There has been plenty of controversy over the UK’s potential exit from the European Union, and what it would mean for the London City’s financial sector. A paper published by think tank JWG “Brexit: Changing Out the Engine of Finance” shows that if the UK exits, the country will enter a long period of uncertainty, and the bureaucracy could become greater rather than less. In a recent DerivSource podcast, JWG’s PJ Di Giammarino and Aoife Quinn discuss the findings of their research.
There is a common misconception that if the UK chooses to leave the European Union, it will be free of the current rule-making environment. In fact, there are several reasons “Brexit” would lead to an increase of red tape. At a global level, there are a number of G20 commitments that would need to be maintained. Dealing with those, and understanding how the UK would stay equivalent with the rest of the G20, requires a lot of work. There are also many international standards, equivalence rules and obligations that would have to be met in order to continue to do business in Europe.
The Lisbon Treaty, which came into force in December 2009, established a new legal right to exit the EU as well as a procedure for withdrawal under Article 50—but it has never been used, and there is no legal consensus on how exactly it would work, or the impact on existing laws and regulations. If a country votes to leave, formal notice must be given to the European Community. There are then two years for negotiations to take place before formal withdrawal occurs. However, the exiting country does not take part in these formal negotiations. The UK would not have a seat at the table to discuss either its exit procedure, or its future relationship with the EU.
Rewriting the UK rulebook
The impact on the UK’s rulebook would be enormous. Some 60% of the rules in the UK are derived from European law. Many of the rules that have been put on the books since 1972 have come from regulations directly applicable under EU treaties. There is therefore an enormous backlog of regulations—MiFIR, EMIR, CRR etc—that would need to be transferred onto the UK books. Any tinkering with the rules could lead to very big business changes in areas like exchange-traded derivatives, how FX is treated, or record-keeping requirements, for example.
Organisations will be most concerned about the kinds of changes that affect the way trading is done—anything which affects sales, trade, workflow, risk calculation, margining, client controls and repapering, distributors, or potentially even vendor agreements.
Decision-making over rules would revert from the European Courts of Justice (ECoJ) to the UK courts. But the UK would no longer have access to the ECoJ to clarify questions of uncertainty or interpretation. With no reference point, understanding the basis of the laws they are trying to rewrite could become a big obstacle for British regulators. There would be a lot of uncertainty over the rulebook, with many people making decisions based on the partial assumptions of a few, very busy legal experts.
Impact of Brexit on operating costs
JWG estimates that exiting the EU would lead to a total additional regulatory spend of between £14 billion and £20 billion over the next ten years. This is on top of the already heavy cost of preparing for regulations and directives like MiFID II, which firms doing business in Europe will still need to comply with.
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This additional spend is likely to come in three distinct waves: as UK regulators reshape rules, and the industry pays massive legal and consulting fees to interpret them and create change programs (2016-2019); then as the EU infrastructure is rewired and firms implement the necessary systems, policy, data, structural and commercial changes required (2019-2022); and finally, as global infrastructure is rewired, reconciling new rules to global standards (2022-2026).
Develop an action plan
If the UK votes to leave the EU, it will mean the largest change program anyone has ever seen. One of the biggest issues will be the irrational component of the human response. Offices might move, teams might change; some people may lose the right to work in the UK. There will be changes to the way people are able to support their families or even travel across borders. There will be an enormous destabilising effect and organisational gap, especially for financial services.
Industry and government estimates suggest this would be a ten-year project. Getting plans together early is going to be crucial if firms are to manage it successfully. The biggest priority will be tracking the overall regulatory change portfolio, and having the ability to spot, know and eventually be able to carry out changes in a better, faster and cheaper manner. Firms will need to know what they need to do, deploy the right kind of regulatory technology, and define a consistent, repeatable way of identifying their infrastructure and operational targets. They will need to be able to make that a very flexible, nimble and robust capability.
Impact on business models
Passporting rights will be one of the biggest variables in this whole discussion. Those that have access to the bigger market via other routes may choose to remain in the UK or not, and there is a lot of speculation about how that would actually work.
There will be winners and losers. The winners will be those that are thinking about the total cost of ownership of this massive change program, and are able to de-risk it across their value chain—i.e. all the way up to clients, and then all the way back down their supply chain to the data vendors and everybody else that they’re relying on. That’s a giant risk management exercise.
From a business model perspective, firms must think about how they are going to keep their clients, and how are they going to position themselves better in front of the competition, as well as lock-in the right kind of service providers (lawyers, consultants, auditors etc) that can provide end-to-end change management support over the next decade. These top professionals will be in short supply, and it is critical to think about locking down those arrangements now.
Managing the psychological impact
Derivatives compliance professionals are already suffering from regulatory burnout.
Deciphering, interpreting, and haggling over the details of global post-financial crisis regulations has put a huge strain on these workers over the last seven years. There is a real possibility a lot of people will not have the will to go through all this again. Firms need to recognise this and provide support to staff to manage the psychological transition as well as the operational burden. Failure to do this could result in staff indifference, stress, and lapses in compliance. Brexit would turn up the dial on an already high-stress environment—if compliance personnel are unable to cope, it could put the organisation’s entire operating model at risk.
To listen to the DerivSource podcast, or view the entire transcript, click here.