This contribution was compiled on 13 June 2017
There is no delicate nor diplomatic way of putting this: the EU is increasingly fed-up with the UK’s politics and Prime Minister Theresa May’s hubris. Despite her most recent humbling, the sense is that the UK is still very much holding the rest of Europe hostage in the divorce proceedings that it wanted. The EU-27 would instead like to promptly get the process over and done with. This not only affects the pending mood on the Brexit negotiations, which were supposed to begin on 19 June, but should also be something that financial services firms bear in mind when ‘Brexit-proofing’ their operations and trading activity. In short, Brexit just got messier and the EU-27 may soon be prompted to take unilateral action to protect its priorities, including the plans of further integration that leave the UK very much on the outside ahead of its exit.
Despite the UK's turmoil, the Article 50 timeline that the UK triggered is quite clear as to what needs to happen and when, and the UK is unlikely to receive any special treatment due to its indecisions and domestic issues. Consequently, financial services firms may need to further step up their planning, given the clear change in the EU’s tone on pushing ahead integration as well as new prescriptive supervisory announcements applying to those that plan on relocating to the single market, which is the UK’s largest market.
As the UK headed back to the polls on 8 June, the European Commission announced its further plans to accelerate and deepen the capital markets union (CMU) project, and do so specifically for the benefit of the EU-27. This renewed sense of purpose and confidence, bolstered by recent defeats of populism in Austria, the Netherlands and France, is evocative of an EU that is pushing integration ahead at full force. This comes on top of other ‘business as usual’ reforms that have come off the table or out of the starting blocks towards rapid implementation. It also extends beyond financial services and is quite different to the post-financial crisis firefighting that focused primarily on making the traditional banking sector ‘safe to fail’ or in implementing the 2009 G-20 Pittsburgh Commitments.
Instead, while Theresa May gambled her snap election to consolidate more power, EU policymakers, following some critical soul searching, are delivering on the pledge to “be big on big things”. This new tone is loud and clear in financial services, in the form of completing the eurozone’s integration, calls for a common finance minister, completing the banking union and the CMU. However, it goes further in the form of the ambitious defence union as well as pushing the European pillar of social rights for the labour market. As German Chancellor Angela Merkel has stated, the time is now for the EU to do more to take its fate into its own hands.
This political priority has not gone unnoticed. With all that is going on, Brexit has, since the initial shock in June 2016, become a bit of a sideshow. The UK’s political statements that “Brexit means Brexit” have left most policymakers in Brussels, Frankfurt and Paris none the wiser as to what that actually means. British calls that it’s “time to get the job done” are met with EU responses of “we’ve been ready to start negotiations whilst you’ve been dragging your feet doing nothing”.
Michel Barnier’s increased Brexit bargaining power
In many ways the UK's views, echoed more strongly by some, to "have the Brexit cake and eat it”, have soured any political capital, let alone sympathy, that Westminster may have had across EU capitals. And all EU member states will have to vote on the Brexit deal (if any). This is also being flanked by consensus that the UK is rather wishful in its thinking that it could, as one fragmented nation, dictate the terms of the exit to a considerably more reinvigorated and united EU-27, comprised of three G7 nations in Germany, France and Italy, which as the motors of EU integration have little tolerance for lengthy dealings with the UK kicking and screaming in a divorce it chose to begin. This explains in part some of the schadenfreude at May’s recent malaise, but also concern about the UK team being flummoxed with some basic principles prior to the general election and now possibly lacking the requisite political stability to get things done.
On top of this, the presidency of the European Council, which represents the EU’s heads of government, will pass on 1 July 2017 from Malta to an EU political direction coordinated from Central and Eastern Europe. The joint-programme of the successive council presidencies of Estonia, Bulgaria and Austria for the next 18 months are quite united on advancing EU integration workstreams and ensuring an orderly Brexit that protects the EU’s resilience and its integrity.
The EU’s agreement on the Brexit negotiating guidelines and principles took under five minutes to agree in a unanimous vote. Even after the UK's election, whether this is difficult, an ‘open’ or ‘closed’ or a ‘hard’ or ‘soft’ Brexit for the UK is irrelevant from an EU negotiation perspective.
Irrespective of all of this instability adding another string to lead EU negotiator for Brexit Michel Barnier's bow, the political divorce will not necessarily cause citizens to want to look back in anger at the UK. After all, geographically, the UK will remain in Europe and both sides will retain ties and want to engage with one another. While the EU’s love for the political class in the UK may be lost, there is still much love for the country, especially following the recent heinous attacks that have quite rightly been condemned and shown a need for continued cooperation, regardless of May’s earlier statements.
As negotiations ensue, where should firms direct their focus for the next 18 months?
As the UK woke up to the political mayhem of 9 June, it became clearer that the UK will likely be between a rock (other than Gibraltar) and a very hard place. This does not in any way stop the actual work over the next 18 months, on both sides of the Channel and the Irish Sea, to make sure that existing firms and those relocating to the EU-27 and/or eurozone are compliant with the existing legal and regulatory regime, plus the breadth of pending changes. These are reshaping the way financial services regulation, supervision and market practice operates in the EU and the banking union. At the heart of this is supervisory convergence so that the single market really does operate on a single rulebook that is uniform across the constituent jurisdictions. This is a defining moment for the EU, the eurozone but also for market participants as efficiencies emerge and the cost of compliance reduces. It is also important as the EU faces some further years of regulatory and supervisory change.
With the entry into force of the second Markets in Financial Instruments Directive and Regulation package, the review of the Capital Requirements Regulation (CRR) and fourth Capital Requirements Directive framework, revisions to the European Market Infrastructure Regulation (EMIR), and finalising the roll-out of the Securities Financing Transactions Regulation, firms will likely be busy. This is on top of CMU workstreams as well as those that are specific to the eurozone and its banking union, which harmonise the single rulebook’s application further in certain areas.
Success on the political agreement on the draft Securitisation Regulation, the CRR-relevant amendments and the simple, transparent and standardised securitisations criteria is a vital step. Reviews of the European system of financial supervision and the functioning of the European supervisory authorities, including bolstering European Securities and Markets Authority (ESMA) and deciding where the London-based European Banking Authority will soon call its home are also now moving at full speed.
So too is how to complete and improve the banking union, new rules on fitness and propriety assessments within the banking union and eurozone, and ESMA “supervisory principles on relocation”, which will shape how financial services firms wishing to set up in the EU-27 and/or the eurozone will structure their business and engagement with clients. These effects go beyond Brexit and apply across all financial transaction types and asset classes. This should really incentivise firms to look at their Brexit-proofing in a manner that does not rely on assumptions of any political deal on equivalence or preferential rights.
While many of the positions on financial and professional services have been laid out, more is yet to come. The European Commission has released its plans for euro-denominated clearing and they could mean that clearing and other post-trade infrastructure may also look at expanding their presence within the eurozone. This comes at a potential cost to London, and on top of the relocation of firms and EU agencies currently headquartered in the UK. Continued criticism from London is expected, unsurprisingly, sympathy from EU policymakers is not. After all, irrespective of certain commentators’ claims this could disrupt an existing market, EU policymakers increasingly take the view that London would not have gotten that market following its 'big bang' had the UK not been in the EU.
Consequently, post-Brexit, the extraterritorial scope of EMIR and existing supervisory powers support the policy that EUR-denominated clearing and oversight of systemically important activity should be moved to the EU-27/eurozone 19. From an EU policy perspective, any relocation does not necessarily mean that any disruption cannot be appropriately mitigated and managed.
Similarly, while the supervisory principles on relocation may prompt some immediate rethinking of Brexit-proofing plans as to what goes where and when, it should also concurrently prompt firms and their advisers to assess how to ensure their policies and procedures, regardless of relocation, meet the EU and eurozone’s supervisory expectations. Equally, this will have to be considered in the context of how such policies and procedures remain interoperable with rules and requirements of third-countries. For the documentation and booking of securities finance transactions, this has some very real immediate implications.
While it is unlikely that English law-governed master agreement documentation will be swapped for, say, a German DRV or the European master agreement, several legacy arrangements will need repapering and certain transactions possibly novated or re-executed within the EU-27. This could also affect collateral arrangements. When the UK, from an EU regulatory perspective, becomes a “third-country”, the enforcement of English law judgements within the EU-27 might become more difficult, especially if no deal or institutional solution is found to resolve this issue. Firms may possibly want to consider replacing their dispute resolution mechanics with suitable alternatives other than just arbitration.
In conclusion, while the UK’s general election seems to have landed egg on the face of Prime Minister Theresa May, including others in the Conservative Party that did not lose their parliamentary seats, the level of political risk and the contagion that this could have across other channels and workstreams has increased. It has also become possibly opaquer with more known and unknown unknowns.
The only certainty among all this uncertainty is that May’s power-sharing means her mandate and ability to confidently steer Brexit negotiations just became considerably more complicated and ultimately costly in what the UK can concede or compromise on.
