Brexit: Over-cooked, over-done and perhaps not the main course

Over the past few months; most of us have been trying to make sense of the actual state of affairs that will occur due to Brexit. We have used our regulatory know how to dissect the legal parts, look at the state of affairs in the market and the various reports from official and un-official sources.

The obvious conclusion to draw is that aside from being an incredibly polarising topic, there is a lot more noise being generated than is warranted, which is not perhaps surprising in the new climate of ‘Fake News’. However, once the politics are stripped away, we can begin to look at this as essentially a ‘change project’ whose parameters are still being formalised, in which case the following areas begin to crystallise:

• More siloed operations (UK vs EU27): Banks are going to have to split their operations with regard to European entities, particularly for execution, and potentially for clearing and risk.
• Split CCPs (clear EUR vs clear everything else): ESMA and the EU27 have clarified their position on EUR clearing, which is not necessarily aligned with market participants, and may make the EUR an increasingly illiquid proposition. Together with cross Atlantic concerns on clearing and the recent agreement on margining, it is highly likely that clearing EUR will need to be split as a distinct process from other currencies, if not a split in the Prime Services offered by banks.
• Settlement and Execution: As has been reported in the press, execution is being moved to the EU27, however the same isn’t true of settlement. Early legal views included the creation of ‘risk-flat’ entities to effectively move the trade back into books in London and maintain current operations. Even without creating that model, there is little appetite to uproot well established operations teams. 
• Locations of customers will drive coverage and process: Whilst inherently obvious, there are going to be some tough decisions ahead. Should the business move country? Is a particular client or business now worth the increased cost? Do the customers want a more localised presence in the new landscape? Once again this is increasing the barrier of entry to the market, which in the long term is not healthy as this reduces the overall number of participants.
• Locations of custodians: As market access is withdrawn or changed, the location of custodians and the mechanisms by which they operate will need to change and require most of the above points to be applied. This will also affect the clients of the custodians.
• Local ‘substance’ to be defined (ECB): The ECB have been keen to emphasise that banks moving to the EU27 must not just be a ‘brass plate’ or a post box, but must have ‘substance’. However, it is not entirely clear what this means, or even if the banks are listening. In a lot of cases current movement plans seem to be more about bolstering local operations (execution, sales etc) rather than creating a new subsidiary or creating a copy of the front-to-back business. There have been comments that the ECB are seeking to ensure that any risk taken on in the EuroZone remains within the EuroZone, however, this is also confusing the EuroZone definition with that of the EU27. Again, this will mean partitioning operations and processes.
• Status of clients and permissions: Defining what are they able to transact and process within, across and between the EU27 and UK jurisdictions.
• Global market remains in UK (need to access via London):  The current liquidity volumes from the Bank of International Settlements show the gross Eurodollar market (UK) is twice the size of the US and a factor of 10 bigger than the next nearest EU market (France). It is interesting to see the figures within the BIS survey imply that there is minimal EU27 to APAC traffic, implying a strong inward focus of the bloc, with the main global link being via the US through London. Also USD/EUR has been dropping with a corresponding uptick in USD/APAC pairs.
• Repapering (ISDA Master Agreements Updated): A consequence of coming out of the EU is that disputes settled in UK courts are not automatically recognised in EU states. The current ISDA agreements mean that an Italian counterparty facing a French counterparty would need to persuade the courts of both countries to accept the UK verdict after Brexit. This is unlikely to be a problem for a UK broker unless the client wants to choose a different jurisdiction; it is more of a problem for a EU27 bank. 

So what can be done?

Whatever the final outcome, it will come down to the same issues that have been at the crux of change projects for decades:

• Where is the data?
• Who has control of the data?
• Who needs the data?
• Is the data reliable?

Currently all the data about contracts will (hopefully) be sitting in the same place. After Brexit, it will need to be split and sent down differing workflows, revalidated, potentially be enriched and controlled. This need to change should be viewed as an opportunity to mitigate the cost of creating new organisations by using technology to apply workflows, look at the overall data landscape, ensure regulatory compliance and perhaps consider a ‘spring clean’ given the impending GDPR regulation coming around the corner.

In summary, any changes will need to be able to demonstrate:

• Control: i.e. nothing has been dropped, contracts are moved, repapered, reported and settled as before, and if necessary, closed out.
• Data quality: i.e. client data specifically is up to date, current, and, if required, removed. In the case of EU citizens, data is in compliance with GDPR, and in the UK, with the ICO guidelines (which will be a copy of the GDPR in UK law). BCBS239 will also be a factor in the current and any new systems.
• Transaction handling: i.e. any changes to the current front-to-back process now enable EU specific transactions to be tracked, isolated, and adhere to data and data privacy standards.
• Permissible business: i.e. some activities will no longer be permissible to be sold into EU clients from the UK, such as being a Systemic Internaliser (under MiFID). Controls will need to be established around these areas and Prime Services may also be similarly affected.
• Change management: i.e. changes to post-Brexit processes (particularly changes that move operations cross-border) also face a regulatory burden. This ‘New Normal’ will mean change management needs to incorporate compliance with the present regulatory stack in the UK, since the UK will lose equivalence with other G20 regulators as it leaves ESMA. It will also mean the requirement to report the same transaction to more regulators if they do not recognise the FCA/BoE as equivalent.
• Process: i.e. there will be more, or there will be the same process, but run in multiple places. However, this is also an opportunity to use technology to automate, and minimise, staff increases which can save cost and increase coverage.

So, whilst there appears to be a daunting amount of upheaval related to Brexit, the overall task can really be considered as a change project that can be broken down into manageable programmes, which is what the financial services industry is experienced at managing.

Even though there is much to be finalised, current early ‘no regrets’ actions which can be started include:

• Close engagement with clients to assess their changing needs and requirements as they respond to Brexit.
• UK and non-EEA banks and EU banks with big UK booking centres, that want to carry on trading with EU27 based counterparts firms will need to set up legal entities (and facilities / staffing) in EU markets, and EU firms need to set up legal entities and booking centres in the EU to mirror UK based operations.
• Preparation and planning for re-papering / amending contracts.
• Discussions with market infrastructure and services providers (CCPs, Clearing and Settlement CSDs, Custodians, etc.) to ensure continuity in post-Brexit environment.
• Implement changes in Finance and reporting to manage and control new entities and booking centres.

Overall there is still a large element of ‘wait and see’ to see what will be the final relationship between the UK and EU after Brexit and how this will affect all markets, including financial services. The EU27 has not really set out their position, whilst the Bank of England has declared the UK is “open for business”. We will just have to wait and see what arrives on the table; sadly, we won’t be able to send it back if it’s not to our taste!