For the past three years, there has been unprecedented political uncertainty surrounding Brexit. Now, with less than 100 days until the UK is due to leave the European Union on 31 October, this has not abated. In the absence of a deal with the EU, the majority of banks have implemented the first phase of their contingency plans.
Banks which have relied on their UK presence for European access are at risk of being impacted the most. As a contingency to overcome the potential loss of access, banks have created or expanded the banking licenses of existing EU-based entities.
The uncertainty around the transition and the departure from the EU has resulted in fragmentation of entities, with banks maintaining European entities in the UK and EU27. This has given rise to the duplication of Financial Market Infrastructure (FMI), including central counterparty clearing (CCP), exchanges and venues, which could have the following consequences:
- Increased capital costs caused by reduced liquidity and rising trading costs for clearing members due to higher capital requirements
- Duplication of membership fees and costs due to the dual CCP memberships required to provide clearing capabilities to both entities (UK and EU)
- Increased balance sheet costs and the netting of trades and funding another entity
- Reduced collateral optimisation
- Increased default fund requirements, as banks will have to maintain dual membership
- For the same CCP, a UK affiliate clearing member and an EU27 affiliate member or
- For two different CCPs, a UK CCP and an EU27 CCP
- Rising margin requirements where there are lower risk netting and cross-margining effects at the portfolio level (depending on diverse customer base and volumes cleared).
Given the uncertainty around the form that Brexit will take, the length of transition period and future relationship between the UK and EU, banks must ensure that their contingency plans are robust enough to continue to operate in a ‘Hard Brexit’ scenario. However, where there is increased certainty, banks must define their medium to long-term strategy.
As part of banks’ strategies, they must address the inefficiencies of the current operating models and activities post-Brexit they want to participate in, whether it be in the UK or EU or both, given the additional costs and inefficiencies.
In the short term, Brexit programmes must consider optimisation(s) of the models in the current landscape. Examples of this include collateral optimisation across affiliate entities, booking model changes to ensure the most beneficial treatment of risk weighted assets and streamlining and consolidation of memberships as the regulatory landscape becomes clearer. This will allow the EU operating model to become more efficient, ultimately reducing costs overall for the bank.
Find out how Capco can help your business to implement a robust Brexit strategy by contacting Kiki Pentheroudaki.