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An SSM update on Brexit

SSM views on Brexit

In the Introductory statements at the annual press conference on ECB Banking Supervision, held on 7th February 2018, Sabine Lautenschläger, Vice-Chair of the Supervisory Board of the ECB, gave an update on the supervisory view of Brexit saying: “Banks must be ready for Brexit; it will happen - even if the EU and the United Kingdom have agreed to discuss a possible transition period. Still, we cannot be sure whether the transition period will really happen. Thus our expectations have not changed: banks must continue to prepare for any outcome, including a hard Brexit”.

So what are the expectations of the SSM, and what further pronouncements have been made since July 2016, when Lautenschlager noted that the SSM had a “wait-and-see mood” to the main outcomes of Brexit? In fact, the SSM has taken a more proactive stance, with steady progress in defining its expectations with respect to passporting and business planning, thereby giving banks a better understanding of what exactly the ECB expects when it comes to their preparations for Brexit.

Passporting and business planning for Brexit

In our previous analysis of potential changes for incoming banks to the SSM, we explored whether the SSM could cope with a sudden influx in applications for banking licenses in the Eurozone. At the time, the SSM was getting ready to tackle a high volume of applications, focusing on granting licenses where they would be needed the most and preventing a backlog of “safety net” type applications.

A year later, the European Parliament's Economic and Monetary Affairs Committee confirmed in November 2017, that they have received numerous applications. Around 50 banks have directly approached the ECB or the national competent authority (NCAs) in preliminary steps for feasibility studies, or to submit applications as part of the banking licence process.

Despite this high amount of contact with supervising authorities, the ECB and NCAs have coped. However, the ECB is noting issues in banks' preparation, namely in three main ways:

  1. Banks are delaying their final decisions on operational restructuring, perhaps “with a view to keeping their options open”
  2. Despite progression in their plans, SSM banks with a UK footprint lag behind overall with their preparations for Brexit.
  3. Some banks attempt to get around actual planning by setting up “empty shell” banks in the union, whilst relying on services in the UK to keep operations going. Empty shell banks are those that do not have adequate local risk management and governance structures, nor sufficient local staff and operational independence to run banks smoothly.

On the first two points, and given short processing time before the final exit of the UK from the EU on 30th March 2019, the ECB is rightly concerned that banks, both inside and outside the SSM, must increase urgency to finalise their plans for Brexit as soon as possible. The ECB has already sent out letters to banks asking them to outline their Brexit plans. In our informal discussions with the ECB, we can further expect supervisory inspections and thematic review on the topic of Brexit and future business models development. 

Booking models and empty shells

Regarding the point of empty shells, this continues to be a hot topic for supervisors, such that on 14th February, the ECB published a clear list of focus areas for supervisors for booking model practices. In summary, the five key expectations of supervisors when assessing booking model practices are the following:

  1. Internal governance, staffing and organisation
    Banks must have:
    1. An adequate and skilled management body, locally based to oversee the local entity practices
    2. Locally manage material product risks without relying on 3rd country operations
    3. Sufficient front office capabilities to cover business activities
  2. Business origination and Financial Market Infrastructure (FMI) Access
    Banks must ensure that the access to FMI is not fully dependent on group entities that are outside of the EU.
  3. Booking and Hedging Strategy
    Intragroup back-to-back hedging strategies / remote booking with group entities in 3rd countries cannot be relied on, and banks must demonstrate their trading/ hedging capacities. In addition, banks must demonstrate how these can continue in a crisis situation
  4. Intragroup arrangements
    Banks must demonstrate how they have control and oversight over their balance sheet within the EU. In addition, supervisors must be provided with plans to transfer / establish pricing, trading, hedging and risk management capabilities based in 3rd countries to the EU.
  5. IT infrastructure and reporting
    Banks must be able to produce complete and accurate data on the above points to ensure risks can be adequately monitored by the ECB. Proportionality will be used on a case by case business, depending on the complexity and size of the banks operations. 

What's next for banks?

The ECB has stated that it will publish further information on booking models and empty shells, but in the meantime, banks have now been provided with a clear expectation for the future of banking business models following Brexit. Existing SSM banks should look to finalise their planning as soon as possible, and incorporate any required adjustments to their governance, models and arrangements as needed. In addition, banks may need to allocate sufficient time and resources in case of potentially more invasive supervisory reviews of their plans. In any case, banks should strive to be proactive and well prepared - as Lautenschlager said herself, “The Clock is Ticking”!

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