Now and next: the transition
The COVID-19 crisis may have diverted attention away from Brexit but, with the end of the transition period looming, what steps have the banks been taking to secure a frictionless departure from the European Union?
The UK left the EU on 31 January, entering a transition period that is due to continue until 31 December. This journey has, of course, been overshadowed by the arrival of the pandemic but, despite the challenges of recent months, ensuring a smooth exit from the Brexit transition period continues to be a priority for the financial services industry.
Fortunately, considerable progress had already been made towards this goal before the current crisis began. “As banks look ahead to transitioning out of the COVID-19 pandemic, they can generally regard themselves as part of the solution to the economic difficulties of the pandemic, rather than part of the problem,” comments Michael McKee, Partner, DLA Piper. Where Brexit is concerned, he adds that banks “will mostly be well prepared for the transition, because they had to prepare for a no-deal Brexit in 2019 and those plans are still in place and available to be used”.
Deal or no deal?
At a speech given remotely in May, Nausicaa Delfas, Executive Director of International, Financial Conduct Authority (FCA), said: “We have continued to do whatever we can within our remit to prepare for a range of scenarios, and ensure as smooth a transition as possible.”
So which scenarios are banks preparing for at this stage? “I think there are only two scenarios in place: no deal, or partial deal,” says Trevor Williams, former Chief Economist at Lloyds Bank Commercial Banking and Visiting Professor at the University of Derby, who predicts that there will be no Free Trade Agreement (FTA). “It looks like there won’t be an extension either – while it’s not impossible at the time of speaking, an extension would have needed to be requested in June.”
Even if an FTA is secured, the impact on financial services may be less significant than many imagine, argues Conor Lawlor, Director, Brexit, Capital Markets and Wholesale, at industry body UK Finance. For one thing, he notes, there is a considerable difference between the implications for goods and services: “In January, deal or no deal, you’ll still be able to buy French wine or a German car; it may be more expensive or cheaper depending on the tariffs underpinning those goods. But financial services are highly regulated, and are underpinned by very different, sometimes changing and overlapping laws. Given the gap in rights and obligations for services between those inside and outside the single market there won’t be an awful lot you can do in the UK for a European customer once we leave. Where you can, it will require innovative solutions and navigating complex and differing legal and regulatory regimes.”
In practice, Lawlor says, “for services, a deal is closer to no deal than it is to passporting in the single market – therefore there is still a huge amount to do for January to ensure the industry is ‘match-fit’, even if we have a deal signed by the end of the year”. As such, the conversation has moved away from trying to synthesise elements of passporting for the UK “to simply being ready for a world in which we are going to be very far away from the single market”. For financial services, while an FTA can be a helpful stepping stone, the real benefits are likely to be seen through complementary supervisory cooperation and regulatory dialogues between key international markets.
Planning and preparation
Against this backdrop, McKee says that banks are, in general, “hoping for the best but preparing for the worst – i.e. assuming a no-deal Brexit will be the outcome.” He continues: “Consequently, those who have clients in other EU countries will all have set up subsidiaries in one or more EU countries to which EU-located customers have been, or will be, migrated. This will generally result in continuity of service for customers who have been migrated.”
A key concept in the Brexit journey is that of equivalence – in other words, whether jurisdictions are deemed to be at a similar level in regulatory terms and can therefore be recognised as an equivalent partner. Lawlor says that with equivalence agreements becoming increasingly politicised, progress has been slow – meaning it is unlikely that there will be a large number of equivalence agreements in place come January 2021.
“In January, deal or no deal, you’ll still be able to buy French wine or a German car. But… there won’t be an awful lot you can do in the UK for a European [financial services] customer.” Conor Lawlor, UK Finance
Indeed, Alex Szmigin, Risk Advisory Partner, Deloitte, notes that the scenario most banks are planning for remains very similar to when they started on the Brexit journey four years ago – namely “an expectation of no equivalence except in the area of central counterparties [CCPs]”. Szmigin adds that the European Commission’s publication on 12 July on equivalence has supported these assumptions.
That’s not to say nothing has changed. “The main area of divergence now to previous assumptions is around the ‘back book’ of legacy over-the-counter [OTC] derivatives transactions,” says Szmigin. He explains that for previous ‘no-deal’ situations – such as those in March and October 2019 – national regulators had announced some measures to enable UK-based firms to continue servicing EU-based customers’ existing stock of transactions. But as Szmigin points out: “This now looks more uncertain.”
As a result, he says, “most banks are assuming such measures will not be in place, and are commencing the process of notifying existing European Economic Area [EEA] clients that they will have to novate trades to their EU entity or will otherwise not be able to fully service existing contracts”.
Expectations and complications
At this point, the majority of banks have either received authorisation for their proposed EU entities or gained approval to repurpose existing entities. However, Brian Polk, Director, PwC, says that three main ‘end of transition’ tasks still remain for UK-based banks: completing EU entity staffing of senior roles; the transition of EU customer business; and developing a level of ‘self-sustainability’ of the EU entity for booking models and operational capability.
In the meantime, it’s fair to say that COVID-19 has diverted management attention away from this topic, as well as hindering activities such as hiring staff in the EU and the movement of personnel between geographical locations.
“EU supervisors expect banks to complete their post-Brexit business plans, and particularly want senior risk management roles to be locally resident, but COVID-19 complicates and delays the task of completing cross-border staff moves,” says Polk.
Szmigin also notes that the pandemic has slowed down the remaining EEA client transition activity, which in some cases was put on hold due to competing pandemic response priorities. “This, along with the migration of outstanding OTC derivatives back book products, will now require a concerted effort, both where COVID-19 impacts delayed moves and where EU clients expressed a preference to transition to the EU entity as late as possible.”
While banks may be well prepared for the end of the transition period, there is still the possibility of disruption, argues Williams. “On the whole, banks are well prepared to become third parties come 1 January 2021,” he says. “But that doesn’t mean there won’t be delays.”
Szmigin says that for UK end-user customers of EU27 banks, “limited immediate impact is expected due to the UK Temporary Permissions Regime [TPR], which can mitigate short-term impacts for EU27 banks with a branch presence in the UK”. However, he adds that potential disruption may arise for EEA end-user customers where they have not been able to transfer their trading relationship to an EU affiliate by the end of the transition period, and where impacted OTC derivatives back book positions have not also been migrated across.
In the meantime, negotiations continue. Polk points out that the outcome of the EU-UK FTA negotiations “will have a lot to do with the precise actions and priorities that banks set for completing their post-transition preparations”. He concludes: “Banks can expect that plans for staffing and customer outreach will need to be executed at speed, once the outcome of negotiations is clear.”