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Brexit: Financial services – preparing for opportunities

Brexit fatigue and uncertainty should not stop businesses thinking about the challenges and opportunities the outcome of the UK's EU Referendum may cause.

July 2016

As predicted, the result of the UK's EU Referendum has not yet brought bring immediate seismic change for most businesses, despite the fact that markets have been spooked.

But as this is going to be a long journey - on an uncertain route to an unknown destination - good governance suggests businesses should already be loosely planning to exploit potential benefits or mitigate any risks, either within the context of an existing business or for in flight authorisations.

In the words of Donald Rumsfeld, "There are known knowns... There are known unknowns... But there are also unknown unknowns."   We don't know when or on what terms we will exit the EU but regulators will want to see evidence of businesses’ awareness and preparedness for that heady combination of Brexit and Donald Rumsfeld. How can you do that when it is also important to be focused on a bigger picture?

  • Be clear what the range of outcomes looks like and analyse scenario modelling to identify pressure points from outcomes and financial market uncertainty.
  • Clearly identify your priority markets and expansion plans as well as areas that could be rationalised.
  • Consider how Brexit pressure points are already addressed within current business continuity or recovery plans and stress testing. Extend and amend such planning appropriately.
  • Identify possible interim contingency plans and enduring solutions, which can be put in place quickly. Any plans would need to be achievable within the time taken to negotiate UK withdrawal: the exit process itself is untested. While it may be as soon as early 2019, we predict a more realistic timescale would be in the region of five to ten years
  • Collect the right management information – what do you need and what might the regulator need? Do you also need to brief key stakeholders?
  • Can you be agile and flexible to move at speed as changes become clearer?
  • Do you need to message clients and staff? PR and communications teams may need to be ready with well-judged responses to changing circumstances.

While it will take time for the UK's position to finalise following the leave vote, 'wait and see' may also be difficult as most significant business planning is complex and protracted too, particularly if this involves exiting a market or rationalising resources, with fixed timetables and processes (such as staff consultations or regulatory approvals for exit).

Here is a roundup of some of the watch points for financial services businesses:

  • Market, interest rate and currency volatility can have knock on effects into capital and liquidity funding. These are core concerns for the UK regulators and businesses must demonstrate competence in managing these risks – most of the PRA's enforcement activity takes place in this space.
  • The UK's credit rating and projections have already been downgraded. It is important to model how this affects borrowing costs, investment and structuring decisions and other capital and funding planning. Redemption rates may increase and it is important to follow documented processes and regulatory guidance to manage this. Businesses must ensure fund portfolios are rebalanced in line with product descriptions, and offer documents and wider implications must be assessed..
  • Losing passporting rights is a prominent risk across financial services. The final negotiated version of"out" may trigger a need to revise business models. A business needs to anticipate which markets it wants to access and where its costs ceilings are for its strategy (e.g. additional prudential arrangements, duplication of effort for regulatory compliance, staff disruption). It may not be viable to reorganise: whether to set up a subsidiary in the EU as a hub to continue to take advantage of passporting; to remain in the UK and meet requirements to operate in the EU as a third country firm; or for incoming EU businesses to set up in the UK on a third country firm basis, for example, because of capital and operating costs in proportion to profit. If you choose to leave a market, whether the UK or the EU, this should be planned, factoring in any necessary regulatory approvals.
  • A firm will need a clear understanding of its current staffing and resourcing in order to understand how Brexit may affect these and necessitate change. As part of business continuity planning, firms should consider the diversity profile of their staff, not only as a whole but also in relation to key persons and the leadership team (i.e. who is either EU, non-EU national or from the UK?). This will help with any transition to a new migration regime and ensure it can be managed and supported with minimal impact on business as usual. This area should be handled with care to avoid any slip ups leading to discrimination claims.

    Additionally, firms may want to consider their core secondary resource - outsourced functions (taking this wider than pure material outsourcing to include items such as office services, cleaning and hospitality), data centres, IT and the like. How are these resourced and are they likely to be affected by any migration restrictions?

  • If reorganising, a consideration will be around commercial contracts and client agreements. Firms need to identify key income streams and core commercial relationships (e.g. distributors, trading venues). Outgoing UK businesses are likely to face some restrictions when accessing EU markets (akin to non-EEA businesses). How can clients and suppliers of a branch that needs to become a subsidiary be migrated? What law and jurisdiction provisions are relevant to the firm’s major commercial agreements and standard terms and conditions? How many contracts have been formed on this basis? Are there any termination or other provisions (e.g. force majeure) that may affect continuity of supply or loss of client base? A business may want to use an existing or recent due diligence process to assess the ball park impact – and related costs.
  • Are there wider commercial and operational impacts? Businesses will already manage costs, risk exposure and investment decisions using options and derivatives (e.g. for currency exchange risk or commodity purchases); should this be considered more widely? How does your firm access financial services – will you still be able to access banking, payments systems (e.g. to pay staff or energy bills)? Will you still be able to get insurance and will it be more expensive as a result of investment outcome volatility? Will finance, services, products, facilities and overall operating costs simply increase, pressing product pricing and profits? Will consumers tolerate price increases or will dividends be affected?
  • Will Brexit provide an increasing push towards automation, consolidation and de-risking? If firms cannot access clearing services or trading venues, for example, perhaps they will be incentivised to find alternatives (such as distributed ledger technology)? Fintech has opportunities here. Additionally, Sterling and Euro exchange rate pressures may make acquisitions attractive to incoming investors
  • Specialist products and operations need careful assessment – special purpose vehicles, insurance products, funds and similar may need adjustments to remain viable (e.g. funds may need to adjust for accessing markets through local private placement regimes). Where will the costs of adjustment fall? Will performance be dragged down by such costs? Consider whether portfolios need rebalancing or whether investors need to receive updated projections on an exceptional basis or at the next reporting juncture.
  • Regulatory uncertainty is nothing new but is likely to be exacerbated. Regulation is a significant Eurosceptic nuisance. One thing is clear: regulation (financial services-specific or otherwise) cannot be ditched that quickly.

    Businesses should continue with implementation projects (such as MiFID II or PSD2). We anticipate that the exit timeline will materialise beyond the implementation date of such initiatives. We also anticipate that a 'slow let down' approach will be used, with any regulatory change being managed with 'grandfathering' and transitional provisions, as already extensively used by the financial services regulators.

    Importantly, certain post-Brexit outcomes anticipate a need to keep or implement major EU legislation as part of the free movement principles or to access a market on a third country equivalence basis. Certainly, regulation is needed to deal with risk in the domestic system. In addition, much financial services regulation stems from global initiatives at G20 level, as measures were conceived to prevent a repeat of the risk contagion seen during the 2007-2008 crisis.

    Clearly, however, a desire to no longer be bound by EU laws was one aim of leave campaigners leading up to the referendum. There is a huge body of relevant law so we anticipate a very slow divergence of regulation and other ancillary laws once an out position is put into place.  The extent of the impact will depend on the exit terms agreed with the EU and the provision for a future relationship with it.

  • Business profits will clearly continue to be taxed, but it is unclear whether Brexit will lead to any material changes in tax policy and application. On the one hand, many aspects of the UK tax code have been influenced or directed by core EU principles such as freedom of establishment and free movement of capital (e.g. loss relief for UK companies with branches elsewhere in the EU) and removal of those constraints could enable a tightening of tax policy to protect the UK fiscal base.

    On the other hand, EU membership arguably introduces constraints in areas of the UK tax code that could be more competitive without those shackles (e.g. VAT, the core principles of which are harmonised across the EU, and venture capital investment reliefs, which are subject to EU State Aid rule restrictions).

    However, the post-Brexit UK will still be subject to international commitments to initiatives such as the OECD’s Base Erosion and Profit Shifting (BEPS) project, which is already leading to tighter taxation rules for international businesses operating in the UK, and it seems unlikely that trend would cease. Additionally, any international arrangements (e.g. EEA entry, EFTA membership or other bilateral agreements) could well come with conditions that include requirements to toe-the-line in matters of tax policy.

    Other taxation considerations may be relevant for firms with a high net worth or international client base and a review of products designed for those clients may be advisable to ensure they are still fit for purpose and suitable for clients.

  • There are many issues to consider generally for financial services, and for technology businesses within that sector. The impact on regulators and the knock on into the sector must also be considered. Useful initiatives (such as the Sandbox, FAMR advisory tech, Regtech) may be squeezed as resource gets diverted to assessing regulatory implications, trade agreements or policy considerations. The regulators may well become more stretched or fee levies increased

Whatever the timing and terms of Brexit, uncertainty should not prevent businesses considering risks. Planning should help navigation and may help businesses to take opportunities.

If you have any questions on this article please contact us.

Financial services – preparing for opportunities
Jonathan Rogers

We look at how to exploit opportunities and mitigate risk in the FS/FinTech space following the EU Referendum.

"Uncertainty should not prevent businesses considering risks. Advance planning should help navigation and may help businesses to take opportunities."