BoE reassures foreign banks on post-Brexit booking models

EU banks that lost passporting rights after Brexit are unlikely to have to establish UK subsidiaries

David Bailey, Bank of England

Photo: Bank of England

Ever since the Brexit vote in 2016, European banks have been wondering whether trading books might end up being almost entirely split between the European Union and the UK after the country left the single market. This week, the Bank of England reassured them that their global booking models were safe, provided they can demonstrate that any risks to the UK’s financial stability are subject to proper controls.

“We recognise that international firms in many cases operate global booking and risk management models, so a variety of approaches may be appropriate,” says David Bailey, executive director of international banks supervision at the BoE. “Our expectation is that if firms are going to operate here, their booking models and arrangements, and risk management and governance [must be] appropriate, transparent and well understood.”

On January 11, the UK’s Prudential Regulation Authority (PRA) issued a consultation paper setting out its post-Brexit approach to supervising the UK activities of foreign banks. The move came 10 days after banks from the European Economic Area (EEA) lost the ability to operate in the UK under the EU’s passporting rules. Any firms with major deposit-taking activities in the UK have already been asked to establish local subsidiaries. Another 66 banks that entered the temporary permissions regime (TPR) have until January 2023 to secure branch licences for their UK entities.

The BoE estimates the international wholesale branch assets it supervises could rise by as much as two-thirds when the TPR ends.

The UK’s flexibility on booking models and risk management is a far cry from the stance taken by the European Central Bank, which has been more explicit about the need to relocate balance sheet and staff to the eurozone in order to handle clients there.

“Banks in the euro area should be capable of managing all material risks potentially affecting them independently and at the local level, and should have control over the balance sheet and all exposures,” reads the ECB’s guidance on post-Brexit licensing.

This has led to growing fears that broker-dealers may come under pressure to establish full banking subsidiaries in the EU – subject to separate capital and liquidity requirements – to service eurozone clients.

The contrast is not lost on Bailey. “We haven’t specified that we require certain people, assets and processes to be located within the UK,” he says. “We think it’s better to say to firms: ‘You see what our expectations are, tell us how you are going to organise yourself to meet our expectations and we will tell you if that is appropriate’, as opposed to saying: ‘This is exactly how you must organise yourself.’ I don’t think the first way leads to as efficient and effective an outcome.”

Systemic branches

Bailey stresses that the BoE is not specifically trying to avoid EU banks being required to form subsidiaries, but nor is it actively pushing those that previously passported their services into the UK to go down that route. The overriding goal is to ensure the safety and soundness of each individual branch and the system as a whole, he says.

A supervisory statement issued by the PRA in 2018 requires wholesale branches with more than £15 billion in assets to have “specific mitigants” in place to ensure the risks they pose can be adequately supervised by the BoE. If those mitigants are missing or inadequate, the regulator might then require the branch to be converted to a subsidiary.

For some of the 66 wholesale branches that entered the TPR, £15 billion is a low threshold.

“Some very well-known firms are in the TPR that have assets way above that threshold. [With] those firms, we already have the kind of close and continuous detailed supervisory engagement and the same expectations that apply to other systemic wholesale branches that operate here, for example from the US or Switzerland,” says Bailey.

But the BoE’s approach is not mechanical, he adds. Before designating a wholesale branch with more than £15 billion in assets as systemic, the regulator will also look at other classic systemic risk indicators. These include the complexity of the activities, how interconnected they are with the rest of the UK financial sector and the level of critical functions the branch provides.

[Systemic wholesale status] doesn’t mean they have to subsidiarise. It just means we have some additional expectations for them around the supervisory engagement

David Bailey, BoE

The UK branches of many EEA banks are likely to tick those boxes. The BoE estimates the number of systemic wholesale branches in the UK – which it does not disclose – will rise by around 50% when the TPR ends in 2023. Even so, many EEA banks can avoid converting their UK branches to subsidiaries by putting in place the mitigants required by the PRA.

“[Systemic wholesale status] doesn’t mean they have to subsidiarise. It just means we have some additional expectations for them around the supervisory engagement – we have a more close and continuous engagement with them than with other wholesale branches, and we have some expectations around governance and risk management,” says Bailey.

He adds: “If firms meet the criteria to move from being a branch to a subsidiary, we will discuss that with them and take that step, but I am not expecting that to be something that happens on a very regular basis.”

Bailey says the PRA has also tried hard to be clear about its expectations, and consistent over time. The firms that have entered the TPR have been in discussions with UK supervisors about their future authorisations for at least three years. He doesn’t believe the contents of the consultation paper will come as a surprise to them.

“I am not expecting what we communicated to them this week to lead to a really significant amount of firms needing to restructure their organisations,” Bailey says. “It is more a case of building on the dialogue we have had already to meet our current expectations.”

Regulatory co-operation

In order for a foreign systemic entity to remain a branch, its home supervisor must have co-operation and information-sharing agreements with UK regulators. The UK Treasury is negotiating a memorandum of understanding with the European Commission, which is expected to be completed by March. But Bailey says the BoE is not relying on those negotiations and has already struck co-operation agreements with most EU regulators.

“We have already agreed MoUs with the ECB and the vast majority of national competent authorities across the EU,” he says. “They provide for the level of information-sharing and co-operation that we would expect, and they reflect the MoUs that we already have in place with the authorities right across the world.”

As the UK’s bank resolution authority, the BoE also has an arrangement in place with the EU Single Resolution Board to provide mutual recognition of any resolution actions taken by either authority.

The flip side of this is that the planned MoU between HM Treasury and the EC will not lead to any special favours for EU banks either – all systemic wholesale branches face the same expectations. As a result, Bailey says new branch applicants currently in the TPR will have to meet the same conditions “that already apply to systemic wholesale branches that operate here but are part of groups based in other jurisdictions like the US, Switzerland or Japan”.

The other elements of the PRA’s expectations rest on the shoulders of individual firms. One requirement specifically concerns integrated cross-border booking hubs: the PRA wants to ensure adequate pre- and post-trade risk controls for trades conducted elsewhere and booked into the UK, or vice-versa. Bailey emphasises the importance of pre-trade controls in particular, and the consultation mentions that the regulator has found “weaknesses” in this area when reviewing front-office operations.

“Our expectations are that there are very clear documented booking arrangements that are understood within the local entity, but also across the group and [among] anyone who can book business to a UK balance sheet, and that there are both pre-trade and post-trade controls to make sure those booking arrangements are followed in practice,” says Bailey.

Wearing two hats

Closely tied to this is the question of staffing and governance. The consultation paper makes clear that, in addition to a head of branch, systemic wholesale branches may need a number of other key functions such as a chief risk officer or chief operating officer.

“In many cases, systemic wholesale branches have significant functions working already in the UK, and it is really a case of them nominating the right individuals to be designated under the senior managers’ regime within the branch,” says Bailey.

However, this could be a problem for non-European banks that previously had a European hub in the UK and have now had to open a post-Brexit entity in the EU27. The ECB’s insistence that entities set up to handle EU27 clients have full, independent risk management functions means senior staff are being pulled in two directions at once. In this area also, the BoE is ready to offer some flexibility for banks looking to execute trades in the EU and then book them into a London hub.

In many cases, systemic wholesale branches have significant functions working already in the UK

David Bailey

“In some cases, it may be appropriate for people who are not located in the UK to have a specific function where they have significant influence over operations that take place in the UK,” says Bailey. “Our expectations are that there is an appropriate risk management function which can be comprised of staff within the UK, but also staff located elsewhere that are specific to the UK entity to make sure that trades are risk managed on an ongoing basis in an appropriate fashion.”

Of course, a regulator’s flexibility must have its limits. The BoE will keep a close eye on any foreign bank that is “making a significant change to its operations” in the UK, says Bailey, to understand the implications. That applies across the board, but the end of the Brexit transition period is a particular focus at the moment. He urges international banks to be “proactive” in explaining any changes to their strategy and plans to UK regulators.

“If a firm was planning to transfer risk management capability and people out of the UK into other parts of the global operations – whether that is in the EU or elsewhere – and that is likely to be detrimental to the firm’s ability to meet our expectations and for its safety and soundness, then of course we would have that discussion with the firm and we would expect them to take steps to make sure those risks were addressed,” says Bailey.

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• Topics
• Bank of England (BoE)
• Brexit
• Cross-border supervision
• Cross-border trading
• Europe
• European Central Bank (ECB)
• Prudential Regulation Authority (PRA)
• Single Resolution Board (SRB)
• Trading book
• United Kingdom (UK)
• Regulation