Brexit financial services risk update - are we nearly there yet?

31 July 2019

With a new Boris Johnson-led government putting No Deal back on the table and a new European Commission remaining consistent in refusing to re-open the Withdrawal Agreement before 31 October, firms will be grateful that the decision to postpone Brexit earlier this year means they still have some time remaining to prepare. So how have firms used the extra time? And have Brexit risks reduced or have new ones emerged?

According to the Q2 update of the CBI/PwC Financial Services Survey, Brexit is now a lower priority for the sector than IT or technology-led transformation. This shows that wider threats to the profitability of business models and the challenges of technological disruption are biting on firms. This also reflects that most firms have used the postponement of Brexit to October to progress planning as far possible under the circumstances. A PwC survey carried out in May of a number of financial services clients shows most firms have established or converted EU-27 entities to be able to serve customers after Brexit. However, this progress and changing priorities does not mean that the sector is fully prepared for a no deal scenario in October.

Through its Temporary Permissions Regime announced last year, the UK has sought to ensure continuity of service for EEA firms in the event of a No Deal by providing time-limited permission for firms to continue business as they seek permanent authorisation. While the EU has taken a number of targeted actions at Union-level, such as temporary equivalence for UK CCPs, a lot of risk mitigation steps have been taken by member state regulators within their own jurisdictions. These have tended to focus on measures to protect residents from cliff edge risks, like permitting the run-off of insurance and derivative contracts.

Gaps still remain in a number of important areas for financial services, including UK data adequacy, the lack of permanent equivalence for UK CCPs, and the lack of temporary equivalence under MiFID. The recent saga of Swiss trading venues also shows that nervousness about whether equivalence can be relied on long term adds to the uncertainty firms face beyond Day 1.

This uncertainty is compounded by low client appetite for migrating to new EU-27 entities which has made the process of novation slow, and has added to wider concerns firms have about the sustainability of EU-27 operations after Brexit. The macro picture also looks unclear for the sector with key structural questions around the fragmentation of liquidity and the broader impact of economic performance remaining unclear.

New risks have also emerged since the movement of the Brexit deadline to 31 October. Unlike previous deadlines, Brexit is now due to happen during the trading week rather than over a weekend. Firms will not have the extra time afforded by the weekend to react to the new dynamic at a time when markets are likely to be extremely volatile. This increases the risk of disruption at a point when operational resilience will be stretched across the sector.

It’s also not straightforward for firms to simply dust off the plans they had developed for March. Different market effects exist in October/November than in March/April in addition to the fact that firms need to ramp up preparation for a second time in a year. The relationship between financial services and real economy industries is also very important at this time. October/November is an important sales period for many businesses, as well as being a time when inventory is being built-up for Christmas and New Year.

Manufacturers have already spent significant resources on stockpiling and bringing forward scheduled maintenance outages this year and doing so again will require a lot of flexibility from businesses and their workforces. Increased demand for financial services is likely to support these activities at a time when the risk of disruption to markets is greatest.

While both financial services and other sectors can use the remaining time to further calibrate plans, all eyes will be on the new office holders in London and Brussels to see whether progress can be made to avert some of these risks, although businesses will continue to prepare for the worst.

Andrew Gray

Andrew Gray | Partner
Profile | Email | +44 (0)7753 928494

Connor MacManus

Connor MacManus | Director
Profile | Email | +44 (0)7718 979428

Daniel de Búrca

Daniel de Búrca | Manager, FSRI
Profile | Email | +44 (0)7483 373960

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