treat EU sovereign debt as risk-free if Brexit goes ahead without a deal. Both sides could decide that exposures in each others’ jurisdiction don’t present increased risk, extending the status quo. The European Commission has in the past issued such “equivalence” decisions for the likes of Brazil, China and Saudi Arabia. U.K. regulators say they’ll proceed slowly because of the potential impact.

The Reference Shelf

• Avoiding a Lehman moment for banks: The Brexit talks that worked.
• QuickTake explainers on a no-deal Brexit, data-sharing and on “equivalence.”
• London’s global dominance in derivatives has already begun to fade.
• A Bloomberg View editorial outlining Boris Johnson’s challenge.

--With assistance from Nicholas Comfort and Marion Dakers.

To contact the reporters on this story: Alexander Weber in Brussels at aweber45@bloomberg.net;Silla Brush in London at sbrush@bloomberg.net

To contact the editors responsible for this story: Sree Vidya Bhaktavatsalam at sbhaktavatsa@bloomberg.net, Andy Reinhardt, Grant Clark

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