U.S. banks and Brexit: ‘keep calm and carry on’ while planning for contingencies

June 28, 2016

The venerable English phrase, “keep calm and carry on,” might be appropriate for U.S. financial institutions as they grapple with unfolding drama of Britain’s separation from the European Union. With uncertainty clouding the timing, the broad shape and the ultimate fine print of the divorce proceedings, U.S. firms will need to consider a series of contingency options regarding their future operations in Europe. However, the greatest immediate test for compliance and risk management across all firms will be the likelihood of continued market volatility and possibility of improper conduct.

“Uncertainty in financial markets leads to volatility, and the (Financial Conduct Authority) will be monitoring the markets to ensure that understandable volatility does not result in improper market behaviour. Firms should have systems in place to address the volatility, observing proper standards of market conduct and reporting any activity in the market that they suspect does not meet such standards,” said Mark Compton of the law firm Mayer Brown LLP.

On Friday, it was estimated that global stock markets lost more than $2 trillion of value in the largest single day drop since at least 2007. Given continued uncertainty over just how Britain will leave the union, and the implications for future trade, investment and economic growth, markets are expected to remain volatile, requiring compliance staff to closely monitor trading positions, profit and loss statements, as well as counterparty credit risks given the potential for substantial losses.

With many investors having been caught wrong-footed on the seismic UK vote, the possibility of both internal bank trading losses as well as those among clients is not to be underestimated, say industry participants.

“We are all hands on deck regarding position monitoring and counterparty credit risk,” said a senior compliance officer at a New York bank. “We really didn’t expect this.”

Tenor of UK negotiations with EU critical

Just how U.S. banks will be affected operationally will hinge greatly on the exit agreement the UK reaches with EU governments. On Friday, British Prime Minister David Cameron said he would leave it up to the new prime minister to begin negotiations under Article 50 under the Lisbon Treaty when he leaves office in October. However, EU foreign ministers over the weekend argued for an immediate change in government, saying there was an urgent need to end uncertainty and hammer out the details of the UK’s separation.

“This process should get underway as soon as possible so that we are not left in limbo but rather can concentrate on the future of Europe,” German Foreign Minister Frank-Walter Steinmeier said after hosting a meeting of his colleagues from the six founding members of the EU – Germany, France, Italy, the Netherlands, Belgium and Luxembourg.

The tone of these discussions will be watched closely to determine whether the EU wishes to punish the UK for leaving the political bloc, or seek a more amicable separation, one that limits the future impact on financial services and trade. German chancellor Angela Merkel , for example, appeared to take a more measured approach over the weekend, saying she wanted an “objective, good” climate for in talks on Britain’s exit from the EU and that there was no need to make it a priority to deter other countries from attempting to leave the EU as well.

“Third country” passports

To that end, what will be critical for U.S. firms, and whether they need to relocate some of their UK operations to other EU countries, is the issue of “passports” for so-called third countries. The “single passport” system allows financial services operators legally established in one EU member state to establish and provide their services in the other members without further authorization requirements.

According to the law firm Shearman & Sterling , there are various scenarios that could affect the current passport regime, both for UK and U.S. banks.

“One possible post-Brexit scenario is for the UK to remain in the European Economic Area (“EEA”), giving it full EU passporting rights. However, this arrangement gives no vote to UK representatives on EU laws and comes with the ‘free movement of persons’. As immigration from other EU countries has been one of the main issues in the referendum, such an arrangement is probably unacceptable to the UK people,” the law firm said in a note to clients.

If the UK opts to stay out of any such arrangements with the EU entirely in order to get the relationship it wants, it could become what in European parlance is known as a “third country”.

“Unless it retained membership of the EEA (which seems unlikely), the UK would become a ‘third party’ for the purposes of much EU legislation. This would mean that, in order to continue to do business with EU entities, the UK would need to maintain a regulatory environment at least ‘equivalent’ to that of the EU despite not benefiting from the advantages of being a member,” said the law firm Ashurst in a note to clients.

“Obtaining an equivalence decision could be time-consuming and may become political. In certain cases (e.g. UCITS), there is no equivalence regime and in others (e.g. MiFID II) the regime is uncertain, or has never been used,” the firm added.

U.S. banks effectively fall under the “third country” definition, and therefore, many of the agreements it has struck with the EU may be considered “equivalent,” allowing it to continue to provide certain services to clients across Europe.

For example, Ashurt suggests a possible decision-tree process that U.S. banks might consider would be as follows:

  • Do you conduct MiFID services in the EU from the UK? If the answer is “yes,” then:
  • Are your clients “professional and eligible counterparties?” Again, if the answer is “yes” the next step would be:
  • Has your third country been deemed “Equivalent” by the EC (Article 46 MiFIR). If “yes,” then the institution would register with ESMA (European Securities and Markets Authority) and be granted access across the EU.

“Belt and braces” approach: relocation of U.S. staff

Of course, if a U.S. bank wanted to ensure that all of its European-wide services could continue under Brexit, it could move its UK operations to another EU country, such as Ireland or Germany, and be afforded full access. This is what many U.S. firms are currently contemplating given the uncertainty over what type of access they will have to the EU should they decide to remain in the UK.

“In the months ahead … we may need to make changes to our European legal entity structure and the location of some roles,” JPMorgan chief executive Jamie Dimon told staff on Friday.

“While these changes are not certain, we have to be prepared to comply with new laws as we serve our clients around the world,” Dimon said.

“We are hopeful that policymakers will recognize the immense value created through a continued open economic engagement between the UK and EU members.”

Compliance requirements: many will remain in place

More broadly, irrespective of which strategic option U.S. banks might take in maintaining their European presence, experts say that many of the compliance requirements they currently face in the UK will likely remain in effect given EU laws.

“There are quite a lot of requirements, such as those governing anti-money laundering and other regulatory compliance issues, in the EU at the moment. I find it hard to believe that in terms of substance that will change a lot. Chances are that we will keep to the same sorts of standards,” said Roger Matthews, senior director for international trade, EU and government relations at the London-based law firm Dechert LLP.

However, given the uncertainty about what Brexit will actually involve, according to Mayer Brown LLP financial institutions—both in the UK and outside the UK–should be thinking about the following:

  • Reviewing their crossborder strategies in the light of developing negotiations – relocation to other EU countries may be an option, but not the only one;
  • Checking the impact of Brexit on their capital adequacy, their liquidity and their access to funding, particularly given a risk of capital flight and the current market volatility;
  • Checking whether their financial contracts will be affected;
  • Reviewing their future staff location and mobility plans;
  • Continuing to work on the implementation of current and forthcoming EU directives as they will be law for at least the next two years and may continue to be so for some time after;
  • Making sure that systems and controls are in place to address the current market volatility and report any activity in the market that they suspect does not meet proper standards of market conduct; and
  • Actively lobbying the regulators and the UK government to ensure that the concerns of the financial services industry, which is such a major contributor to UK GDP, are put to the fore.


(Henry Engler is a North American Regulatory Intelligence Editor for Thomson Reuters Regulatory Intelligence. He is a former financial industry compliance consultant and executive, and earlier served as a financial journalist with Reuters. Email Henry at henry.engler@thomsonreuters.com)

(This article was produced by Thomson Reuters Regulatory Intelligence and initially posted on June. 27. Regulatory Intelligence provides a single source for regulatory news, analysis, rules and developments, with global coverage of more than 400 regulators and exchanges. Follow Regulatory Intelligence compliance news on Twitter: @thomsonreuters)

No comments so far

We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see http://blogs.reuters.com/fulldisclosure/2010/09/27/toward-a-more-thoughtful-conversation-on-stories/