The European Central Bank (ECB), acting in its role at the head of the Banking Union’s Single Supervisory Mechanism (SSM), has used its regular supervisory newsletter1, a very welcome communication channel, to remind BUSIs that a ‘trick or treat’ no-deal Brexit is currently on track for October 31. The ECB-SSM fears that much work remains to be done, and it therefore has reminded BUSIs to focus on preparations to comply with not only the ECB-SSM’s own Supervisory Principles on Relocations (SPoRs)2 but also those set by other European Supervisory Authorities (ESAs) such as the European Banking Authority (EBA) and the European Securities and Markets Authority (ESMA).3 Supervisors are likely to probably follow up on this most recent reminder and require BUSIs and other supervised firms to provide evidence on compliance preparations with SPoRs and other Brexit-related changes affecting operations on both sides of the post-Brexit landscape. This may require many to take even greater preparatory as well as remedial steps than previously and possibly amend how they plan to operate. These SPoRs remain quite prescriptive, despite some relief offered in certain EU Member States through national emergency Brexit legislation.4
There are now around 60 days to go until an October 31 “do or die” no-deal Brexit and tension is running at fever pitch, especially following UK Prime Minister Johnson’s success on August 28 in HM the Queen exercising the Sovereign’s power to “prorogue” (i.e. brining the current parliamentary term to an end and suspending) the operation of the UK parliament, thereby restricting the time available to debate an alternative. British MPs across all parties are likely to try to overturn this suspension, which will run for a key period commencing the week after parliament’s return from its summer recess (July 25 to September 3) until October 14, when there will be a Queen’s Speech setting out the government’s legislative programme. The EU’s next and possibly last-ditch Brexit-related meeting is scheduled for October 17 and 18 in Brussels. With UK opponents of a no-deal Brexit struggling to agree on an alternative approach, and the EU indicating at the G7 Summit on August 27 that it will not revisit the current draft of the Withdrawal Agreement, it is looking more and more important for BUSIs to meet SPoR compliance.
In summary, the ECB-SSM’s communication, which was published well ahead of the events of August 28, reiterates previous statements on the SPoRs and states its supervisory expectations on the amount of presence − i.e. substance − that is to be maintained within the EU-27. This includes the preferences on outsourcing5 and the limits on back-branching, permission for BUSIs to conduct certain business from post-Brexit UK branches, compliance of booking models and the location of key staff. The ECB-SSM is unequivocally brusque on BUSIs (or those applying to become BUSIs) needing to prepare and finalize their target operating models (TOMs) on both sides of their post-Brexit operations, as well as fully staff their resource commitments, in particular their EU-27 “on-shore” risk management and control function capabilities, and reflect this in fully compliant governance structures. The SSM points out:
“So far, banks have transferred significantly fewer activities, critical functions and staff to euro area entities than originally foreseen as part of their plans for Brexit Day 1. The ECB now expects banks to speed up the implementation of their plans. Where contingency plans for a no-deal scenario are not yet fully implemented, banks should step up their preparations to minimise execution risk. They should also address operational challenges associated with transferring staff and clients and setting up the necessary internal processes and systems. Looking ahead, the ECB sees a risk that, as a result of the delays observed, banks will not be able to fully implement their target operating models within the timelines agreed with their supervisors.”
The tone indicates an ECB-SSM that is frustrated in having had to make the same point multiple times, despite having been echoed by SPoRs published by other supervisory authorities. Some BUSIs, or applicants, may find that messages addressed to them individually may be less accommodating in terms of tone or timeline to meet compliance. The tone adopted also suggests that the ECB-SSM may be less inclined to grant some temporary relief from full day 1 readiness, which some firms may have previously hoped for. This is supplemented by the SSM warning of potential divergences between how EU prudential regulatory requirements may apply to BUSIs operating on both sides i.e. in the UK and the EU-27 and that the ECB-SSM may be far more interested in looking at how BUSIs are meeting those challenges than was previously the case.
On contractual continuity the ECB-SSM does acknowledge that some industry associations have taken preparatory measures to limit cliff edge effects with some documentation fixes but flagged that BUSIs need to proactively engage with their clients and counterparties to inform them of their preparatory plans and also step up efforts on novating contractual relationships to EU-27 “on-shore” entities. A similar statement was made by the ECB-SSM in its earlier advice that BUSIs ensure there is sufficient on-shore capacity (our Eurozone Hub has already flagged in previous publications this key move to terminology to this term that i.e. excluding group entities or branches in non-EU i.e. third countries) to have access to key financial market infrastructure providers or alternative providers. This updated advice, however, also specifically (and quite rightly) stated that financial instruments and their settlement finality could no longer be guaranteed because of the UK’s divergence from EU law, notably the EU Settlement Finality Directive and the Financial Collateral Directive, each as amended.
Moreover, as flagged in previous publications, the moves of the ECB-SSM and the ESAs in setting their SPoRs mark a much more joined-up supervisory approach, and one with much stricter expectations. The SPoRs are also setting supervisory principles that are being used beyond Brexit-related issues or being picked up, indeed the ESA’s have a pan-EU-27 approach, outside of the Banking Union and the ECB-SSM’s strict supervisory mandate.
While the ECB-SSM, the ESAs and the European Commission are all clear that they will not get involved in the domestic politics of the United Kingdom, they are all interested and possibly quite frustrated observers. This frustration has probably increased since the August 28 announcement of the proroguing of parliament. That frustration is even more evident in the UK’s pan-party “Remain Alliance”, which may decide to call a parliamentary vote of no confidence in Mr Johnson’s government, which commands a majority in the House of Commons of just one MP. That vote could be called irrespective of the various judicial review and other legal challenges being progressed in the UK courts to contest the constitutional validity the advice given by the Prime Minister to the Sovereign and the exercise of the royal prerogative in proroguing parliament, in what would be the longest suspension since 1945.
In the event that Mr Johnson should lose a vote of no confidence − and it is debatable whether that vote could even be held between the end of the summer recess and the prorogue date − then Mr Johnson would stay on until an alternative government can be formed or an election is held. The Remain Alliance are still in talks to finalize what a caretaker or national unity government to extend Article 50 and postpone Brexit might look like, and there is a serious risk there that the UK could continue the current default legal position of leaving without a deal and thus follow a “sleepwalk Brexit” on October 31.
If the current Prime Minister were to survive such a vote, assuming it is called, then this would confirm the plans for the UK to leave on October 31, with or without a deal. It should be noted that the UK has already said it will cease to participate in EU meetings from September 1 and thus Finland will, as current holder of the EU Consilium’s rotating presidency, exercise a proxy vote to ensure that in the absence of the UK, EU decision-making can go on while the UK officially remains an EU Member State.
The UK is unlikely to hold a general election before October 31 but, with all political parties holding their annual party conferences from September to early October, the political momentum will grow for an early general election sometime shortly after Brexit.
All of this, however, offers no respite for financial services in the UK or those looking to do business there. The current situation is so complex and the uncertainty could continue well into the autumn. Even if a new UK government were to revoke Brexit, the SPoRs are likely to be amended as opposed to being abolished as any revocation is likely to be viewed as a temporary stay while trust is rebuilt. While the UK runs down the clock, the blame game is also stepping up on both sides. BUSIs and other market participants will want to ensure they are prepared for both eventualities and are not caught uncompliant somewhere in the middle.