Can the City of London survive Brexit? Banks are preparing for the worst and are pretty sure they will lose much of the freedom they now enjoy to trade with the European Union. But just how bad Brexit gets for banks hinges on the details that will be worked out in political negotiations, as well as in private talks between firms and supervisors. There are five battlegrounds that could spell the difference between a modest and a major hit.

Equivalence of Regulations

The EU rebuffed the U.K.’s plan for “mutual recognition” of each other’s regulations, which would have allowed banks with bases in London to continue providing services in the EU with few disruptions. The EU said all that’s on offer is regulatory “equivalence,” which relies on European recognition that U.K. laws and oversight are as strict as its own. This prompted Prime Minister Theresa May, in her White Paper last month, to water down her suggestions for a post-Brexit trading relationship. Yet equivalence as it stands won’t do for Britain: It’s scattered over many pieces of legislation and opens doors to only some parts of the finance industry, leaving out deposit-taking and lending. And as it’s granted unilaterally by the EU, it can be withdrawn at short notice. May’s White Paper suggests expanding the regime to more services and addresses how to ensure each side has autonomy over granting market access while making sure firms can’t be kicked out overnight. Officials in Brussels, who’ve started rewriting the rules, are debating whether to take the U.K.’s ideas on board. But initial drafts suggest the EU is in little mood to make concessions.

Cross-Border Bookings

A 2017 report by management consultant Oliver Wyman said banks may need to find an extra $50 billion of capital to support new European units were they to lose privileged access to the single market. That cost would decline significantly if -- as banks hope -- EU watchdogs allow lenders to route business back to London from their EU-based entities through so-called back-to-back trades. Such transactions are used to shift derivatives and securities trades between a bank’s legal entities, allowing a firm to consolidate its business in a global or regional hub that may need less capital to manage risks centrally. The European Banking Authority, which coordinates standards across the bloc, has made clear that the transactions will continue to be permitted after Brexit. But the European Central Bank’s supervisory arm has warned that it won’t tolerate offices that are “empty shells” without sufficient management capabilities on the ground. The exact level of business that regulators eventually demand in the bloc will go a long way toward determining how much capital and how many employees are necessary there.

Location of Clearinghouses

London is particularly protective of its dominance in the crucial business of clearing euro-denominated derivatives. The location of clearinghouses emerged as one of the first flash points following the 2016 Brexit vote, with French and German politicians laying claim to the business and saying it must be located in the euro area. The finance industry has pressed for EU and U.K. regulators to cooperate on supervision of clearinghouses to avoid the higher costs that would probably result if the business were split between London and the euro area. Some German regulators are hesitant to force a relocation because of the extra costs. European Parliament lawmakers in Brussels insist that relocation would be a last resort, should joint supervision prove too difficult. It will take months for the EU to complete its policy on the matter.

Delegation

U.K. asset managers were spooked last year when the European Securities and Markets Authority outlined how many senior staffers they would need to keep in the EU in order to hold a license. Such delegation rules are particularly important to so-called UCITS funds, which are officially based and sold in the EU but can be managed from New York, Hong Kong or elsewhere. While regulators said they merely want to keep firms from setting up “letterbox entities,” the industry saw the move as a way to steal business from the U.K. Moreover, legislation pending in Brussels would hand Paris-based ESMA more power to intervene when firms plan to “outsource, delegate or transfer risks” to non-EU countries. Asset managers are lobbying hard to avoid a stricter regime, which could cause large-scale relocation of senior managers from London.

Contracts and Data

Without any action by regulators, long-term financial contracts between U.K. and EU parties could be disrupted by Brexit. At issue is the ability of firms to amend existing contracts or continue servicing them over their life. The problem concerns 29 trillion pounds of uncleared derivative contracts and 67 trillion pounds of cleared derivatives, along with 10 million U.K. insurance policyholders and another 38 million in the EU, according to the Bank of England. U.K. regulators have underlined the issue and want a coordinated governmental response to ensure so-called contract continuity. Their EU counterparts instead are pushing companies to make their own preparations and, if necessary, re-paper contracts as the process is known. The EU approach could accelerate the shifting of business from the U.K. to the continent. Andrew Bailey, head of the U.K.’s Financial Conduct Authority, also wants “mitigating actions” by regulators to ensure the continued flow of large amounts of data between the EU and the U.K.

To contact the reporters on this story: Silla Brush in London at sbrush@bloomberg.net;Alexander Weber in Brussels at aweber45@bloomberg.net

To contact the editors responsible for this story: Neil Callanan at ncallanan@bloomberg.net, ;Emma Ross-Thomas at erossthomas@bloomberg.net, Laurence Arnold

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