Brexit: financial services businesses prepare for 'most disruptive cliff-edge scenario'

Uncertainty surrounding Brexit is putting the financial services sector in a bind as businesses attempt to ensure future compliance with as yet unknown regulations. Urged on by regulators, they are preparing for a worst-case scenario that could make parts of their business transactions illegal overnight as Britain leaves the European Union.

‘It is a challenging time, yet again, to be in senior management at a regulated business,’ says James Bateson, Global Head of Financial Institutions with Norton Rose Fulbright.

Lawyers are advising financial services businesses on contingency plans for the ‘most disruptive scenario’ that should provide protection against the immediate structural challenges.

‘Businesses need to plan for a hard Brexit. What they don’t want to find is that, come March 2019, they have to stop trading in that locality. This is a massive problem,’ says Bateson.

"Businesses need to plan for a hard Brexit. What they don’t want to find is that, come March 2019, they have to stop trading in that locality. This is a massive problem

James Bateson
Global Head of Financial Institutions, Norton Rose Fulbright

Regulatory bodies are spurring companies on to get their contingency plans in place.

Hendrik Haag

Hendrik Haag

‘The supervisory authorities are concerned that banks are waiting too long. Because once the regulatory status changes and we have a hard Brexit, the regulatory status changes overnight and many banks may have compliance problems,’ says Hendrik Haag, a partner at Hengeler Mueller in Frankfurt and Chair of the IBA’s 2009 Task Force on the Financial Crisis.

Businesses are not yet wholeheartedly committed to implementing the more disruptive parts of their contingency plans, lawyers tell Global Insight.

They are starting small, doing only what they need to do now to avoid making too many changes that might later prove unnecessary.

‘If you want to manage uncertainty you are running the risk of overinvesting too early, but some institutions say "I’d rather do that than be caught by surprise",’ says Haag.

Though some banks and businesses are considering bolstering their operations outside the United Kingdom, most informed observers agree that the emergence of a financial centre equalling the City of London remains a long way off. ‘This will strengthen New York, not Frankfurt or Paris, because they are far, far smaller and less significant on the global scale. It will strengthen them, but not significantly,’ says Simon Morris, a partner in CMS’s Financial Services and Products team.

Morris sketches a dark picture of Brexit as he says companies are ‘building their own Brexit’, prompted by the uncertainty of the UK government. ‘Brexit is about the destruction of certainty and the destruction of certainty equates to the destruction of value,’ says Morris.

Uncertainty also surrounds the transitional period, which the government has repeatedly said will be about two years. Caroline Meinertz, a partner with Clifford Chance, says that, though from a business perspective a transition period would be ‘the longer the better’, two years is an acceptable minimum. ‘Also the substance of the transition period is important. It would have to be negotiated whether businesses would have to comply with existing and new EU laws during this period,’ Meinertz says.

A longer transition period is seen as unlikely. ‘A two-year transition period is simply not enough time. But political expediency is such that you would have some turbulence about [extending it],’ says Bateson. After all, it would be a hard sell to Brexit voters or supporters that, even after the divorce date, the UK would remain bound by European regulations for another 5 or 7 years.

Leaving the EU without a transition period, most likely in the case of a no-deal Brexit, could have considerable negative consequences for the financial services sector. ‘The most difficult scenario would be no deal; an exit with no transitional arrangement and it being illegal for companies to carry on some lines of business,’ says Michael Wainwright, a partner in Dentons’ Financial Services and Funds practice.

Hogan Lovells and the International Regulatory Strategy Group (IRSG) look at the possibilities for a free trade agreement that would avoid such a cliff-edge scenario and reduce additional risk of market instability, in a new report entitled ‘A New Basis for Access to EU/UK Financial Services Post-Brexit’.

‘We are looking at something that has some similar characteristics to passporting, because this would ensure capital efficiency and eliminate the need to relocate. The EU and the UK now have aligned legal and regulatory regimes and, by managing divergence, we can ensure that EU and UK laws remain sufficiently aligned to guarantee access across borders,’ says Rachel Kent, Global Head of the firm’s Financial Institutions Sector.

Problems do not start or end in March 2019, however. Already, contracts – usually signed for more than a single year’s cycle – will transcend the Brexit period. ‘This isn’t a 2019 problem. The practicalities are really quite immense,’ says Bateson. The actual impact of any Brexit deal, without a historical precedent, will not be clear until at least 10 years from now.

Many lawyers who spoke to Global Insight say they remain open to the idea that Brexit might not happen. ‘It’s legally difficult now because we are on a fixed time frame with no way out of it except through agreement, but you certainly couldn’t rule out that possibility,’ says Wainwright.