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Brexit: meeting supervisory expectations

In August 2018 the ECB published “Supervisory expectations on booking models” to clarify to banks operating under the Single Supervisory Mechanism (SSM) how the ECB intends to apply the provisions of the Capital Requirements Directive (CRD). They concern, in particular, the CRD provisions for governance and risk management. Further information can be found in the dedicated FAQ section on the ECB Banking Supervision website.

The expectations were developed in discussion with the industry in response to the United Kingdom’s decision to leave the European Union (EU). They are very relevant for significant banks with operations in the United Kingdom, known as “outgoing banks”, given the significance for the EU of activities performed by SSM banks from their UK branches. Given that, after Brexit, the United Kingdom will become a third country, SSM banks will not be able to operate there with the same degree of certainty as before. From a prudential perspective this will require parent companies to be particularly attentive as to how they steer, risk-manage and control the activities of their branches in the United Kingdom.

Depending on the degree to which banks rely on their UK branches, the transition to the post-Brexit situation may entail a number of organisational challenges (and costs). Banks are expected to address these considerations in their Brexit plans before March 2019.

Third-country branch assessment

The Joint Supervisory Teams (JSTs) of outgoing banks have assessed the plans for their UK branches against the supervisory expectations. The assessment encompassed the plans for 46 branches, corresponding to 42 banks in 11 euro area Member States.

Overall, the picture is encouraging, with most banks having already aligned, or being well advanced in aligning, their target operating model with the supervisory expectations. However, not all banks have been moving at the same pace and some still need to make substantial improvements to their plans. In all cases, supervisors will closely monitor implementation.

Impact of the temporary permissions regime

The UK temporary permissions regime announced on 7 November 2018 provides branches that currently operate in the United Kingdom under the EU passporting regime with a “deemed permission” if the United Kingdom leaves the EU on 29 March 2019. This permission is not an extension of (nor a bilateral agreement with the EU regarding) the freedoms of the internal market, which will be abolished as of the date of Brexit. In addition, it only applies to branches and not to subsidiaries.

The temporary permissions regime is welcome, as it reduces the cliff-edge risk around Brexit day for credit institutions, at least as far as the UK authorisation is concerned. However, it does not change the situation that, under national laws, SSM banks may need to obtain ECB approval for their third-country branches in London by the end of March 2019.

The time limit for UK regulators to process authorisation applications and provide final permissions is set at three years from Brexit day. If the situation of a significant SSM bank’s UK branch changes significantly within this three-year period, the ECB, for its part, will re-examine the initial third-country branch assessment.

Booking models, FMI access and business model

The supervisory expectations published in August also clarify for banks how the ECB intends to apply the CRD provisions as regards booking models, access to financial market infrastructures (FMIs) and business models.

For example, the ECB expects SSM banks to have booking models and hedging strategies in place that enable them to have full control over their onshore exposures. Under the SSM, EU27 products and transactions with EU27 clients are expected to be booked onshore and banks should have adequate risk management capabilities onshore (including first and second lines of defence).

Regarding FMI access, SSM banks are expected to have sufficient onshore ability (i.e. excluding branches in third countries) to originate business and access key FMIs on a continuous basis. SSM banks should consider which alternative FMIs are available should their access to existing FMIs be impeded or the finality of their instruments/settlements no longer be guaranteed.

As for the business model, the ECB expects branches in third countries not to perform critical functions for the SSM bank or group. If banks wish to provide services from their third-country branches to customers based in the EU, they should have objective business reasons for doing so. In the same vein, an SSM bank should not depend materially on key function holders and key systems or tools based in its third-country branch.

Way forward

Given the uncertainty arising from the current political discussions, and independently of a possible transition period, banks with incomplete plans need to act now to develop the post-Brexit target operating model that the ECB expects them to have in place. A transition deal would provide more time for these banks to move towards their new model, but would not remove the need for them to do so at as fast a pace as possible. JSTs have discussed implementation periods for this transition proportionate to individual banks’ specific situations and will closely monitor their progress.

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European Central Bank

Directorate General Communications

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