- SUPERVISION NEWSLETTER
Brexit: banks should prepare for year-end and beyond
18 November 2020
The end of the Brexit transition period is approaching fast, with negotiations on the future relationship between the United Kingdom and the European Union still ongoing. This, together with the additional uncertainty generated by the coronavirus (COVID-19) crisis, raises the stakes for banks and other market participants. Banks must continue to use the remaining time to ensure that they are fully ready for the regime change once the transition period ends.
A few of the banks under the ECB’s direct supervision still need to complete actions in specific areas, in particular regarding the repapering of contracts with their EU clients. Overall, the year-end risks for banks supervised directly by the ECB appear to be contained, but the COVID-19 crisis has created more uncertainty and increases the need for preparation. ECB Banking Supervision is continuing to engage with all banks to follow up on any outstanding risks.
Banks with a UK nexus are also expected to concentrate on achieving their target operating models. These are the models that will enable them to trade, book and manage risk in the EU in a way that ensures prudent risk management and effective supervision. Most of these banks have already reached their target models or are well on track to do so, which is a significant achievement. In the wake of the COVID-19 crisis, ECB Banking Supervision has provided flexibility where required, notably to account for the impact of the lockdown measures and travel restrictions on the relocation of staff. No additional flexibility is foreseen in principle. Staff relocations scheduled for the future need to be planned with COVID-19 as a baseline assumption and be subject to only minimal delays. Any exemptions to this could undermine the capabilities that need to be built up in the EU. It is important to note that remote working arrangements do not change the fundamental need to relocate staff to the EU: ensuring that banks have a physical presence within the EU to the extent necessary is a prerequisite for achieving prudent risk management and effective supervision. The ECB looks forward to receiving evidence that staff subject to relocation have been or will be duly integrated in the entity under European banking supervision.
Moving assets and staff is an important step, but it is only the first step. The ECB also expects banks to be structurally profitable and operationally self-standing, in particular by not relying excessively on back-to-back set-ups with entities in third countries for their risk management. Our message is clear: EU products and transactions with EU clients involving non-EU products should be booked in the EU. Similarly, risk management capabilities related to EU products should be located in the EU. The same applies to funding. As a rule of thumb, euro-denominated funding of the EU business should be originated and booked where the EU business sits, i.e. in the bank under direct ECB supervision.
Beyond the end of 2020, the ECB will continue to focus on strengthening the EU’s financial system, which includes individual banks, the wider financial sector and financial market infrastructures. In this respect, there are a few matters that ECB Banking Supervision expects banks to take into account.
First, in cases where national regimes allow the provision of cross-border services from a third country, the ECB expects banks not to use such set-ups as a means to carry out large volumes of activities in the EU in a business-as-usual environment. The ECB expects activities and services involving EU clients to be carried out predominantly within the EU.
Second, as mentioned, one of the ECB’s key objectives is for banks to be operationally self-standing and not overly reliant on group entities outside of the EU. Each bank directly supervised by the ECB is expected to be able to independently manage all material risks that could potentially affect it at the local level (i.e. in the EU), and to have control over its balance sheet and exposures. Responsibility for implementing governance arrangements lies with the management body at the local-entity level and, accordingly, the governance and risk management mechanisms should match the nature, scale and complexity of the business. In particular, the extent of outsourcing to other entities and branches in third countries, especially for critical or important functions, should not result in empty shell structures, which do not sufficiently reflect the size, nature and complexity of the business and risks of the bank. Therefore, each bank directly supervised by the ECB is expected to have the necessary infrastructure, processes, staff and knowledge to be able to independently identify, monitor and manage all of its risks at the local level in the EU on a sustainable basis.
Finally, banks should be mindful that the European Commission’s equivalence decision regarding UK central counterparties (CCPs) is time-limited, in that it is valid for only 18 months. The European Commission has asked banks to use this time to reduce their exposure to these counterparties and to decrease their reliance on those UK CCPs which are systemically important for the EU. Banks should pay particular attention to this matter. They should also engage with their clients and dedicate an appropriate amount of resources to make them aware of the need to be prepared for a changing regulatory environment.
In relation to developments connected to Brexit, six banks have been placed under the ECB’s direct supervision since 2019: UBS Europe SE, J.P. Morgan AG, Morgan Stanley Europe Holding SE, Goldman Sachs Bank Europe SE, Barclays Bank Ireland PLC and Bank of America Merrill Lynch International.