The UK formally leaves the EU on 29 March 2019. After that date, there will be a transition period until 31st December 2020. It has looked like the cliff edge scenario of no agreed Brexit was going to happen. Theresa May has now agreed outline terms with the EU but still has to gain the UK Parliament's approval.
Where does this leave Australian banks with respect to their European operations? All the banks we have spoken to are making plans for a cliff edge Brexit.
Currently MiFID allows a UK-based financial entity to passport any of their business into the EU. This covers all trading activities whether FX, equities, derivatives or capital raising through initial placements or similar. Post Brexit, capital held at the parent company to support UK branches will not be sufficient. Banks will need to create subsidiaries and ring fence their capital, in addition to applying for banking licenses and setting up an independent governance structure. Not to mention the disruption of moving and/or hiring hundreds of staff to maintain trading and operations.
It is estimated that the amount of capital that must be ring-fenced is in the region of 4-5% of the banks' total global capital (assuming that core capital is about 10 to 12% of risk-weighted assets). In addition, the EU has stipulated that any subsidiary must also be the location for trading, operations and any other services that the bank may offer. Essentially this means any existing branch or subsidiary based in the UK will become a representative office only.
Other expected changes post-Brexit will be to market structure. Nearly all financial markets in Europe are strongly weighted towards the UK with the exception being Eurex. The LSE group lists 430 foreign stocks versus 160 at Euronext and 50-odd at Deutsche Bourse. Average daily share turnover is also weighted strongly towards the LSE. In FX, London is the global leader at nearly 40% of the market, approximately twice the share of the next location, the US. For derivatives, e.g. IRS, a loss of MiFID passporting has implications for the state of existing contracts in terms of enforceability, whether grandfathering can be agreed and how novation will actually work. UK based CCPs will have third country status unless equivalence is agreed for the UK and EU rules. The recent statement by the European Commission supporting equivalence is encouraging but it should be noted they have stressed the arrangement is temporary and conditional on a subsequent final agreement. Post Brexit, European financial centres such as Frankfurt, Paris, Amsterdam, Luxembourg and Dublin will compete to take London's capital markets business. There is no clear natural alternative and the likely outcome is further fragmentation.
In short, Brexit will cause significant disruption to the Australian banks UK operations as well as huge costs to facilitate their EU subsidiaries. And with very limited opportunities for revenue uplift.
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