Brexit: impact of a potential transition period

On 23 March 2018, the European Council adopted guidelines on the framework for the future relationship between the European Union (EU) and the United Kingdom (UK). These guidelines cover the negotiation agreement reached on 19 March 2018 regarding certain key withdrawal issues, including the transition period. This period would apply from the date the withdrawal agreement enters into force and would last until 31 December 2020. During the transition period, the UK would continue to participate in the Single Market. Banks located in the UK would have access to the Single Market for financial services through the use of passporting rights. Similarly, banks located in other EU Member States would have access to the UK market. They could establish branches or provide financial services across the EU without the need for further authorisation. However, despite the progress made in the political negotiations, the transition period is not finally agreed yet.

How does the transition period affect what ECB Banking Supervision expects from banks?

The precise content of the withdrawal agreement will not be known until late 2018. Uncertainty remains, including the risk that the agreement might not be ratified by all sides involved in the negotiations. In that case, there would be no transition. The ECB therefore expects banks to continue preparing for all possible contingencies.

Banks are responsible for taking the necessary steps to obtain all authorisations required for them to carry out their activities in a timely manner to make sure that they can continue to serve their customers after 30 March 2019.

As discussed in a Notice of the European Commission published on 8 February 2018, there are legal implications that banks will need to consider when the UK becomes a third country, meaning a country that is not a member of the EU. They should be aware of the consequences, for authorisation to operate in the UK and the EU, of losing the “EU passport”. Furthermore, arrangements which may affect the ability of banks to develop independent risk management and control frameworks will have to be re-assessed by the supervisor. The prudential treatment of certain third-party exposures and the continuity of contractual arrangements between certain parties established in the EU and UK will also be affected.

The ECB and national supervisors expect banks to come up with credible Brexit plans as soon as possible. For banks that are planning to relocate activities to the euro area – known as “incoming banks” – the ECB and national supervisors expect to receive their authorisation applications as soon as possible but at the very latest by the end of the second quarter of 2018. In that sense, banks should not use a possible transition period to delay planning, but rather to implement their Brexit plans and adapt their operations to the new framework that would result from the UK becoming a third country. A transition period could be instrumental in smoothing the process of the UK’s withdrawal from the EU. It could help mitigate the execution risks banks face in implementing their Brexit plans, given the scope and complexity of their planned activities in the euro area and the operational and information technology-related changes required to support those activities.

Independently of any transition period resulting from a political agreement, the ECB and national supervisors recognise the challenges that incoming and euro area banks are facing to adapt to the new situation after the UK leaves the EU. The ECB has already communicated its intent to provide flexibility to enable banks to meet certain supervisory expectations and build up their capabilities in the euro area. The ECB and national supervisors do not plan to change this approach, which is however limited to those elements within the scope of supervisory expectations.

During this so-called “build-up period”, which will be discussed on a case-by-case basis, the ECB and national supervisors may allow more time for banks to meet certain supervisory expectations regarding their local risk management capabilities and governance structures, and to move to an adequate and balanced business organisation within the euro area. On the basis of detailed and reasonable business plans for all euro area operations and a clear understanding of the banks’ long-term target operating models, the ECB and national supervisors will determine when banks should meet certain supervisory expectations and how much flexibility can be provided. The arrangements should in no case endanger robust internal governance and sound and effective risk management, or mean that capabilities and controls are “running behind the business”.