The opinion is technically addressed to National Competent Authorities (“NCAs”). Nevertheless, it is effectively a statement about what the EBA perceives as a lack of proper Brexit risk planning by firms across the industry and a call to urgent action to address these perceived deficiencies.
The EBA believes that firms have placed far too much reliance on the political agreement reached in March 2018 that a transition period would be put in place by the time the UK leaves the EU on 29 March 2019. There remains, however, considerable political and legal uncertainty as to whether such an agreement will be formally agreed and ratified in time. In the EBA’s view there is still a “material possibility” that the UK’s departure from the EU might occur without such a transitional agreement being in place.
On this basis, the EBA believes firms should be undertaking their Brexit contingency planning on the basis of a “hard” Brexit and must, in light of the inherent uncertainty in the process, begin implementing their Brexit risk mitigation strategies without further delay.
Amongst other things, the EBA has indicated that it expects firms to consider the following:
- Identify areas of potential risk to the firm’s business, including:
- Direct financial exposures to UK counterparties;
- Existing contracts with UK counterparties;
- Reliance on the UK for financial market infrastructure (such as trading venues and CCPs);
- Data storage and transfer concerning the UK; and
- Reliance on the UK markets for funding;
- To the extent risks are identified, firms should consider the consequences of those risks materialising and put in place appropriate risk mitigation strategies. In this context the EBA has expressly referred to the potential for risk weightings attached to certain UK assets to be changed as a result of Brexit, with the potential consequence that firms might need to hold more capital against those assets; and
- Ensure that the firm has the requisite regulatory permissions to support existing business and any contemplated new business post Brexit, particularly in light of the fact that the passporting regime could potentially disappear overnight.
In order to properly address these concerns, firms will first need to undertake a regulatory risk assessment, business line by business line and product by product, to ensure it properly understands the nature of the potential risks to which its business might be exposed to following Brexit. This should be undertaken on the basis of a worst case scenario – a ‘hard’ Brexit. Only once this exercise has been completed, can appropriate and effective risk mitigation strategies be devised and implemented.
The financial services industry across the EU is hopeful that the March political agreement will manifest itself in a legally certain transitional period following Brexit. However, the nature of the political process means that this hopefulness is not an appropriate basis on which a firm should base its preparations for Brexit. This is really a case of hoping for the best but preparing for the worst. The EBA believes this too.