Download Brexit could prove a game changer for big

Brexit could prove a game changer for big investment banks
based in London. With the start of negotiations to extract the UK
from the European Union looming, banks are rushing to draw up
contingency plans to ensure they can still do business across
Europe.
What are investment banks doing?
Most are working on a worst-case
assumption that the UK financial system
gets frozen out of the EU. This requires
them to create an entity in the EU to
deal with customers there. Lenders are
going through their businesses line by
line to work out which jobs have to be
done where. Banks are also calculating
profit margins on each product to see if
it is worth continuing to provide it to EU
clients. For cost reasons banks are
looking at scaling up in European cities
where they already have banking
licenses and basic infrastructure.
So how could investment banks
restructure?
The aim is to continue serving important
European clients, while moving as few
roles and as little capital as possible out
of their existing UK operations. This
won’t be easy. Investment banks are
broadly looking at four models:
The introductory model. Banks keep
most of their traders and compliance
teams in the UK. Sales teams in the EU
“introduce” clients to the UK entity. This
is the dream model for banks as it
wouldn’t require a vast reshuffle of their
activities or trapping a pool of capital in
the EU. Lawyers say EU local regulators
probably wouldn’t sign off on this model
because it doesn’t give them enough
oversight of the banks.
The European branch. In the 1990s,
before the creation of the European
common currency, banks had a series of
licenses with different European
countries. These could be re-activated.
Instead of building fully capitalised
subsidiaries, banks would “branch” from
the UK or US into specific countries
where they already have licenses. Unlike
a subsidiary, which is essentially a local
bank, a branch functions as an outpost
of the home office. The upside: they
don’t have to trap capital in EU
subsidiaries. The downside: banks could
only do business where they have a
branch, so they wouldn’t be able to
access clients across the entire EU. Each
country would need its own branch. This
could work for smaller banks. But the EU
is already discussing rules that would
force big banks to create holding
companies – not just outposts – inside
the bloc.
The back-to-back model. This requires
banks to build a compliance team and
put a few traders into an EU entity.
Deals would be booked in the EU and
then flipped over to a bigger entity in
the UK or even New York. The
advantage of this model is that, because
the risk is taken out of the EU entity, it
probably wouldn’t have to hold as much
capital. It also requires less
infrastructure build out. Again, it would
require regulators to be comfortable
with the set up.
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The full blown bank. If all else fails,
there’s this. Lenders re-create a “minime” version of their UK investment
bank in the EU. This would require
substantial capital, trading
infrastructure, compliance and top
management to be in place in whatever
country is chosen. This would be the
most costly outcome for banks and
given that investment-bank profit
margins are less fat than they once
were, some banks might decide it isn’t
worth it to preserve the business.
Regulators are likely to be most
comfortable with this model.
“The aim is to continue serving
important European clients”
What jobs are affected?
Most bankers say they don’t yet really
know. There isn’t an EU wide definition
of what counts as doing cross-border
business with a non-EU country. So it
depends on which European country a
bank bases itself in.
Banks broadly think the following...
Those very likely to move: Sales staff
who do business with clients based in
the EU. That covers a big swathe of
products including the buying and
selling of shares and derivatives, the
ability to offer loans, and provision of
services like custody and clearing.
Further along the chain the picture gets
fuzzier. Regulators could demand on site
compliance teams, and back-office and
legal support to process those deals.
They could also ask that key risk takers,
such as traders, be present, along with
senior managers. Business
considerations will also come into play.
Banks, for instance, may want to keep
their trading and sales teams physically
together even if regulators don’t require
it.
Unlikely to move: Merger advice, for
instance, could be provided from
outside the EU, because it isn’t
considered selling of a financial product.
Other “ancillary” services such as
accounting or investment research
could also be done in a post-EU Britain.
The uncertainty is reflected in
consultants’ estimates of the impact of
Brexit. Oliver Wyman, for instance, sees
anything from 3,000 to 35,000 roles
leaving London.
London is a pretty big financial prize. Is
the rest of the EU keen to claim it?
Cities like Frankfurt, Paris and Dublin
certainly want a piece. All would
welcome at least some of London’s
finance business. But national politicians
and regulators might not be so keen.
With big investment banks come big
investment-bank balance sheets.
Countries such as Ireland, which went
deep into debt to fund bank bailouts
during the Eurozone crisis, could be
wary of taking on the risk.
“Cities like Frankfurt, Paris and
Dublin will want to claim some of
London’s financial business”
Is a big, painful shakeup certain?
No. There are a few ways it could be
avoided. The most straightforward
would be for the UK to strike a fresh
treaty with the EU that retains access
for its banks to the single market.
European leaders have made plain that
such an arrangement is only palatable if
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Britain continues to allow their citizens
to work and travel in the UK. Since many
Brexit proponents are keen to tighten
borders, the politics of this option look
difficult to square. But everything is a
negotiation.
One option is for Britain to join the
European Economic Area, a larger group
that comprises the EU plus Iceland,
Liechtenstein and Norway. Those extra
countries abide by some but not all EU
rules, and have access to some but not
all of the passporting rights. This seems
unlikely: EEA countries also have
obligations to permit foreign workers to
come.
Another option: On paper, at least, rules
coming into force in 2018 permit nonEU companies to access the single
market if their countries have adequate
regulatory regimes. EU authorities
would have to decide to grant this
“equivalence” status to the UK – and it
only applies to some of the things banks
do. What’s more, the EU authorities
could withdraw equivalence at their
discretion. That makes it hard to form a
business plan around.
“Big banks don’t turn on a
sixpence. They’ll need the path to
be laid out with some certainty
years in advance – these
decisions can’t be made on the
eve of Brexit. For now
uncertainty rules”
What happens next?
Bankers are hoping this all takes years
to play out. Brexit negotiations are due
to start by the end of March, but that
might slip pending legal challenges to
Brexit in the UK. The two-year
negotiations could be followed by a
transition period, lasting several more
years, allowing banks to reorganise their
operations. Banks will continue to work
on contingency plans, speeding them up
if it looks as if things won’t go in their
favour. If jobs must move, it will likely
be in drips.
That said, big banks don’t turn on dimes.
They’ll need the path to be laid out with
some certainty years in advance – these
decisions can’t be made on the eve of
Brexit. And for now, uncertainty reigns.
If all else fails, European clients could
come to London. Some corporations
might simply choose to continue doing
business with London-based banks.
They could do that if their own financing
arms were based in the UK. That might
be appealing to big companies keen to
dip into London’s massive capital
markets. But it likely isn’t an option for
smaller companies.
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