The Bank of England’s (BOE) head of supervision said a Brexit transition deal must be reached by the end of the year to provide assurance to financial firms as they prepare for life after the UK’s withdrawal from the European Union.
“If we get to Christmas and the negotiations have not reached any agreement on this topic, diminishing marginal returns will kick in,” said Sam Woods, the chief executive of the Prudential Regulation Authority (PRA). “Firms would start discounting the likelihood of a transition in the central case of their planning.”
The British prime minister Theresa May has pledged to secure a two-year transition period after Brexit in March 2019, but the EU’s position “is not yet clear”, Mr Woods said. Some big investment banks with their European headquarters in London have decided Mrs May’s promise last month was too little, too late, and are forging ahead with plans to create new trading hubs elsewhere in the region.
Mr Woods’ Christmas deadline is consistent with comments he made in Parliament in December 2016, when he said: “I would not want to be sitting here in a year’s time, a transitional not having been agreed.” In August, he said the workload caused by Brexit is likely to be a “material extra burden”, forcing the BOE to make tough decisions on priorities.
Mr Woods on Wednesday said a transition arrangement would “not only help mitigate the Day 1 risks, but will also enable firms to adjust to the new relationship in an orderly way”.
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The PRA also published two sets of proposals on Wednesday covering measures to address “double leverage” in banking groups planning for resolution and changes to the regulator’s large exposures framework.
Double leverage occurs occurs when a parent company sells outside investors senior debt to fund more junior - and therefore more expensive - debt or equity at a subsidiary and profits from the price difference. That can lead to problems servicing the new debt if the subsidiary gets into trouble and can’t pay the parent the coupons or dividends it needs to pay the outside investors.
A UK bank might decide to go down this route should a host-country supervisor force a subsidiary to have “an outsize portion” of the group’s capital, he said.
“We will expect firms to demonstrate to us that they can manage the cash-flow and other risks associated with double leverage,” Mr Woods said. “And we will reserve the right to set double leverage limits or apply capital add-ons for group risk if we are not satisfied.”
The PRA also plans to boost reporting requirements for capital and liquidity to gain the information needed to decide whether lenders are using resources appropriately across jurisdictions and currencies. It will also use its powers under the senior managers regime to ensure someone is responsible for the submissions.
The PRA is also consulting on changes to its large-exposure framework, which sets out how much of a firm’s capital can be at risk to the rest of its group. While EU law sets the limit at 25 per cent, supervisors have discretion to exempt some exposures.
The supervisor plans to allow firms exposed to “certain cross-border group entities” to raise their exposure to 100 per cent of eligible capital from 25 per cent, according to the document. It will also allow firms to apply to exempt from the large exposure limit loss-absorbing bonds positioned at overseas units known as minimum requirements for eligible liabilities and own funds.
