6 minute read
How could the end of the transition period affect how companies in the UK and EU access financial services? Mike Slevin, a Managing Director specialising in Corporate & Institutional banking, gives a quick take on the main implications and outlines a seven point review plan for corporate finance decision-makers to consider.
To watch a webinar replay on this topic visit the Association of Corporate Treasurers page here.
With the whole world focusing on the coronavirus outbreak for most of 2020, Brexit may have slipped to the back of many people’s minds. But with the end of the transition period nearing, businesses need to revisit how Brexit is going to affect them. Here, we briefly outline some of the implications for how companies will be able to access financial services from 1 January next year. For more in-depth analysis of the topic, please click here.
Brexit will change the state of play in the financial services arena
Most of the analysis of the impact of Brexit on financial services has focused on the consequences for the providers of financial services rather than their corporate customers. But corporate finance decision-makers are going to face some key changes: there’s likely to be a major impact on both the availability and cost of financial services as providers from the EU serving UK customers and vice versa will no longer have the benefits of free access through the single market
It’s not possible to say exactly what the consequences will be for individual customers, as they will depend on the complex interplay between financial firms within wholesale markets and their clients in a significantly changed, and more costly, legal environment for which there’s no precedent. The impact will also vary by sector, as well as by corporate size and business model but we outline some general considerations below.
The impact of Brexit on different financial services for corporates
It’s important to remember here that we’re focusing on short-term impacts – we don’t consider how conditions could shift further down the line as rules and regulations change.
The cross-border sale of investment services will be limited so achieving the same activity will need some elements to be conducted elsewhere. The customer may choose to act through another route, perhaps using a competitor financial firm. This could involve higher cross-border investment costs or other barriers for both UK and EU companies. There may be, for example, less equity coverage by EU firms of UK companies and vice versa.
M&A, debt and equity fund raising for EU issuers is currently centred in London. Fragmentation will affect London’s role, especially if there are restrictions imposed on EU banks that currently rely heavily on their London-based operations to provide critical debt and equity financing services. A shift to third-country status for the UK will have profound impacts on the functioning of these EU markets and have consequences for EU-based issuers until onshore capabilities are fully developed.
Cross-border lending and deposit activity would become constrained by the ending of passporting, depending on the precise legal position in individual EU Member States. This would affect UK corporates that require financing for their operations in the EU or to manage EU-based cash and liquidity positions. The same could apply to EU corporates needing finance in the UK, depending on the position of their current suppliers.
Payment services provided by banks in the UK to the EU or vice versa could potentially be restricted, resulting in a fragmentation of payment services for corporates that trade between the UK and EU. However, this seems unlikely in the short-term.
FX translation is a core activity for banks in the UK serving EU corporates and vice versa but it could become heavily restricted because derivatives are regulated under MiFID. The fragmentation of underlying FX markets could result in reduced competition and thinner liquidity, possibly leading to higher overall costs of FX services.
Interest rate and FX hedging activity is operated through the UK as a global hub for FX markets. Banks in the EU could be prevented from distributing to UK clients and would have less access to London, forcing them to divert to onshore trading where there is less liquidity available. This could make it harder for banks in the EU to provide risk and hedging services to their EU client base as competitively as previously.
Financial market infrastructure – including clearing, venues and custody – could be affected, although temporary equivalence for clearing has been granted until 2022. Changes to the regulation of financial market infrastructure will result in additional costs and risks, and will fragment pools of liquidity.
Intra-group transactions within financial services groups will be affected by the loss of waivers, making the movement of funds and capital more difficult and expensive.
Amended capital treatment could affect trading models and hence bond market spreads. This would affect conditions for both issuers and investors.
The use of financial benchmarks administered in the UK may be restricted or prohibited in the EU (although this would not apply to LIBOR).
There is also the direct cost of regulatory divergence through the duplication of requirements, which might at the same time also differ, making it more complex and expensive for both UK- and EU-based banks to provide harmonised banking services to clients across the UK and EU.
Risk of instability in the short term
There could also be instability for a period of time as market participants try to work out the possible availability and price of transactions. These will depend on their assessments of the likely actions of other participants in the financial market and their views on how Brexit itself affects the creditworthiness and behaviour of final users.
In the immediate term there may be unexpected secondary impacts; for example, as we’ve seen in the coronavirus crisis, the disruption of expected commercial flows of goods and services may mean that some corporates have over-hedged their anticipated trading positions, and these hedges may need to be reversed. There may be therefore be volatility in sterling FX rates, not just against the euro but against the US dollar too.
This note has benefitted from input from the staff of the Association of Corporate Treasurers (ACT), the Association for Financial Markets in Europe (AFME) and the Confederation of British Industry (CBI).