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Will New York Gain From a 'Hard' Brexit?

Traders Magazine Online News, August 2, 2017

Shanny Basar

Banks may choose to redeploy resources in Asia or the US if they need to find up to $50bn (€42bn) in extra capital to support new European entities after the UK leaves the European Union.

If the negotiations over the UK leaving the EU result in a ‘hard' Brexit, with UK financial services losing access to the trading bloc, this will fragment the European wholesale banking market and make it significantly less profitable. In a report, One Year On From The Brexit Vote, consultancy Oliver Wyman estimated a hard Brexit will result in the wholesale banking industry needing to find between $30bn and $50bn of extra capital to support new European entities, equivalent to between 15% and 30% of the capital currently committed to the region.

"Given that returns on equity in European wholesale banking are already below hurdle for many players, these new challenges from Brexit will raise difficult questions about the viability of some activities over the medium term,” said Oliver Wyman. “Some banks may even choose to withdraw capacity from the European market as a whole and redeploy to other regions, such as Asia or the US.”

In addition, banks would face increased costs if clearing of euro derivatives contracts is forced to move from London to one of the member states remaining in the EU after Brexit, putting further pressure of profitability.

LCH, the clearing house owned by the London Stock Exchange, clears more than 90% of global cleared interest rate swaps and 98% of all cleared swaps in euros. Mark Carney, governor of the Bank of England, warned in a speech in June that the fragmentation of clearing would lead to higher costs. He gave the example of Japan, where the clearing of yen-denominated swaps by certain Japanese firms must take place onshore, and the price is one to three -3 basis points higher than in offshore markets .

“Such seemingly small price differences translate into significant costs for users given the scale of activity in these markets,” said Carney. “Industry estimates suggest that a single basis point increase in the cost resulting from splitting clearing of interest rate swaps could cost EU firms €22bn per year across all of their business. Those costs would ultimately be passed on to European households and businesses.”

Carney continued that if existing trades of EU firms were trapped at a clearing house that was not recognised by the European Commission, those EU firms would face capital charges as much as ten times higher until they could be moved.

The European Commission has proposed stricter supervision of central counterparties, including more rigorous recognition and supervision of  non-EU CCPs which are of key systemic importance for the EU and relevant to financial stability. In addition, the European Central Bank is seeking tougher banking supervision across the Eurozone.

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