2021: The year of Brexit for banks

Brexit, or the UK’s departure from the European Union, became a reality on 1 January 2021. In terms of the regulatory impact for the financial sector, and the banking sector in particular, the UK being a third country, UK banks can no longer benefit from the European passport for their continental activities. Therefore, they can no longer provide their products and services to European consumers if they have not established a subsidiary within the EU27 area, or at least a branch if the EU business is limited to the country of establishment. The same applies to EU banks wishing to maintain their presence in the UK market.

Prudential requirements

The establishment of an EU subsidiary for a UK bank wishing to maintain full access to the single market will require compliance with prudential requirements such as solvency, liquidity and eligible liability ratios and reporting. These newly authorised institutions and existing banks planning to expand their activities will also have to prepare a recovery plan in accordance with the Bank Recovery and Resolution Directive (BRRD), which will have to reflect the obligations set out within three to six months of starting operations. In addition, existing internal models may be maintained until 30 June 2022 to allow for their review and validation, according to the ECB.

As for EU banks, the Single Resolution Board (SRB) has decided that UK debt issues without a contractual bail-in recognition clause would continue to be considered as eligible instruments for the minimum requirement for own funds and eligible liabilities (MREL) ratio until 28 June 2025. This is provided that they meet the other applicable MREL criteria and have been issued before 15 November 2018.

The specific case of investment firms

Brexit, combined with the entry into the application of the regulation and the directive on investment firms known as IFR and IFD, has a double consequence for the latter. First, they will be subject to the new prudential requirements of IFR, which will affect in particular intermediate IFs known as Class 2 IFs[1]. Secondly, the largest IFs, those whose balance sheet exceeds €30bn of assets will be under the direct supervision of the ECB and be obliged to be licensed as a credit institution.¹ They will also have to be subject to the ECB’s comprehensive assessment ².

Supervisors’ points of attention

The ECB is firm on the fact that “EU products and transactions with EU clients involving non-EU products should be booked in the EU”. Thus, banks operating in the EU from their London hub and wishing to maintain access to the single market must – beyond the establishment of a subsidiary – deploy in a proportionate manner the human and financial resources to manage the activities and associated risks locally and equip themselves with robust governance in full compliance with EU legislation. This is the purpose of the “target operating models” validated with the ECB, which the banks applying for relocation are gradually implementing. 

Moreover, empty shells are prohibited, and so-called “back to back” operations must be strictly controlled so that they do not generate uncontrolled risks when these are transferred to group entities outside the EU.  In addition, the French Prudential Supervision and Resolution Authority (ACPR) has explicitly required the UK institutions concerned to provide their customers in France with personalised information on the terms and conditions under which their services will continue – or cease – to be provided in France from 1^st January 2021.

Equivalence decisions: a way to keep an access to the single market in financial services?

On 26 March 2021, the EU and the UK adopted a Memorandum of Understanding, which creates the framework for voluntary regulatory cooperation in the area of financial services. The MoU establishes a joint forum to serve as a platform for dialogue on financial services issues, such as informal consultations on decisions to adopt, suspend or withdraw equivalence. For instance, the Commission adopted a temporary equivalence decision to the regulatory framework for clearing houses (CCPs) in the UK for 18 months from 1^st January 2021, in order for EU banks to progressively transfer the settlement of their euro transactions to EU CCPs.

However, banks should not place heavy reliance on such provisions as, insofar as banking prudential rules are concerned, these equivalence agreements are currently largely non-existent.

References:

¹ As a reminder, see the dedicated article in the Regulatory Letter #22.

² Consists of an asset quality review (AQR) and a stress test.