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Global Treasury

Brexit a Moving Target but Treasurers Prep Anyway

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October 30, 2018

BNP on Brexit: Banks and corporates prep despite elusive deal and final details

Brexit 209The deadline of March 29 to reach a Brexit deal is all-too-quickly approaching, and while progress is being made in that direction, albeit in fits and starts, corporates may be wise to hedge the possibility of no deal while preparing for the inevitable break up.

Paul Hollingsworth, BNP Paribas’s United Kingdom (UK) economist, noted at a NeuGroup Treasurers’ Group of Thirty Large-Cap Edition (T30LC) meeting in early October the challenges related to the UK’s breakaway from the European Union (EU), starting with inking a formal deal but by no means ending there. In fact, the resolution to reach a deal that was anticipated to arrive at an October 17 EU summit meeting never materialized, pushing back the follow-up summit to formerly complete the deal.

“Not enough progress was made to schedule another meeting in November, and solutions to the Irish border issue remain elusive,” Mr. Hollingsworth said.

The Irish border issue arises because Ireland will remain a member of the EU, and so far, the two sides have been unable to agree on the border status between it and the UK’s Northern Ireland. Mr. Hollingsworth said that the outline of an agreement is beginning to emerge, but thorny issues remain that ultimately must find a political resolution.

“[Prime minister] Theresa May appears to have faced down her challengers recently but remains fragile. It now looks likely that a deal won’t come until the December summit” on December 13 and 14,” he said.

Mr. Hollingsworth said a necessary vote by the UK parliament to approve the deal will be key, and currently the government appears to be banking on some Labor Party members of parliament (MPs) voting to support it—potentially risky.

“While there’s progress on a deal, the next few months could be volatile,” Mr. Hollingsworth said. “We think markets are still underpricing the risk of a disorderly outcome, even if that is not our base case.”

He added that it is “worth hedging against a no-deal outcome, because it’s very possible.”

The second issue standing in the way of a Brexit deal is a nonbinding political declaration stating its intent. Mr. Hollingsworth said that agreeing on such declaration could be even more problematic, since views in the UK range from an ultra-hard Brexit—essentially breaking away completely from the EU—to a relationship more like Norway’s. It is a part of the EU’s single market and its financial services firms operate freely in the EU, but it also contributes significantly to the EU budget.

Should no deal be reached by the March deadline, the UK’s relationship to the EU would be no different than most other countries, requiring the negotiation of a full-fledged trade agreement as well as resolving an extensive list of legal issues. For example, while it’s in neither the UK’s or EU’s interests to stop plane flights between the jurisdictions, in the absence of a new aviation agreement, which is unlikely to be in place by next March if the UK and EU fail to reach an agreement on the UK’s exit terms, insurers would hesitate to insure such flights.

“There needs to be some agreement for that to happen, and this is the case for all kinds of stuff,” Mr. Hollingsworth said. He added that in the EU’s trade deals with countries such as Canada and South Korea, there are clauses in those deals requiring the EU to improve their terms if it reaches better deals with other jurisdictions such as the UK, unless those jurisdictions have additional obligations to the EU along the lines of a Norway.

“So the idea that the UK will get a special deal … You can have more rights, but there will be more obligations as well,” Mr. Hollingsworth said.

There are other Brexit-related issues that so far have flown under the radar. For one, , Mr. Hollingsworth said, even should a deal be reached, it must be passed by the EU and UK parliaments, and the latter could be problematic, given the UK’s political parties are politically far apart. BNP still gives passage a 50/50 chance, given how damaging a hard exit would be for the UK’s economy. In addition, following a successful nonbinding deal the new relationship would not be finalized until the end of 2020, providing for plenty of uncertainty in the meantime.

BNP Bankers attending the T30LC meeting said banks have already started to move operations out of London to cities in the EU, such as Paris, Frankfurt and Luxembourg. Assuming a deal is reached, such moves are expected to accelerate in the transition period.

“They’re moving key people so if there is no deal, on day one they’ll be able to function, and then they’ll continue moving more people over the next few years,” said another banker at the meeting.

A key issue still to be resolved, Mr. Hollingsworth said, is whether the UK will continue to have access to the Single Euro Payments Area (SEPA), since providing special access to the UK would almost certainly prompt other countries, such as the US, to seek similar treatment. A lack of SEPA access, however, could limit corporates’ ability to make payments on a euro-denominated account in London.

Hollingsworth added that that he hasn’t seen many corporates physically moving operations and staff from London to the Continent. To mitigate SEPA complications, however, some are putting in place “shadow account” structures in EU financial centers such as Dublin and Luxembourg, to switch to at a moment’s notice and mitigate that risk, he said.

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