Based on Autonomous Research’s discussions with major international banks, it appears they are well advanced in their preparations for Britain’s departure from the European Union. To date, the shifting of capital, assets and people has been minimal, although activity is likely to pick up significantly in the next six months.
Although London looks set to remain Europe’s largest financial centre, over time one can expect a partial rebalancing towards other hubs. Given banks’ extensive preparations and the assumption that policy-makers will adopt a pragmatic approach to the major potential cliff effects, there is only a slim chance that a ‘guillotine Brexit’ would lead to chaos in financial markets.
Although there are several possible cliff effects, there are also achievable work-arounds, if only temporary in most cases. Markets can take comfort from Bank of England Governor Mark Carney and European Central Bank President Mario Draghi, who are chairing a Brexit working group. Common sense seems likely to prevail.
Indeed, Autonomous Research’s survey of 11 investment banks suggests they feel well-placed ahead of Brexit. All are working on the basis of a worst-case, ‘hard Brexit’ outcome. They appear confident that they will be fully prepared for the end of March 2019. More than 60% have made changes to their European group structure because of Brexit, but none are planning to exit any business activities.
So far there has been no meaningful movement in banking assets or capital. The assets of the large US and Swiss investment banks in London remained unchanged at around $3.3tn at end-2017. Meanwhile, the assets of their fledgling continental EU hubs remain very small ($80bn at end-2017). Forecasts of massive staff movements have also been falling, to around 5,000 from more than 10,000.
One should expect a shift in banking assets to the continent over the next six months, propelled largely by regulatory change. But in some respects, such a shift is also natural, given that London is an outsized financial centre. For example, while New York is three times the size of the fifth largest US financial centre (Orange County), London is eight times larger than the European equivalent (Luxembourg).
Up to €1.3tn of banking assets may need to be relocated to the continent in the event of a hard Brexit. Initially this might be achievable through remote or back-to-back booking. But one can imagine policy-makers in charge of the ECB Single Supervisory Mechanism taking a progressively tougher stance on banks’ remote and back-to-back booking policies. In its supervisory guidance, the SSM has stated that ‘the expectation is that EU products and transactions with EU clients are booked onshore and that risk management capabilities related to these products are also located onshore’.
It is possible we at Autonomous are being too complacent on Brexit. In theory, there are many assets to be rebooked, little has taken place so far, and time is tight. However, in our experience the large international banks have a good track record in delivering on such essential high-profile projects. Not being ready for a guillotine Brexit simply isn’t an option for these institutions.
Bank investors can be relaxed. It is hard to imagine Carney and Draghi allowing politicians needlessly to create a market meltdown, although tail risks cannot be eliminated entirely. There is always the danger that, despite their best intentions, policy-makers may be too slow and behind the curve.
Based on our discussions with investors, there does not seem to be anything priced into European (or US) bank shares for the risk of Brexit-induced dislocation in financial markets. That is the logical investment stance to take at this point. But the longer the uncertainty lingers, the greater the likelihood that investors begin to price in a growing probability of a negative tail scenario.
Stuart Graham is a Partner at Autonomous Research, analysing bank strategy. This article is based on a report prepared by Autonomous Research entitled ‘Brexit: In Draghi & Carney We Trust’.