Over the past 25 years, the European Single Market has helped to transform Europe’s economies, creating jobs and raising incomes across the continent. From the outset, the Single Market project promoted closer economic integration and specialisation within key industries to deliver its gains.
For the UK, the prospect of Brexit will reverse this dynamic over time. And while the continuing EU Member States should generally see less impact, some sectors where the UK is currently a leading producer will inevitably suffer the knock-on effects.
The capital markets are an obvious example. By some estimates, two-thirds of EU capital markets business is conducted in the UK. This pattern of activity has developed over decades and there is a growing realisation that the market capacity currently based in the UK cannot be quickly rebuilt in neighbouring financial centres. The European Commission has made clear that Brexit adds to the urgency of building a Capital Markets Union (CMU). However, it is equally clear that CMU is a long-term project and that existing capacity must be managed carefully while capital markets continue to develop in the EU27.
Brexit is not a zero-sum game for Europe’s capital markets. Two essential public goods, financial stability and market efficiency, are at stake. However, safeguarding these aims during Brexit will not be easy. Given the fixed two-year timescale under Article 50, market participants are already having to make key decisions amid deep uncertainty. The actions of wholesale banks, their clients and supervisory authorities merit close attention and support. Each group faces important decisions, which in turn shape the choices available to other parties.
For wholesale banks, adapting to Brexit may involve establishing or expanding entities in the EU27 or the UK; obtaining licensing and approvals; putting in place capital and funding; finding people and premises; building out technology; and integrating with market infrastructure. The transformation process will be particularly stretching for banks which currently use the UK as a European hub. Today these banks account for more than half of all capital markets revenue in the EU.
Brexit will require supervisory capacity to follow a changing pattern of capital markets and banking business. For some authorities, this will mean new firms and new risks to supervise and a far higher workload overall. Collectively, Europe’s supervisors will face a major challenge to ensure that sufficient resources and expertise are in place to provide timely approvals and maintain rigorous, common regulatory standards. The European Central Bank (ECB), as the single supervisor of banking union, is already preparing. So too are the European Securities and Markets Authority and national regulators.
Brexit also brings uncertainty for corporates and investors who depend on wholesale banking services, particularly those holding (or planning to hold) long-dated contracts such as swaps, loans and credit lines. The risk is that after Brexit, a bank which had signed a contract could no longer lawfully perform the services it had promised. Moreover, corporates may be uncertain whether they can or should rely on a single European hub for capital raising and advisory services.
Given the scale and complexity of the practical challenges ahead, AFME – as the voice of Europe’s capital markets – is calling on policymakers to help guide the Brexit implementation process to an orderly outcome. The support that is needed is effective coordination, regulatory flexibility and enough time.
With close coordination, policymakers can provide certainty on key questions including how regulations will be applied and the range of interim business models that will be acceptable post-Brexit. Helpfully, the ECB is starting to communicate its expectations to the market on the latter point. We would encourage supervisors to build up and pool resources and to intensify information sharing during the planning and implementation phases of Brexit.
Flexibility also matters. For example, some national regulators are already seeking to accelerate their licensing approval processes or taking account of prior approvals from the UK and EU27 authorities for risk models. A further aspect requiring flexibility will be continuity of contracts. For example, it will be impractical for firms to fully unwind swaps books held in UK entities or to novate all trades to a new EU-based entity. It will be much safer to find a way to continue through existing contracts.
The final essential requirement is time. Transformation programmes for wholesale banks are long and complex. A recent study by PwC, commissioned by AFME, suggests that affected banks will require three further years after the negotiations to fully adapt to Brexit. Phased implementation of Brexit will be essential. And the sooner that phasing-in is confirmed then the smoother the adjustment process will be.
Industry will do all it can to continue to serve clients and keep the capital markets working well. However, with the scale of the challenge ahead, we will need the support and guidance of Europe’s politicians and policymakers to help ensure success.
This opinion originally appeared in Börsen-Zeitung on 5 April 2017