Firms’ respective end customers also need to establish whether they are comfortable with the local level of client asset protection if their assets are transferred to a new entity. Firms will need to ensure that they meet all their regulatory requirements and establish whether boards understand and are comfortable with their new entities. In particular, business functions will need to ensure that they are adequately prepared to manage the hand-off of operations from in-flight Brexit programmes.
To mitigate some of these risks, firms should undertake a health-check or gap analysis. This will help to establish whether they are likely to meet regulatory expectations should they be subject to increased regulatory scrutiny or required to provide evidence to the regulator in a new country.
Firms should also assess contracts for their relevant notice periods to understand any risks which may arise by terminating these contracts. Similarly, firms need to be cognizant of any spilt relationships with clients.
Financial Market Infrastructure
If the UK becomes a ‘third country’ without a Withdrawal Agreement, UK-based banks will need to acquire FMI and trading venue membership for their EU entities. FMIs and trading venues may also be forced to restructure, as they will not be able to rely on MiFID II passport rights enabling cross-border access between the UK and the EU.
This will force UK-based FMIs and trading venues to create EU entities to provide members with continued access into the EU27 market. Similarly, it is expected that EU-based FMIs and trading venues will undergo a restructuring in order to maintain UK market access. Whilst most banks have taken a proactive approach, they have been constrained by the fact that they need FMIs to act in conjunction with them. Most FMIs have adopted a patient approach, given the ongoing political and regulatory uncertainty, and banks now face difficult timelines to acquire FMI membership and go live in a new entity.
We continue to see on-going regulatory developments in this sphere, with the European Securities and Markets Authority recently confirming that three central counterparties (CCPs) established in the UK will be able to operate as third country CCPs, enabling them to continue to settle derivatives trades for investors and companies based in the remaining EU27 in the event of a no-deal Brexit.
To minimise disruption and mitigate unforeseen risks, FMIs and trading venues should seek migration assistance to manage the expectations of banks and dealers. To enable their respective preparedness, banks should assess what FMI dependencies they have and test their end-to-end connectivity and operational readiness in order to prepare for migration.
In a no-deal Brexit, EU tax directives will no longer apply to and in respect of the UK. The EU Merger Tax Directive prevents corporate income taxes being crystallized in several EU cross-border restructuring situations. Where a Brexit-related re-structuring – for example the merger of a UK company into an Irish company – relies on the Directive to remove tax charges, particularly in any EU branch jurisdictions, it is imperative that such re-structurings are completed before Brexit to ensure that such taxes do not arise.
Firms will also need to consider UK exit tax risk on any move of assets or functions from the UK to EU27 jurisdictions — the subject of much discussion between industry and the UK tax authorities.
Key questions to consider include:
- Have you assessed your potential UK exit tax exposure by reference to tax, transfer pricing and valuation principles?
- Have you got documentation in place to ameliorate risk?
- Have you socialized identified issues with tax authorities?
Furthermore, companies, irrespective of whether they are based in the UK, the EU27 or anywhere else, will post-Brexit no longer be able to rely on EU law when considering their tax position in the UK, or in future disputes with the UK tax authorities.
The ability of UK groups and companies to do so with respect to tax authorities in EU27 jurisdictions may also be constrained compared to the current position. Accordingly, it’s advisable to lodge claims or defenses, ahead of 29 March, before competent courts where the prospects of success in a tax case depend on EU law arguments.
Finally, a similar point arises in relation to disputes involving the use of the EU Arbitration Convention. This Convention establishes a procedure to resolve disputes where double taxation occurs between enterprises of different Member States because of an upward adjustment of profits of an enterprise of one Member State.
Whilst the Convention is an international treaty rather than EU legislation, following Brexit, the UK would fall outside the territorial scope of the Convention. So, whilst disputes involving the UK arising pre-Brexit should fall to be dealt with under the Convention, disputes involving the UK arising post-Brexit would not. Consequently, it would be advisable (as the clock runs down to 29 March) to accelerate in-scope disputes wherever possible to fall within the terms of the Convention.
As a result of Brexit, most firms have established new or significantly expanded EU entities with required resourcing and infrastructure, appropriate governance arrangements, additional layers of management, risk management frameworks, new booking models, outsourcing arrangements and infrastructure support.
Firms must now meet a new and significant additional regulatory burden outside the UK, including enhanced supervisory stress testing. This will all bring significant additional operating costs and additional capital (at least in the medium term), give rise to large intra-group exposures and treasury management considerations, and cause firms to evolve their recovery and resolution planning.
This has already crystallized for most firms — certainly for any firm with sizeable EU business. A no-deal Brexit will not prevent them conducting business, but with additional resources, costs and capital commitment.
The additional impact of a no-deal Brexit, beyond those arising from restructuring to date, will primarily be felt through the macroeconomic impacts and second-order effects on bank customers and the flow-through to demand for financial markets products and services.
In a no-deal Brexit, financial institutions will remain open for business and able to service clients from an operational perspective. However, the future is more uncertain from a business model and viability perspective. Many firms will need to be extremely agile, prepared to follow client strategies, enter new markets and geographies, and deal with an even more diverse regulatory infrastructure.
A no-deal Brexit would bring a challenging set of circumstances to businesses across Europe. Overnight, companies will have to cope with different ways of trading, regulation, licencing, tax and moving their people around. Whilst extensive plans have been made and issues identified, it is unclear what level of disruption such a scenario might entail given the scale of change.
Most will have never attempted such a wide-ranging overnight change to systems and controls, and they do not have complete control of the actions of all their suppliers and customers. Many businesses will be reliant on all of the organizations involved in their supply chain being ready, and their clients’ consent for data or relationships being ported to a new EU entity.
Financial services firms, even those with the most Brexit-proof models will need to be prepared. The structures for dealing with any sort of unpredictability should be rehearsed: governance to ensure leaders can react quickly to clients and the market; communications protocols to share messaging rapidly internally and externally; and open lines of communications with supervisors.
Firms should focus on identifying remaining gaps whilst also maintaining sight of their internal firm resilience to unforeseen market events. The final few weeks ahead of 29 March still provide valuable time to finalize execution activities. Identifying any gaps that might still exist will be imperative in order to put in place contingency strategies ahead of time and allow for engagement with relevant regulators where necessary.