Federal Ministry of Finance, Germany, Director General, Financial Markets Policy
Central Bank of Ireland, Deputy Governor
Euronext N.V., Chief Executive Officer
Deutsche Bank, Chief Regulatory Officer, Member of the Management Board
HSBC Bank plc, Chief Executive Oficer
House of Lords, Member
Banque de France, Honorary Governor
Opening the roundtable, the Chair stated that the challenges and impacts of Brexit for the financing of the European Union economy form a very crucial and topical issue. Three questions were to be discussed during this session: the impact that Brexit will have, the ways in which the potential impact of the UK leaving the EU can be alleviated, and whether the supervisory arrangements should be reinforced.
1. Uncertainty about the future EU-UK relationship
1.1. Uncertainty about the outcome of negotiations and the potential impact on financial institutions
An industry observer began by stressing that, in the current market, the main issue that people are dealing with is uncertainty: this includes the corporate community, the ‘buy side’, the asset management community, and the banks. Globally, clients are looking at a two stage approach, the first stage of which is to anticipate the worst case scenario resulting from the Brexit negotiations. The second stage is to develop an end state solution based on a logical, rather than emotional, negotiation process, with their goals being stability and certainty.
An industry representative recalled that ahead of the Brexit vote, their institution had been clear that they believed a Leave vote would have an impact on the City of London, with a large number of roles moving from London to continental Europe. However, the vote has now taken place, and it is difficult to predict the result of the negotiations. Although their institution is anticipating a hard Brexit, the speaker predicts that London will remain an extremely important financial centre and the best place to headquarter an institution of major importance, and it will therefore continue to be based in London.
The industry representative added that their institution has tens of thousands of employees across the UK and the rest of Europe; several thousands of those employees are European Union nationals that are living in the UK. Hundreds of British nationals also work for this institution in other countries of the European Union.. It is therefore important that these employees should be given certainty and clarity on what is going to happen to them.
A representative of a public authority added that, at this stage, the future relationship between the UK and the EU 27 is uncertain. The positions that the British government has taken so far have considerably increased this uncertainty over the course of the past month. The deadline for Brexit is approaching, and in a recent survey, investors estimated a 40% likelihood of a ‘train crash’ Brexit, i.e. a Brexit without any agreement. The extent to which this will become a true operational risk mainly depends on how financial institutions prepare for it, and if these preparations have not yet begun, it is crucial that they should start immediately.
However, despite this uncertainty, a market observer expressed the view that if Brexit is managed properly, there will be no impacts on the financing of the EU economy. Everyone has understood what is at stake and has started to prepare, and if this is done well, there will be a very smooth transition to the new state.
1.2. How the UK approach to Brexit is perceived
An industry representative stated that a major reason for Brexit is that finance has been too isolated from the societies in which it operates. People underestimate the fundamental historical impact of Brexit, beyond the financial dimension: it is painful to see a European country decide to walk away from the continent’s common destiny that was built after the First and Second World Wars. This can be seen as a signal of de globalisation alongside other political events that happened in the US, in Russia or in Turkey. Business leaders need to adjust to a new reality, fundamentally changing their behaviours. The present situation is a new one, and much newer than many people think. However people will need to be in a position to address this in two years’ time.
This situation has occurred as the result of two fundamental mistakes, both of which are rooted in emotion: the first is wishful thinking. Many originally believed that Brexit would not occur; then, that the UK’s Parliament would not support it, that the UK would stay in the single market, that passporting would be maintained, and that the UK would benefit from a third country equivalence regime. Now, people are talking about a transitional period, which the industry representative regards as similarly wishful thinking. It is difficult to accept such a change in established ways of life and the cessation of good things that people have become accustomed to, but it is important not to engage in this wishful thinking.
The second mistake is nostalgia for the ‘good old days’, and regarding the past as something that will never change. The present day realities are blunt: the City’s prominent position is the result of three fundamental factors, which are London’s inherent competitive advantages such as the English language and a superior tradition of contractual law; the single market, which has fundamentally changed the size of the UK; and the Eurostar, which has been the ultimate facilitator of all of these things. The Eurostar is not at risk, and the UK’s inherent advantages will remain in place, but the single market is going to disappear.
Britain will need to decide which version of Brexit will prevail: an “English Brexit” that is nostalgic for the days before EU membership and Margaret Thatcher, or a “post modern City of London Brexit” that aims to free the UK from the complexity of Europe. Once Britain has decided which example it wants to follow – Zurich, Geneva, Oslo, Monaco, Panama, or Dubai – negotiation will be possible. It will, however, be very difficult to reach consensus between people who want to ‘take back control’ and those who have a mandate to improve and share control. Creating cohesion is going to be painful, and there will be incremental costs associated with doing so.
A market observer observed that the headlines in some British tabloids and the positions of Britain’s representatives during the negotiating process will be very different. Those who did not believe in the EU’s systems are having to learn for themselves how the EU works, which is why the UK side looks very unprepared whereas the EU side already knows how European institutions and rules work. In practice, ‘taking back control’ will mean that the UK will voluntarily do the things that it has previously been required to do. Recent statements regarding freedom of movement prove this: there is a target of 10,000 ‘in the distance’, and sometimes the UK may have to introduce controls, but essentially it will be taking in the people that the UK’s economy needs. As with David Cameron’s negotiations, there is a great deal of ‘over-claiming’ about what things mean.
1.3. Potential customer impacts
Panel members shared their experiences as regards the main concerns expressed by customers about Brexit, with one industry representative stating that it has frequently been expressed that separation between the EU and the UK will create de synergies and incremental costs. Another representative of the industry added that one significant concern is liquidity pooling; this is a logical area of concern for most corporate banking clients, and some are beginning to relocate their treasury locations or create backup plans. However, most customers are ‘getting on with it’, and some have identified opportunities as a result of Brexit. Brexit cannot be used as a reason to stop projects.
An industry representative noted that there is also concern about treasury funding, liquidity, where exchanges or CCPs will be domiciled, and the incremental frictional costs of accessing those utilities in the marketplace. 30 years ago, one of the predominant models had been correspondent banking; in many ways, there will be a reversion to this correspondent banking model, with certain institutions providing cross border access and certainty.
Another industry representative presented what they regarded as their priorities in this context. It is important to avoid market disruption in the period between the triggering of Article 50 and Britain leaving the EU, which means that, for instance, legal certainty in terms of existing contracts needs to be maintained. Institutions also need to continue listening to their customers, and remaining close to them; in addition, financial sector employees will need to be given some clarity about what their residency and employment status will be in the future.
2. Planning for a possible hard Brexit
A number of changes are anticipated as a result of Brexit; an industry observer stated that the first question that needs to be considered is what can be moved, and where it can be moved to. An earlier speaker during the Seminar mentioned the need for regulators across Europe to meet the increased burden of oversight, and all of the industry representative’s clients to whom they have spoken are considering the option of relocating some activities to New York. Another factor that needs to be considered is the difference between regulated and non regulated activities, and where these splits are in the entity’s organisational construct and what is acceptable to the regulator in a particular jurisdiction. Issues such as real estate, school places, corporate tax and effective tax all need to be considered, as well, and such a consideration takes time.
A industry representative stated that their institution is hedged: it has a physical presence in 22 European countries, and therefore anticipates that the impact of Brexit is not going to be hugely significant. It has tens of millions of customers across the UK and the rest of Europe, and it is therefore important to stay close to these people during the negotiation and the following transition. The institution’s customers themselves are engaged in scenario planning, and both UK and continental European customers are fairly cautious. It is therefore too early for the representative’s institution to make a decision about what it will do, because the outcomes of the Brexit negotiation are not yet known. It is anticipating various outcomes, but it will follow its customers.
At present, the institution is receiving requests for proposals, including in the area of cash management, where large corporates are asking it what its post Brexit strategy will be. As some of these contracts are 10 or 15 years long, these corporates need to be provided with clarity. There is a ‘lead time’ to making these moves; the representative’s institution has the shortest lead time possible, as it already operates in 22 European countries although some of the roles that will be moved are still in the process of being defined. However, a bank that does not yet have a presence in continental Europe will need to get a licence, infrastructure, and get their people to move. As that will take much longer, these banks may start preparations earlier.
Another industry representative explained that their institution has a significant presence in London; as such, Brexit is a very important development. It can be subdivided into three dimensions, which are issues, timing and cost. The more time that the institution has, the more issues it can deal with and the less costly the process will be. Four areas need to be looked at: licensing, client interaction, capital market activities and supervision. In relation to licensing, if a bank wishes to deal with its European clients from Europe, it will need to choose a location from which to do so. For the speaker’s institution, this is an easy decision: it will move to its home jurisdiction, a continental European state, where it is already completely licensed and has all of the appropriate agreements and authorisation. A bank that does not have this will need to go through the full licensing process, which may take some time and consequently will need to be initiated quite early.
On the issue of client interaction, sales people who want to deal with EU clients will need to be based in the EU. The representative’s institution, consequently, will need to consider moving some of its front office staff to continental Europe. Additionally, banks will need to decide where they want to book transactions, and although London is a large booking centre for this institution, in future, they will need to book interactions with European clients in their home jurisdiction. To do so requires significant IT capacity, which takes time to build up. Relationships will also need to be re documented, and onboarding and KYC activities will need to be done in the location where the bank has its client relationship and where the operation is booked. As such, if a bank moves a client to a booking place in Europe, it will also need to do the KYC process again, which takes a significant amount of time.
Another issue is risk management. Some supervisors in certain EU jurisdictions have stated that if an operation is to be booked in the EU, having the front office located in the EU is not sufficient and risk management capabilities also need to be based in the same place. This requires making significant additional local hires or transferring large numbers of people, and this cannot be done in a short period of time. If the goal is to do this within two years, then institutions will need to begin work now.
The third issue is that of capital market activities and notably the derivatives business, which, for the representative’s institution, is mostly done in the UK for its European clients. This is a matter that impacts everybody, not just the financial industry but also many corporate clients using different types of swaps. The speaker’s institution does millions of these transactions daily, and all need to be done in so called qualified CCPs; on the day that the UK leaves the EU, then UK based CCPs will no longer be qualified, and the capital requirement will escalate sharply. A solution to this will need to be found, but transferring an operation of this scale involving trillions of euros will not be easy. If a player is not going to do these activities in the UK any more, it will need to find a place where it can do these activities; a clearing house with the capacity to deal with these huge amounts of transactions, and a local supervisor comfortable with managing trillions in exposure.
The final issue is supervision: banks will continue to have activities in the UK, and there will therefore need to be interaction between the UK supervisors and the European ones. Dealing with a large number of different supervisors is not easy, and the future relationship between the ECB and the UK authorities (the PRA and the FCA) has yet to be defined. For banking institutions, this is very important: if trust is lost, and there is fragmentation in terms of liquidity of capital, this is going to be very expensive for the banking industry and have a negative impact on the broader economy.
A representative of a public authority added that in the short to medium term, cliff edge risks cannot be ignored, and these risks are predominantly on the UK side. His authority’s view is that the EU would be able to mitigate most, if not all, of these risks, and could do so unilaterally without an agreement if necessary. The EU needs to prepare for this kind of cliff edge as part of its negotiations. Nevertheless, prudent management of the transition towards a new arrangement for the City of London is in the interests of both sides, and transitional arrangements might be very useful in specific areas. However, as reflected in President Donald Tusk’s guidelines and the vote that the European Parliament has taken, these arrangements must be clearly defined, limited in time, and subject to effective enforcement mechanisms. The draft guidelines also mandate that there must be a phased approach to the negotiations, and Germany supports this approach.
3. Conditions for a continued interaction between EU and UK financial markets
3.1. Avoiding a circumvention of EU single market rules
A representative of a public authority summarised that Brexit is a disruptive event for both the UK and the EU; the government of the representative’s country will regret it, and wants to maintain the UK as a close partner. It also has no interest in seeing New York become the main beneficiary of Brexit, and this needs to be borne in mind by everybody who negotiates on both sides.
The first phase is disentanglement, and this will be the most difficult stage; only once it has been completed can the next phases begin. Ensuring future access, as well as potential equivalence, will require common, high regulatory standards and strong supervisory cooperation, ensuring common enforcement. This will give rise to tensions with the principle of the UK ‘taking back control’, and it is not clear how the UK will resolve these. The representative’s country would also require a level regulatory playing field that covers areas such as competition and state aid law, and a framework that enables the EU 27 to manage financial stability risks that concern the Union. In the longer term, the EU needs to develop a stronger, more efficient and more resilient financial market of its own, and work towards that goal is in progress, with Capital Markets Union (CMU).
A market observer commented that there is a need to be clear about the consequences of leaving the EU. It must be made clear that the single market is something that has a strong logic underlying it, with a single set of regulations, a single judiciary power, and a coherent regulatory and supervisory framework. This has been made clear for a number of years by the European authorities, and countries that do not accept this cannot be part of the single market; although the EU has financial relationships with a number of third countries, including its close relationship with Switzerland, this is not the same as being part of the EU. It must be made clear that there will be changes for the UK, and there must be clarity also that ‘brass plating’ will not be allowed, as this would circumvent the rules of the single market. The ECB has already made this clear in relation to banking activities, and the European Commission – and particularly ESMA – ought to do the same as regards asset management and market activities.
3.2. Clarity about the transition period
A second area in which there needs to be clarity is that of a transition or implementation period, a market observer stated: this should not involve an indefinite amount of time, but should cover the amount of time necessary for each kind of activity to migrate in a safe manner, without operational risks. Another speaker has mentioned the possibility of a three year period to relocate derivatives activities, and if relocation begins in mid 2017, this will mean that a longer period than the two years foreseen by the treaty will probably be necessary. For banking activities, three years might be enough; however, it ought to be clear that this transition period will be allowed, so that there is no panic. Another market observer observed that the UK has already said that it will not change the arrangements for banks that branch into their country, which will aid the transition period.
Over the next six months, the issue of mutual recognition will be key. Within the next two years, there will need to be some sort of conclusion and mutual agreement regarding how to proceed, which is quite a significant challenge.
The market observer noted that equivalence is important, but has always been viewed as something that can help ‘at the margins’. For example, the EU has negotiated equivalence agreements with the US to avoid having double registration of operations in trade repositories in Europe and in the US, or having two clearings for the same operation in Europe and in the US. Equivalence cannot be a means of circumventing the rules of the single market; it is something that is useful, but limited, and the same applies to delegation as it relates to asset management. Funds are managed in the US that are sold worldwide, and funds managed in Europe are also sold worldwide; however, institutions cannot ‘brass plate’ registered funds in the EU delegating all the real management of the funds (portfolio management, risk management and control, compliance…) in another jurisdiction.
A representative of a public authority replied that they agree about brass plating: as since the banking union and single supervisory mechanism have been launched, it is not possible for UK banks looking to relocate to play one European jurisdiction off against another. The ECB’s supervisory board is working very hard to develop appropriate standards for the Eurozone, whether in the areas of internal models, booking models, large exposures, or liquidity; these will be launched soon.
However, the same system does not exist for asset management and insurance. ESMA needs to do something in relation to asset management, and is working on an opinion at present in order to spell out what is expected from EU based entities. This opinion will basically state that subsidiaries or companies in the EU should be deciding for themselves what to do. The decision-making should be in the EU including commercial decision making and balance sheet management. Firms should not be ostensibly managed by executives in the EU, but in fact operated from the UK. This is already the case for pan European firms based in Ireland: two very large companies have their group headquarters in the US or in Switzerland, but have true insurance companies with hundreds or thousands of staff based in Ireland, working for the EU as a whole.
In the area of insurance, two very large insurance companies have already announced where they are going to locate themselves in the EU, but it is not yet clear what the ratio is between the workforce that they will establish in the EU 27 and the size of their global business. It would be worrying if a company were doing 20% of its global business with 1% of its workforce; this would be clear circumvention. For the time being, authorisation will be given by national competent authorities in the 27 member states, which are independent.
Finally, the public authority representative agreed with a previous speaker that if a company has its client base in the EU27, then its sales force, onboarding of clients, and risk management should also be based there. At present, many firms argue that while they will have some people based in the EU, there is still much to be gained from relying on London based expertise. That is not the way operations should be handled in the future.
3.3. Supervision of UK based entities that are systemically important for the EU
A market observer stated, on the issue of financial stability risks, that some critical activities need to be under the supervision of authorities that have a clear remit for the constituency those operations are dealing with. If activities are denominated in euros, it is not for authorities in other constituencies to ensure that financial risks or crises do not create systematic risk for the euro area. The Eurozone cannot ask the British government and authorities to add to their remit the future of the Euro area. The critical mass of systemic activities, including clearing, must take place under the supervision of the ECB, ESMA, and the European Union’s political authorities: the EU Commission, the Council, the European Parliament, and the interested governments.
A representative of a public authority agreed: clearing is currently under the supervision of NCAs, but it should not be. Either the ECB or ESMA should be given this responsibility, or a new, third agency could be created, but clearing should be supervised at EU 27 level.
Another market observer added that politics will not become involved in UK regulation. It is likely that, following the ‘great repeal act’, UK supervisors will take over many of the activities that are currently done by Parliament and the Council at the European level, which will help to depoliticise them. UK equivalence is done in a ‘broad brush’ way for regulatory and supervisory standards in a country, but looks very closely at whether systems for resolution are appropriate. The criteria that apply to third countries do not apply to EU branches, and the UK is not proposing to change this; however, the UK’s approach when third countries are lacking in terms of supervision is to propose supervisory sharing. Supervision is shared with the United States in relation to clearing, and the market observer does not believe there is a reason why, for sensitive and global issues, the same approach cannot be applied and hoped that this option will be explored during the Brexit negotiations.
4. Developing EU27 capital markets
4.1. A significant development potential
An industry representative stated that Brexit resembles a break up, and like a break up, the European Union now has a choice between wallowing in unhappiness or getting more involved in other aspects of its life. It will be difficult, because of the conversation that will need to take place regarding people and the outstanding divorce bill; these are fundamental issues, and it will be difficult to reach a deal on them.
The countries of the European continent, plus the Republic of Ireland, represent 86% of the GDP of the European Union. They have the highest concentration of large companies with a global strategy, and especially industrial companies, across the continent; the highest concentration of strong banks in good shape; and the highest concentration of population with a relatively high standard of living, which generates a huge amount of savings. The concentration of talent in Europe, the result of Western investment in education, drives innovation, and as such, global financial institutions can be successful if they make money in three markets: the US, Asia, and continental Europe. The eurozone needs to rediscover the energy it has had in the past, and to realise that it has the potential to transform savings into debt and into equity.
A market observer added that if the EU is cut off from London, which the speaker personally does not believe will be the case, there is no reason why the CMU cannot continue. It will be up to the EU to decide whether it wishes to link this with London, but if the EU is serious about the CMU it will have to sort out supervision at the EU level and simple securitisation. It will also have to remove politics from markets and supervision, being ‘open Europe’ and not ‘prison Europe’, and looking beyond the eurozone to other capital markets, as well as Asia and the rest of the world. The EU will also have to address the issues of non performing loans and banking. At the present time, some of the dossiers that are ongoing contain elements of politics, which are unhelpful.
4.2. The need to improve the EU supervisory structure
A market observer stated that something needs to be done about the ESAs in relation to supervision, but if the EU is serious about having a capital markets supervisor, this cannot be achieved just by empowering ESMA to take on tens of thousands of institutions. This issue is more complex than banking, and there is not an institution as strong as the ECB to take responsibility for it. Markets are more diverse than banks and much closer to issues of retail and consumer protection, about which Member States are significantly concerned.
If there is to be a European supervisor, this cannot be a supervisor that has no discretion, but this goes against the Meroni doctrine1. Somebody will have to clarify what Meroni means in relation to discretion regarding the ESAs. Following this, supervisors will need to be found who have the capacity to supervise all of these entities. For incoming entities (from the UK) that might be quite large, such as big broker dealers, there needs to be clarity about who will supervise them and whose balance sheet they will be on, or whether the notions of authorisation, supervision and balance sheet will be separated, and what it means to say that ‘the public authorities stand behind everything’. The UK already has experience of standing behind every bank, subsidiary and branch globally; that is why the UK’s national debt rivals that of countries that accumulated this debt just by spending.
The Chair concluded the discussion by stating that the debate, in a sense, has been worrying but has also brought some clarity; there is a need to think about the common ground, to be clear about all the different dimensions that are involved, and be very precise from a legal perspective. The outcome for the UK could be far short of a single market outcome, but a ‘win win’ solution with the EU is still possible. The European position must be made clear: Europe will not accept anything that fragments, weakens, or puts at risk the key principles of the European Union.
1. The Meroni doctrine sets the criteria to be met by delegations of powers from EU institutions to other bodies within or outside the organisation of the EU. The gist of Meroni is the following: a delegation must be explicit, justified and may only encompass powers the exercise of which can be reviewed in the light of objective criteria. In addition to that with regard to the institutional balance, the role of the EU Commission as the central EU authority must remain intact, for which reason the delegation of powers to other bodies must remain an exception rather than the rule. This requirement cannot be dismissed as irrelevant in the case of the ESAs. The EU’s agencification has brought about a shift of competences from the Member States to the EU level but has left the EC’s existing powers notably legislative powers untouched.