This is the seventh paper from EY assessing the potential direction and likely implications of Brexit for the financial services sector.
In anticipation of UK withdrawal from the EU on 29 March 2019, this paper considers the continuing uncertainty around negotiations over the next seven months and its impact on financial institutions. Given the important role UK and EU politics will play, we examine the process of ratification for both an Article 50 Withdrawal Agreement and any new treaty-based relationship, some of the possible implications of a ‘no deal’, the possibility of extending the negotiations, and other UK and EU political mechanisms that might impact the negotiation.
While we anticipate a bumpy ride and believe negotiations may go to the wire, our view on Brexit and the City remains largely unchanged: that the process will ultimately be one of evolution rather than revolution and that far more fundamental challenges for financial institutions lie ahead. However, the possibility of a disorderly or no-deal Brexit has increased.
Most boards have now made their major decisions in respect of business models and locations on a ‘hope for the best, prepare for the worst’ basis. Privately, many senior City leaders admit that Brexit (coupled with US tax reforms) has prompted a strategic reflection and refresh. In particular, this has given rise to a rethink of the default ‘serve everything in Europe from London’ model.
Regulators in the EU have strongly indicated that they expect institutions serving customers within their borders to have business substance in the EU and be subject to local supervision, in addition to whatever other supervisory arrangements they may have.
Many financial institutions are already well into implementation projects, and based on EY’s Brexit tracker, we anticipate moderate relocation of some activities from London and the establishment of new operations and capabilities in Frankfurt, Paris, Dublin, Brussels, Luxembourg and elsewhere. Since an acrimonious UK exit without agreement would be in nobody’s best interests, great effort and a good deal of compromise should be made to avoid this.
Nevertheless, boards should be prepared for six months of tension and should think through plans for communicating with staff and customers during that period. All boards should have prepared in outline a contingency plan for a no-deal Brexit (i.e., a unilateral UK withdrawal from the EU without a negotiated agreement), given the uncertainty.
This means that decisions that impact firms’ people, operations, clients and customers are now being taken in order to support new future contracting arrangements and fixing existing arrangements. Decisions and progress are increasingly public, with Brexit becoming an increasingly competitive issue.
In the event of negotiations not being successful, preparatory work is being done by officials on both sides of Europe. Recent announcements from the European Central Bank (ECB), the European Securities and Markets Authority (ESMA) and the European Insurance and Occupation Pensions Authority (EIOPA) have emphasized that risk and have advised financial institutions to take immediate compensatory actions.
However, even if the industry did everything in its power to be prepared, some form of public intervention would be needed on key issues such as cross-border data transfers, insurance contract servicing and access to market infrastructure.
Unilateral or bilateral solutions will need to be considered by the UK and EU, though any mitigants are likely to be time limited and imperfect in their effect.
Of course, all Brexit strategies will also need to be set in the context of volatile international politics; an upsurge in populism and accompanying skepticism around financial institutions; an unpredictable economic and monetary policy environment; the looming spectre of trade wars; the threat of highly disruptive technology; and the impact of changes in macro- and micro-prudential regulation.
However, for almost everyone in the short term, tactical actions to ensure stability in March 2019 will need to be prioritized, with as much flexibility as possible to allow for optimization against any confirmed future state.
In addition to our own thinking, the ideas contained in this paper are based on a continuous programme of Chatham House Rule discussions with governments at both political and administrative levels, as well as with firms, regulators, professional observers and analysts across Europe.
We would like to take this opportunity to thank all who have contributed to the debate.