Regulatory challenges for banks in a no deal Brexit scenario

With the Brexit negotiations currently deadlocked and no clear route towards an agreement between the UK and EU-27, the chances of a no deal Brexit are higher now than they have ever been. The possibility of the UK leaving the EU without a withdrawal agreement and implementation period means that banks should ramp up their planning to meet changing regulatory requirements in both the UK and EU in the event of a no deal scenario.

If the UK leaves the EU without a deal it will automatically leave the single market and the EU’s regulatory framework will no longer apply. To ensure the UK has a functioning regulatory framework in this scenario the Government and regulators have been going through the process of ‘onshoring’ EU regulations into UK legislation and regulatory rulebooks. In the event of a no deal Brexit this will be the regulatory requirements financial institutions operating in the UK will have to comply with, at least in the short term prior to the outcome of the Government’s recently announced review into the UK’s financial services regulatory regime.

The intention of the onshoring process has not been to make substantive policy changes to the current EU requirements, but in a number of areas substantial changes will have to be made due to the UK’s exit from the EU. Many of these changes will be phased in, but a number of important changes will not, and banks need to be ready by the end of October.

Banks currently operating in the UK as EEA branches will be required to comply with the same rules that apply to other third country branches on 31 October 2019 (‘exit day’) subject to transitional relief in a limited number of areas (for up to two years after exit) such as the UK’s remuneration rules, status disclosure requirements to retail customers, and branch level P&L reporting but other requirements such as FSCS membership will occur from exit date. EEA branches should particularly familiarise themselves with the requirements that will apply under the Temporary Permissions Regime (TPR) which will allow them to continue to operate in the UK for three years after the UK leaves the EU.

UK authorised banks should also prepare for a number of Brexit related changes, taking into account whether they will take effect from 31 October or will be phased in. One consequence of Brexit is that the current preferable treatment applied to EU exposures to EEA institutions and assets will no longer apply in the UK. This means that the preferential treatment of EU-27 exposures and assets for the purposes of bank capital and liquidity requirements will end under a no-deal Brexit scenario, but will be subject to a phase-in period of up to two years.

Similarly EEA assets that currently automatically qualify as collateral under EMIR will no longer do so unless they meet the credit quality requirements currently applied to third country assets. Changes to the requirements around the contractual recognition of bail-in will require firms to include contractual bail-in clauses in the case of any new issuance (or material amendments) under EEA law of bail-in liabilities after Brexit by UK bank, with the exception of unsecured liabilities that are not debt instruments.

Both UK authorised firms and EEA branches should be prepared to report transactions to the FCA starting from exit day. This means they should begin preparations to connect to the FCA’s Market Data Processor (MDP) either directly or via a third party service provider, i.e. an Approved Reporting Mechanism (ARM).

The ECB is also increasingly vocal in its demands that banks speed up their planning for a no deal Brexit. In a recent communication the ECB called on banks to meet commitments made in their Brexit plans to build-up local risk management capabilities and governance structures. The ECB also reinforced concerns over current booking models which do not meet their expectations and the extent to which euro area banks are planning on providing services into the EU from the UK post-Brexit. The ECB also calls on banks to be prepared for a potentially different treatment of the UK under prudential regulation, including the treatment in exposures to UK assets and institutions.

Thanks to the extension of Article 50 firms still have some time remaining before we leave the EU to prepare and while there may be some flexibility from the regulators in specific areas such as strict compliance with the FCA’s transaction reporting regime, firms need to be working towards compliance on a best effort basis. So, banks should make strategic use of the extra time to finalise their preparations, ensuring that they are able to document evidence of their progress if requested.

Preparing for the suite of changing regulatory requirements in the UK and meeting the ongoing expectations of the ECB over the short term will be challenging for banks operating cross border, but it is of fundamental importance that banks continue to do so. The potential consequence of the changes to the UK’s regulatory regime and the ECB’s expectations is increased regulatory costs, meaning that once compliance with immediate changes is ensured, banks will have to assess the impact of the new regulatory dynamic on their business model and profitability.

Andrew Gray

Andrew Gray | Partner
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Mete Feridun

Mete Feridun | Manager, Financial Services Risk and Regulation
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