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21 November 2017

Likelihood of a no-deal on the rise: The no-Brexit option finds its way back to the table - 135th Brussels for Breakfast – CPD Notes

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The downs-and-downs of the Article 50 negotiations so far have put into focus the harsh reality of Brexit: there is no alternative to EU membership that is even better than being a member state, but rather a binary choice: to be ‘in’ or ‘out’ of the largest economic market in the world.

Graham Bishop/Paula Martín

Organised by the Centre for the Study of Financial Innovation (CSFI) with co-presenterDavid Thomas and sponsored by PWC

This blog covers the key subjects since our last meeting that I hoped to cover but, as always, we ran out of time to deal with them all. As a Friend, you can watch the 27th `structured’ CPD web-cast with CISI. These Notes may be read to record a further 30 minutes of `structured CPD’, including a dipping into the links to the underlying stories.

Highlights from the “Brussels for Breakfast” meeting

“493 days until we go over the cliff” dominated the discussion in various ways as opinion polls are now showing a distinct shift towards the UK public feeling that a wrong decision had been made and only one third approving of the government’s handling of the Brexit negotiations. So it may yet be important that legal opinion seems to be lining up behind Lord Kerr – author of Article 50 – that the UK can withdraw its Notice – implicitly assuming that EU27 would welcome such a move.

The direct impact on the UK’s financial services industry becomes ever more apparent: 20 banks involved in detailed discussions with the SSM; many more reviewing their structure of branches (including in the UK); German insurance regulator asking for details of how UK companies will honour their policies after Brexit; asset management industry focussing on delegation issues back to the UK. Even the CCP location debate has taken a major turn. Deutsche Bőrse offered a new co-operative deal to its members and the take-up seems very significant amongst the largest players. ESMA said that its new “trade reporting” system shows that the notional value of derivatives in Europe is €453 trillion – 30 times GDP – though the underlying meaning of the figure was disputed.

We also debated the ultimate significance of the overnight news that Paris had won the right to host the EBA – though only on a “penalty shootout” as one discussant put it. With the euro-outs dramatically reduced in relative size after Brexit, could the rule-making EBA be folded into the rule-enforcer SSM? Or could it be merged into ESMA – the likely winner of the tussle for the Capital Markets Union regulator? For the moment, the EBA’s consultations on matters such as the SREP review and the mechanics of smoothing the impact of IFRS9 on bank capital will remain central. Even if regulators allow banks to flow their new “expected credit losses” into their P&L over five years, it was pointed out that the full hit will be revealed and investors will be fully aware.

The General Data Protection Regulation (GDPR) raised surprisingly strong views as a survey reported that only 10% of firms were fully prepared. The inevitable Brexit dimension appeared instantly: what if UK standards diverge in due course? Is this the ultimate nightmare for financial services?

But we finished on an item of good news: the SEC had issued three “no action letters” on payments for research to US broker-dealers so solving – for the moment – a major problem thrown up by MiFID II which will be fully in force in just 28 working days!


These Notes for the Friends of Graham Bishop will be supplemented by our full Workbook for our CPD clients (link) – in conjunction with the 30-minute CISI webcast. We have launched our new “CPD Weekly – 10 Minute Read ‘n Verify” (link) to comply with ESMA Guidelines

Key items in the rest of the month’s news included:

The downs-and-downs (no ‘ups’ in sight) of the Article 50 negotiations so far have put into focus the harsh reality of the whole Brexit chimera: there is no ‘soft’ or ‘moderate’ alternative to EU membership that is even better than being a member state, but rather a binary choice: to be ‘in’ or ‘out’ of the largest economic market and political construction in the world.

British voters are increasingly realising that there is no silver lining to losing EU membership and are changing their minds about the vote they casted almost 18 months ago. The 46% of people that now think that voting for Brexit was wrong, combined with the amount of evidence suggesting that the only achievable form of Brexit is the hardest one, might provide a range of MPs with enough courage to try and stop the whole process while it is still feasible, as Brendan Donnelly at the Fed Trust suggests. This possibility has been approved as entirely legal by the Article 50 author himself – Lord Kerr claimed that the withdrawal process was still reversible, even if the government is already tangled up in divorce talks and has set a withdrawal date , has the support of the EU officials, and could save Britain its budget rebate. A revealing set of data may tip the scales towards a no-Brexit: “the latest ONS annual Pink Book on the UK’s balance of payments shows a further deterioration of the current account balance mainly driven by a trade deficit of a 7% of GPD. So the UK is becoming ever more reliant on the ‘kindness of strangers’”, writes Graham Bishop. But those “’strangers’ who are kindly funding our huge excess of imports are likely to panic well before we go over the cliff. The consequences of such a currency panic will bring Britain’s electors face-to-face with grim reality”.

The ‘whole brave world out there’ dream depicted by Brexiteers is crumbling down as the negative economic consequences of Brexit, and Theresa May’s government fails to conduct negotiations in an orderly and united manner, are both widely reported at home and across Europe. This confrontation of the Brexit fantasy with the crude reality the Europeans present is weighing on public opinion: An ORB survey found that only 34% of British people approve how the Government is handling the talks, while Europeans support the EU’s hard line and think the British should pay a ‘large sum’ to ‘compensate for the costs of Brexit’.

The EU seems to have listened to its citizens’ claims and is determined to continue the talks for as long as it takes to get a good deal and to safeguard its interests as a bloc. May's initial offer of €20bn has been seen as uncompromising and EU leaders have demanded a “firm and concrete commitment” that even doubles that figure. The UK may ultimately agree to that exit bill as well as to whatever the EU demands,  Gideon Rachman observed, since it is increasingly likely that theUK government will simply be politically and technically incapable of delivering a negotiated Brexit and will be offered a “take it or leave it” deal at the eleventh hour. The top UK Brexit broker, David Davis, seems to have accepted this probability and is quietly drawing up plans for a ‘no-deal’ Brexit. A possibility deplored by the business organisations: The CBI’s President asked the Government to stop the “Brexit soap opera” and urged all actors to achieve the best deal that can protect the UK’s economy. Whatever deal the UK gets, it may take years to agree on post-Brexit trade arrangements and a very likely outcome of the talks may be a Canadian-style deal, EU’s chief negotiator Barnier warned.

The financial sector has shifted up a gear and is not willing to surrender its unfettered access to the European market once the exit is effective: the Bank of England’s Sam Woods called for the withdrawal bill to make sure derivative contracts and insurance policies will continue to apply across Europe under the new rules. Since there is no certainty that cross-border contracts will still stand after Brexit, around 20 UK- based banks have applied for EU licences, ECB’s Danielle Nouy said – and the number keeps growing by the day. The EU is moving swiftly, too, with Belgium approving the creation of an English-speaking court to settle international disputes between companies, in an effort to drag the lucrative business away from British shores once Brexit has left the sector in shambles.

The EBA published its final guidance on the supervision of significant branches of EU institutions established in another Member State, and was urged by the German bank regulator to put fixes in place to prevent market distortion resulting from a no-deal scenario. European banks may suffer the hard Brexit aftermath when it comes to resolution, Bloomberg analysis showed, since a radical departure it could make it much harder for EU authorities to impose losses on investors with an English law contract if a bank fails. The European insurance market wants to avoid disruption too: BaFin, the German financial regulator, has written to UK-based insurers to demand details of how they plan to deal with a hard Brexit.  

David Davis met an asset management task force to discuss post-withdrawal policy and was informed about top executives’ fears of a jobs exodus to the continent, combined with a drop in EU nationals working in the UK - only  42% of the respondents to a CFA poll planned to stay after Brexit. The collapse of EU workers has made May’s team to discreetly concede that EU citizens coming to the UK any time before the official Brexit date will have their rights protected.

All this made the Lords’ EU Financial Affairs Sub-Committee to call for an urgent transitional deal for the financial services sector “to stop the trickle of banks and insurers that have started to implement their contingency plans ahead of access to the Single Market being suspended in March 2019 turning into a flood,” in Baroness Falkner of Margravine’s words.  

UK-based banks have ramped up calls for David Davis’ team to clarify whether there will be a transitional deal, saying it is needed ‘before Christmas’ if he wants to avoid massive relocations: Davis told MPs that he expects to strike a deal that serves as a bridge between the withdrawal from the EU and the new shape of the EU-UK relationship by early 2018.

That period might not last enough to solve the conundrums of disentangling a country from the EU: Despite Theresa May’s request for a two-year transition, Brussels sources said the transition would be limited to 20 months. Not even enough time for Ireland to get ready for such a tsunami of economic consequences: Dublin called for a 5-year transition period, while the former Taoiseach Enda Kenny said it could take up to 5 years “to properly transition”.

The physical border of Northern Ireland issue has given the Irish government an effective veto over the first phase of Brexit talks and PM Leo Varadkar has toughened his stand to try to diminish the collateral damage that Brexit could inflict on the country – a report has found that hard Brexit could wipe almost 10% off Ireland’s GDP -, but it should not push too far because Ireland has much to lose if talks fail.

The EU has been exploring alternative ways of tackling the border issue and is for givingNorthern Ireland “Hong Kong-style” autonomy after Brexit, a solution supported by Dublin but rejected by London, which insisted that Northern Ireland must leave customs union. But even customs in EU27 may not be prepared for a cliff-edge Brexit, a Financial Times analysis has shown.  

The Commission released its Work Programme for 2018, in which it tries to seize the “window of opportunity” now open for Europe – positive data keeps flowing in, with Economic Sentiment on the rise and GDP up by 0.6% in the EU - and builds on the current momentum - created by the wins of Europhile leaders that have neutralised the drive for nationalism - on the path of Juncker’s Roadmap for a More United, Stronger and More Democratic Union. But more integration comes at a cost, and some voices like French President Macron are rather backing the idea of a multi-speed Europe that will make it more attractive to new members.

Nationalist challenges should also find their way into the EU agenda: The unfolding of the constitutional crisis in Spain, with Catalonia declaring independence followed by the imprisonment of the autonomous region’s leaders and its autonomy being suspended, has shown Europe the nationalist threats the bloc may face in the years to come, and that should be addressed as a major issue in the EU’s reform, argued Simon Jenkins.

The European Council endorsed an agreement with the EP on two banking proposals: a draft directive on creditor hierarchy and a draft regulation on transitional arrangements to phase in the regulatory capital impact of IFRS 9. Economists at Bruegel praised the new standard that forces EU banks to provision for credit losses. But there might be a dark side to it: an anonymous whistle-blower claimed that the IASB made changes to its new financial instruments standard, IFRS 9, without following the proper processes for such changes. 

The ECB’s President Mario Draghi took stock of European banking supervision and recognised that the most important issue causing weakness across the EU banks was non-performing loans (NPLs). The ECB drafted an addendum to its guidance on NPLs whose main goal is to have timely provisioning, which should prevent new bad loans from becoming a problem with systemic implications, as the bank official Sabine Lautenschläger explained. But the EP President accused the ECB of a power grab over its plan to address NPLs, intensifying pressure that could force the supervisory arm of the Central Bank to water down the proposal.

The Basel Committee released its final Guidelines on identification and management of step-in risk - the risk that a bank provides financial support to an entity beyond, or in the absence of, its contractual obligations should the entity experience financial stress.   France is firmly opposed to the so-called output floor, a reform included in the revamped Basel rules that limits the extent to which banks can use their own models to calculate the riskiness of their lending, and the French fear it could lead to an increase in banks’ capital requirements.  The Governor of the Bank of France called for an agreement on the Basel III reforms but said that the “new rules must be fully compatible with the smooth financing of the French and European economy and sound credit growth. In particular,” De Galhau noted, “our mortgage lending model, based on guaranteed loans, and our financing of SMEs cannot be called into question”.

The EBA released its annual assessment of  the consistency of risk weighted assets(RWAs) across all EU institutions authorised to use internal approaches for the calculation of capital requirements. The Authority also published its final guidelines on the treatment of connected clients as defined in the CRR, provided an overview of Competent Authorities implementation and transposition of the CRD IV package, recommended a proportionate approach in coverage of entities in banking group recovery plans, launched a set of consultations  that seek to strengthen the Pillar 2 framework and announced the final timeline of the 2018 EU-wide stress test. The number of credit institutions in the euro area banking sector declined by 25% between 2008 and 2016, according to the ECB’s 2017 Report on financial structures.

The EU reached an agreement to fast-track some elements of the Banking reform such as the Capital Requirements Regulation (CRR) and Directive (CRD), and the Bank Recovery and Resolution Directive (BRRD) – the Parliament released a briefing drawn up to support ECON’s work on the scrutiny of two draft EBA Regulatory Technical Standards on valuation under the BRRD.

Ministers attending the Eurogroup meeting of 6th November exchanged views on the future of fiscal governance in the euro area, and floated ideas for possible new euro area fiscal policy instruments. One of them could be Graham Bishop’s plan for a Temporary Eurobill Fund (TEF), a proposal that can be complemented with a strong European Monetary Fund (EMF) – the time is right to turn the ESM into an EMF, authors at Bruegel propose, with the idea of designing it as part of a broader risk-sharing and market-discipline agenda. These could be feasible proposals to provide the European banking union the final leg it needs, the European Deposit Insurance Scheme (EDIS), the FT writes. So far, the banking union has failed to deliver on its promises, argued Tobias Tesche in his assessment of the progress that has been made to date.

Capital Markets Union

The Commission issued guidance to clarify how EU investment firms should interact when they seek out brokerage and research services from broker-dealers in non-EU countries under MiFID II rules. The FT looked more closely at the resulting EU investment market and concluded that it will focus on the economics of paid-for analysis.  The nub of the problem is who pays for the service – will fund managers absorb it, or will it be passed on to investors? –, and how much.

The rules were complemented from the US with a set of SEC’s measuresto facilitate cross-border implementation of the EU's MiFID II's research provisions, following concerns that MiFID II could create an uneven playing field with EU peers and that investors could lose access to valuable research. AFME, the Investment Association and the FCA welcomed the outcome of the cooperation between both actors.

ESMA published [GB1] the responses to its Consultation on Guidelines on certain aspects of the MiFID II suitability requirementsand updated the MiFID II Q&A on market structure issues. Such an amount of new rules to comply with is making that more than half of EU member states are still struggling to convert MiFID II into domestic law by the time it goes live,  according to the European Commission and reporting by Bloomberg.   

The European Parliament made amendments to the Commission proposal on the framework for securitisationand drafted a regulation text.  It also released a briefing on securitisation and capital requirements[GB2] 
PCS analysed the new regimeand found it is workable and provides the basis for a revival of a safe and robust securitisation market in Europe.   IOSCO published a report with updates to peer reviews of the regulation of MMFs and securitisation and reported on the implementation of the G20/FSB post-crisis recommendationsto strengthen securities markets.  
The European Parliament approved rules to constrain packaged loans converted into securities to be made less complex and more transparentbefore selling them on to investors.  

AFME responded to the Commission consultation on post trade in a CMU, whereas ECMI assessed the opportunities and constraints facing Europe’s Capital Marketsand ESMA produced its first overview of the EU derivative markets size.[GB3] 

ISDA published a Whitepaper on the EMIR refithighlighting that certain aspects of the reforms impose unnecessary compliance costs and burdens on end users, for little benefit.  AFME’s response to the Commission’s proposal for a regulation amending EMIR
stated that particularly in the domain of OTC derivatives, robust and efficient clearing services enhance the safety of the risk reducing transactions undertaken by real economy corporates and investors.    CEPS’s Karel Lanoo analysed the proposed EMIR revisions and concluded that the Commission should have proposed a more integrated architecture for the supervision and resolution of CCPs. The ECB's Mersch provided an overview of the evolving regulatory environment for CCPstaking into account the EMIR review as well as the British departure.

ISDA, AFME and GFXD sent a letter to ESMA setting out their concerns about some uncertainties in MiFIR post-trade transparency framework for investment firms from an over-the-counter derivatives perspective.   ESMA updated its Q&As on MiFID II/MiFIR Investor Protection items.

Clients Union

The General Data Package Regulation (GDPR) will be in place in May 2018, but nearly all organisations around the world don’t feel prepared or are unsure if the regulations even apply to them, a study found. A panel of British MPs analysed the UK compliance with the GDPR after Brexit and concluded that deep concerns remain in the event of a no-deal Brexit scenario.

ACCA’s enhanced ethics and professional skills module, designed to ensure that finance professionals are equipped with the skills needed to support exam success at Strategic Professional level, went live.

The UK Financial Conduct Authority (FCA) launched a market study to assess how competition is working in the wholesale insurance broker sector. The enquiry has the potential of opening a can of worms that could force the London market, in particular, to a radical reform of the way it conducts business.  


Gabriel Bernardino, Chairman of EIOPA, spoke about the planned review of the insurance standard, Solvency II, and said that EIOPA wants to simplify the models and increase proportionality. The Pensions Authority consulted on a second set of Advice for the Review of the Solvency Capital Requirements and recommended simplifications to the calculation of this requirements. It also published a new set of Solvency II statistics on the European insurance sector.

Insurance Europe published an online consumer resource that lays out how policymakers and supervisors can ensure that rules governing insurers are in the best interest of consumers.

Corporate Governance/Accounting

The IPSASB published a revised IPSAS, Financial Reporting under the Cash Basis of Accounting, with amendments that seek to address some of the main barriers to the adoption of this standard.    ACCA has called for governments, public sector entities and the accounting profession to work together to assist in the implementation of International Public Sector Accounting Standards.

New research from Board Agenda revealed that while some boards recognise the value of corporate culture, a significant number are still grappling to give corporate culture the adequate time and attention it needs.  

The FRC published its updated Governance Bible and Code of Conduct, and a Register of Interests for members of the Board and Committees.   

Market Abuse Regulation/Anti-Money Laundering

The Parliament committee that is investigating the“Panama Papers” leaks concluded that some EU countries are obstructing the fight against money laundering, tax avoidance and evasion. The FCA’s Julia Hoggett provided an overview of the way to effectively comply with the Market Abuse Regulation.  

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