The Prime Minister's announcement of the Government's decision to trigger Article 50 (Art 50) and commence the process of the UK's formal withdrawal from the EU is momentous in many ways. However, for financial services firms - many of which have been working on their Brexit contingency planning for six months or more - the significance of today is that it means that they now have a maximum of two years in which to implement their plans.
We observe varying levels of preparedness for Brexit in the financial services sector. As expected, large complex wholesale banking firms which use London as their base to access the rest of the EU are well advanced in their contingency planning, and have already shortlisted two to three locations in the EU27 to establish a new entity. They will now move quickly to identify a single, preferred location and develop a selection of design scenarios for deeper regulatory discussions and implementation. Other firms which have done less detailed business and product line analysis will now mobilise greater resources to deepen their analysis to understand the full complexity of the challenge ahead. Art 50 should be the trigger for boards to satisfy themselves about any residual doubts they have concerning the implications of Brexit for their firm's business, including the impact of the "severe" scenario.
"Are two years really two years?"
For many firms which, after detailed business line and product level analysis, have concluded that they need to establish a new entity (Newco) in one of the EU27 Member States the two year implementation timeline is tight, given everything that needs to be done. One particular area which puts pressure on implementation timelines is the set of activities that can only happen in a sequential manner after Newco has been authorised. This includes activities such as applying for membership of Financial Market Infrastructures (typically six months or so) for trade clearing and settlement and novation of clients to the new entity. While a certain level of preparation can be done in advance for those activities, there are limits on how much progress can be made until Newco has been authorised
In the last few weeks, EU27 banking regulators have re-emphasised their message around the unacceptability of "letterbox" entities and their interest in, and scrutiny of back-to-back booking models. For most firms these messages have come as no surprise and they have been planning on this basis from the outset. But work has still to be done to design the detail in areas such as target operating model (TOM) and governance frameworks and gain agreement to them from both internal and relevant external stakeholders. Similarly, regulatory approvals for the internal capital models (or related transition arrangements) have to secured for the Newco.
Some of the areas that have proven to be most challenging in the analysis and design phase are the Newco TOM and its interaction with the existing UK entity, the short- and medium-term booking model, redesign of the shared service centre support, defining the extent of middle and back office outsourcing, developing a governance structure and projecting capital and liquidity requirements. These are all intrinsically interdependent and need near-, medium- and longer-term design and transition considerations. These details will be essential to support discussions not only with regulators but also with senior internal stakeholders.
Given the very short timeframe, the current focus of affected firms is very much on minimising execution risk by moving the least amount of activities to continue to be able to provide an uninterrupted service to clients and maintain access to relevant markets.
We have expanded on some of these issues further in the accompanying note to this blog.
Early regulatory conversations and flexibility will minimise client impact
The uncertainty around the timing and terms of cross-border market access between the UK and EU27 presents a contingency planning challenge for all affected firms. Implementation plans need to be flexible enough to adapt to the fluidity and uncertainty around the transition timings and terms of the future relationship between EU27 and UK. The Art 50 trigger is bound to focus minds at the most senior level as we move one step closer to Brexit. In the face of uncertainty a well thought out design underpinned by detailed analysis, with a carefully phased roll-out to allow for any opportunities that emerge as part of the negotiations, should ease the path for a successful business transition with minimal client impact.
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