13 June 2017

The Brexit boot moves decisively to the EU27 foot – 131st Brussels for Breakfast

Graham Bishop/Paula Martín

Organised by the Centre for the Study of Financial Innovation (CSFI), hosted by Grant Thornton with co-presenterPeter Snowdon (Norton Rose Fulbright)

Highlights from the “Brussels for Breakfast” meeting

The General Election in the UK may have “changed the game” here but there are two sides to the Brexit negotiation. The election of President Macron in France – and now his landslide majority in the Assemblée Nationale - has changed self-confidence in Europe as populist forces seem to be in retreat, re-enforced by the collapse of support for Italy’s Five Star Movement in local elections. Moreover, the Eurozone economic upswing seems to be accelerating gently while the UK economy is slowing. The boot seems to have shifted perceptibly to the other foot!

If the election has reduced the chances of a brutal/hard Brexit, would a “soft” Brexit save the City? Sadly, the feeling seemed to be probably not. Banks that have now investigated alternative locations around the EU are now wondering why they never did this before as things are not as awful `over there’ as they had feared. The policy of “no deal is better than a bad deal” means that any transitional arrangement would be very last minute. Firms cannot wait to that last minute as the issue of a banking licence can easily take a year – implying that serious decisions must be taken in the next few months. We discussed – yet again – that `free trade agreements’ usually exclude financial services anyway.

Derivatives clearing remains a totemic topic – especially as we waited for the Commission’s proposal on location of clearing. Whatever the possibilities of clever legal stratagems to contract regulation out of the UK, the financial stability issues are likely to remain paramount as the size of potential calls for euro-denominated liquidity are immense.

The takeover of Spain’s failing Banco Popular by Santander for a symbolic €1 was hailed as the first example of the BRRD in action but there was still some caution about what would have happened if there has not been a willing and capable buyer.

The Commission’s consultation on the future of the ESAs produced a flurry of papers on the potential merits of combining them into a `twin peaks’ system (such as in the UK) but respondents did not evince much enthusiasm for this concept. However, what is clear is that a decision will be made in October about the new location for the European Banking Authority. In reality, the UK has left the `financial services’ EU already and the “death by a thousand cuts” is probably underway.

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Key items in the rest of the month’s news included:

Political

May’s bid to secure a ‘strong and stable’ leadership to strengthen her hand in Brexit talks ended up in tears on June 8^th after the Conservatives failed to achieve an absolute majority and the UK woke up the morning after to a hung Parliament. Jeremy Corbyn’s Labour party did better than expected and the Socialist leader has been found in a Survation poll to “make a better PM” than Theresa May, with Labour 5 points ahead of the Tories if a new election were called. Former Chancellor George Osborne told the BBC May was a “dead woman walking” after surveys showed that nearly half of the public expects her to resign, and her fall is very likely as we write – with Tories calling for Boris Johnson to take the reins.

Once the new government is formed, one of its first and most pressing matters will be the Brexit agreement with the EU – they will be “extremely difficult negotiations”, warned EU Parliamentarian Danuta Huebner - a challenge that could drag on for years and that will define the new Government’s term. Theresa May’s plan of a hard, clean divorce with the EU seems fatally wounded, and the chances of a softer Brexit have increased after the British people rejected May’s programme at the polling stations. What are the practical alternatives? There aren’t any – except to stay in the EU– wrote Graham Bishop, voicing the renewed calls for a second referendum.

No deal would be much worse than a bad deal, voters have said: a CER think tank report detailed the huge costs to the UK economy of failing to strike a deal, with figures backed by an Open Britain/CEBR analysis that pointed to a £36 billion a year loss if the UK lose access to the Single Market in services. According to a new report from the Centre for Economic Performance, this would be the worst-case Brexit scenario for the UK economy. Even if the economy, so far, has proved resilient, the British industry is concerned that it won’t be able to withstand the actual divorce proceedings. The banking sector is bracing itself for hundreds of millions in Brexit costs, senior executives told the FT.

What are the options for a ‘Global Britain’ after it has withdrawn from the EU? Not many, if the UK doesn’t agree with the EU on a deal that essentially reproduces the current membership terms, as written in a VoxEU column. Though the biggest trade deal the UK would have to renegotiate, a treaty with the EU isn’t the only one officials should agree merely for the UK to stand still: FT research revealed that at least 759 agreements with 168 countries must be renegotiated in the years to come. Hence, trade realities have exposed the absurdity of a Brexit ‘no deal’, and as Martin Wolf wrote in the FT , the UK would do well not to refuse the EU’s terms for an amicable split if it wants to secure the co-operation of Europe in ensuring the smooth flow of trade.

While the British discuss a ‘deal’ or ‘no deal’ scenario, their EU counterparts are bracing themselves for a “big crisis” over Brexit, the FT reported, including a possible break up as early as this summer. This possibility has made the Commission to start thinking about a Plan B, Andrew Duff wrote – Duff described the many ways in which Europeans and British officials could mishandle the talks, causing a massive vortex. Top EU negotiator Michel Barnier fears that talks could collapse over the so-called “Brexit bill”if member states’ demands and the British stance towards the financial settlement aren’t softened.

The Council authorised the start of Brexit talks at the end of May and adopted its negotiating ‘red lines’. The EU toughened its language on a future transitional arrangement – a harder stance that might please most Germans by focussing on a good deal for the EU27 as shown in a Die Welt poll. Moreover, the EU is  refusing the UK’s request to keep talks secret.  Britain won’t regain full control for years: the Commission published negotiation papers showing that, after effectively withdrawing from the EU, the UK will still be entangled in the EU’s financial and legal systems for an undetermined period that could last years. It will also lose the two UK-located EU agencies – the EBA and the EMA - as soon as October: Brussels has asked for bids on their next location by July.

The ‘big row of the summer’ might be the Brexit bill, as David Davis spelled it, but The City fight with the EU over the euro-denominated derivatives could prove fiercer – ESMA issued its principles on supervisory approach to relocations from the UK and the endgame is now in sight, Graham Bishop warned. Clearing oversight after Brexit is `crucial' for ECB, said the Central BankPresident Mario Draghi – keeping the bulk of the business in London after Brexit would be an “anomaly”, in Euronext boss Stéphane Boujnah words. But EU management of euro clearing  should be free from political strains, Barnabas Reynolds warned.

The move, that could mean a loss of  €100 billion in LSE estimates, has raised concerns globally, with the  Futures Industry Association telling the Commission that forced relocation of euro clearing would be "severely detrimental" to the EU, and Washington warning that forcing the lucrative business out of London would break with international norms and could lead to US countermeasures.  

Euro clearing is not the only business to be already suffering from Brexit side-effects: a survey by investment manager Invesco has found sovereign wealth funds and central banks have started to invest less in the UK. The FCA has demanded detailed contingency plans from UK asset managers, who are fine-tuning their Brexit blueprints as concerns mount over the impact of EU withdrawal on the industry. UK insurance firms might have started to feel the bite of chunks of its business from the continent, and European regulator EIOPA will issue guidelines to prevent a “race to bottom” on regulation among EU countries to attract British companies looking to move from London.

Even after all these warnings, the British electorate is more pro-Brexit than a year ago, with a YouGov poll finding out that the rise of the “Re-Leavers” – those who voted to Remain in the EU but think that the government has a duty to leave – means that 68% of the British voters wants to leave the EU. What they care more is about reducing non-EU than EU migration, the LSE found, despite the Brexiteers original main argument of “taking back control.”

The EU may find strength in the Euro scepticism crisis, with a big help from economic recovery, and use it to reinvent itself: the Commission continued its works on deepening the EMU and published a reflection paper that included work in three key areas: completing a genuine Financial Union, a more integrated Economic and Fiscal Union and strengthening euro area institutions. LSE economists analysed the plan and proposed three key building blocks for a lasting and workable reform that should have been contained in the EMU paper: a first aid kit, a structural reform and investment agenda, and significant risk-sharing.  

 There is a renewed sense of confidence in the EU’s economies, and Financial Commissioner Moscovici called to press ahead with long overdue economic reforms, while Banque de France’s Villeroy de Galhau appealed to createa common stabilisation fund and a euro area finance minister.

A VoxEu study recommended the EU27 to complete the banking union, harmonise national regulation, and accelerate the realisation of a true capital markets union.  Nicolas Véron at Bruegel wrote that the combination of banking union and Brexit justifies a reform of the EBA and ESMA.

The Economic and Financial Affairs Councilagreed on a new system for resolving double taxation disputes between member states and discussed a proposal for a common corporate tax base (CCTB) in the EU – the plan was analysed in detail by Accountancy Europe CEO.

Banking

The Basel III capital rules (Basel IV) could be finalised in the near future, a Basel Committee top officer hinted – and it has been reported that the BCBS have agreed a 75% output floor.  The remark was seen as a helpful intervention by the BBA “at a time when it appears that there is a heightened risk of fragmentation.”

Regulators are increasingly anxious over banking union implementation, with ECB’s Praet urging on an ambitious timetable.  But simple rules on bank capital to finish the resolution pillar are needed in order to complete the banking union project, the ECB Governing Board member Francois Villeroy de Galhau said. The EBA is taking steps in this direction: the Authority released its final technical standards on valuation in resolution whichare a crucial piece of regulation for the resolution framework.   The Single Resolution Board had its first test with Spanish Banco Santander acquiring struggling Banco Popular for a symbolic €1 after the SRB warned the bank was likely to fail. Nevertheless, a Commission report on NPLs stated that an exception to the resolution rules can be made with temporary state aid provided to a bank to address a capital shortfall identified in a stress test.

Setting aside Banco Popular troubles, the Eurozone’s increasingly robust recovery is helping banks to ease pressure, said S&P, which rated positively European corporate credit in Q1. But banks might have overestimated the renaissance and are being overconfident about their capital strength, according to the ICAEW.

The European Banking Authority updated its list of capital instruments classified as Common Equity Tier 1  and called for a possible strengthening of the Authority's role in assessing issuances of CET1 instruments. The banking watchdog announced that it will publish data for its EU-wide transparency exercise in December 2017 together with the Risk Assessment Report (RAR).   

The EBA published its final guidelines on credit institutions' credit risk management practices and accounting for expected credit losses as a part of its workon the implementation of IFRS 9.  An ECMI study of 131 EU banks shows that the credit support policies of the Eurosystem have been successful in stimulating bank credit to the private sector.  Bruegel analysed the governance and ownership of significant euro-area banks and found that bulk of these institutions are government-owned or cooperatives, or uniquely influenced by one or several large shareholders, or otherwise prone to direct political influence. The FSB released the results of its monitoring exercise of the global shadow banking system.

The EBA ban on 'screen scraping' (financial technology firms directly accessing bank accounts) received a mixed response: the EU financial services chief Valdis Dombrovskis said he will ask the watchdog to rethink its proposal, while the Banking Federation supported the measure and warned that discarding it will increase the risk for privacy of client data, cybersecurity and innovation. The Authority dismissed a suggestion by Brussels that it should be merged with the EIOPA, saying it could be counterproductive and yield little savings as staffing was already too slim in core areas.

Securities

The Council presidency reached an agreement with MEPs on proposals aimed at reviving the securitisation market in Europe, in a move that was well received by the European Commission and AFME.   Simon Lewis, Chief Executive of the Financial Markets association, dubbed the accord a “crucial milestone in the development of a Capital Markets Union.” Consensus was reached also on new prospectus rules and venture capital regulation.

The ECB's Vítor Constâncio gave an account of the synergies between banking union and capital markets union, saying they areundoubtedly the two central policy initiatives to catalyse financial integration in the EU. A Europe-wide primary market for securities may be also on the cards to advance in financial market integration: Yves Mersch said the ECB stands ready to explore such a possibility. To this end, IOSCO Annual Conference focused on the challenges of strengthening market resilience, addressing financial misconduct and financing the real economy through capital markets.  

ESMA’s Maijoor confirmed that “MiFID2/MiFIR will come into effect on 3 January 2018, there will be no further delay in its implementation” and said that ESMA should be the central point for technical third country related issues. The Authority issued an opinion to clarify “traded on a trading venue”(TOTV) under MiFID II and found improvements in regulators’ supervisory practices concerning MiFID rules on fair, clear and not misleading information. The Autorité des Marchés Financiers consulted on the transposition of the directive into its General Regulation.

The set of rules has been designed to bring transparency to bond allocation in Europe, but it might pose big challenges when it comes to certain rules such as the creation of a three page information document for retail investors, summarising the potential risks of a deal – a task that was usually developed in hundreds of pages and might open the door to lawsuits if things go wrong. CFA Institute continued its series of articles on MiFID II implementation, with renewed interest on issues relating to dark pools and high-frequency trading (HFT).

Insurance

The IASB finalised a fundamental overhaul of insurance accounting and issuedIFRS 17 Insurance Contracts, the first truly international IFRS Standard for insurance contracts that was welcomed by ACCA and Insurance Europe.

The FT reported that the latest batch of data released under the EU’s new Solvency II capital rules reveals gaps in insurers’ capital positions due to temporary rules that came into force in 2016.The fresh data showed UK life insurers in a particularly bad light because of the way that annuities, one of their core products, are treated by the rules.

Change management is the greatest risk faced by the global insurance industry, according to a survey by the CSFI and PwC that points out that the climate for insurers is becoming more challenging.   EU institutions will have to grapple with cyber risk and technology - ranked in the top three insurance ‘banana skins’ – when designing new rules: they must be digital-friendly to reflect consumers’ needs, according to Insurance Europe’s president, Sergio Balbinot.

Asset Management

EIOPA launched its second EU-wide occupational pension’s stress test. The European Commission is expected to set in motion a legislative proposal on a framework for a Pan-European Personal Pension product (PEPP) at the end of June - EFAMA reiterated its support for the project and outlined its recommendations for the PEPP to contribute to the CMU plan success.

The Council adopted a regulation to ensure the smooth operation of the money market funds that will go “a long way in improving supervision and regulation of a largely unregulated sector”, as envisioned by the Maltese presidency.  

Corporate Governance/Accounting

The Financial Stability Board published a reflection on its efforts to strengthen the governance frameworks to mitigate misconduct risks, setting out next steps for the FSB’s work in this area.  

The IAESB revised its Continuing Professional Development standard (IES 7) that focuses on learning and development directly related to an accountant’s professional responsibilities. 

Financial Services Policy

The Commission presented its annual review of EU's financial stability and integration in which it highlighteda positive trend in the recovery of the European economy, identifying private consumption as the main driver for growth – a push supported by improved bank funding and a better regulatory and supervisory framework.  The ECB reinforced the good news in its latest Financial Stability Review, that shows that systemic stress indicators for the euro area have remained low over the past six months.  

Several EU institutions and international financial associations provided their views on the operation of the ESAs: EBA,  EBF, ESMA, AFME, ICMA, EIOPA, Insurance Europe, Accountancy Europe and Deloitte remarked how the Supervisory Authorities could better achieve its objectives of investor protection, and stable and orderly EU financial markets. 

Insurance Europe suggested changes to the Financial Stability Board’s proposed framework for the post-implementation evaluation of the effects of G-20 financial regulatory reforms.  

The Council adopted its position on the proposed Directive on countering money laundering by criminal law.