Will your Brexit plans meet European Central Bank expectations?

26 April 2017

By Nicola Shield and Conor Macmanus

The UK triggered Article 50 on 19 March 2017, starting the two year process following which it will leave the EU. Despite increased speculation over some form of transitional arrangements after the UK exits, banks that currently use passporting rights to access the EU’s single market must plan for a so-called ‘hard Brexit’ in 2019, in case politicians are not able to reach a deal.

Triggering Article 50 pushed banks to accelerate their Brexit planning. The Prudential Regulation Authority (PRA) brought the point home recently, by writing to all  banks, insurers and designated investment firms to request confirmation of their plans.  For all UK firms it supervises with cross-border EU/UK business, the PRA is requiring the boards of UK firms and the senior management of European Economic Area (EEA) branches to set out their plans to deal with Brexit. Firms’ responses must set out contingency plans for a scenario where there is no agreement between the UK and EU-27 and single market access is ended abruptly.

To future proof their single market access, most firms are considering establishing a new presence in the EU or increasing an existing presence. In the vast majority of cases, the EU jurisdictions firms are considering relocating certain activities to are in the euro area. The European Central Bank (ECB) has supervised significant euro area banks since 2014 under the Single Supervisory Mechanism (SSM), so understanding its views will be vital to banks’ plans. Insurers and investment firms are still supervised by national regulators, although in future we may see their supervision centralised at an EU level as well.

The ECB recently published guidance on relocating to the euro area, which provides helpful clarity to banks planning to relocate activities. It addressed a number of key supervisory issues which banks should review carefully and consider how it impacts their Brexit plans.

Meeting euro area authorisation requirements   

In the euro area, the ECB authorises all banks, and supervises those deemed to be ‘significant’ (i.e. banks with balance sheets over €30bn or with particular importance to a member state) . Even banks that would not be deemed ‘significant’ and would not be directly supervised by the ECB will need to follow the ECB authorisation process.

Banks wishing to establish a presence in the euro area should seek to engage the ECB and national supervisors early to smooth the application process. But banks should ensure they plan adequately for a prolonged authorisation process. The ECB aims to complete authorisation requests within six months, but the process can take up to a year. Brexit is likely to test the capacity of authorisation departments in the ECB and national authorities, extending timeframes for authorisation. The ECB will also expect banks to have operations and infrastructure in place well before it starts doing business and to build up the scale of business over time.

Many banks currently calculate capital requirements using internal models. The alternative of relying on the standardised approach to capital models can be significantly more capital intensive. A bank must have pre-approval from its supervising regulator (ECB or national authority) to use an internal model. The ECB has indicated that it will allow banks moving activities to the euro zone to use PRA-approved internal models for a limited period, but only under certain circumstances. Those banks planning on continued use of internal models - particularly to calculate risks such as counterparty credit risk - should ensure they engage early with the ECB and leave adequate time for model approval.

No ‘brass plates’

The ECB confirmed that it will not allow banks to operate with a minimal ‘brass plate’ presence in the euro area. The ECB expects banks it supervises to have significant risk governance capability locally, and to manage all material risks at the local level. The ECB will also expect euro area banks to be operationally independent and not overly reliant on outsourcing functions or services.  

Banks should ensure that plans for post-Brexit arrangements are consistent with the ECB’s expectations. For example, some banks are considering a back-to-back booking models, with market risks continuing to be managed out of London. The ECB has made clear that they will allow this model but would only consider this approach as a short term solution and on a case by case basis.

Many banks have been planning for a post-Brexit world for some time. The operational challenges for wholesale banking and capital markets posed by Brexit have been set out in a report PwC produced for the Association for Financial Markets in Europe (AFME).  But these plans are coming into even sharper supervisory focus on both sides of the channel. We now have greater clarity about supervisory expectations in the euro area. Banks must continue to make progress on their Brexit plans in a manner consistent with these expectations.  

If you are interested in a discussion around the topics raised in this piece please contact us at nicola.j.shield@pwc.com and conor.macmanus@pwc.com

Nicola Shield: View Nicola Shield's profile on LinkedIn   

Conor Macmanus: View Conor Macmanus' profile on LinkedIn   

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