How businesses can prepare for Brexit
How will the UK leave the European Union on 31 January 2020? The UK will hold a general election on 12 December, which should provide clarity. We can expect an election campaign with tough and unavoidable clashes between opponents and supporters of Brexit.
There is continued uncertainty about the UK leaving the EU. Commerzbank is ready to support you with preparing for every possible Brexit scenario, regardless of whether you are based in Germany or the UK.
What will happen if a Brexit deal is agreed upon?
Even with all the current uncertainty, a Brexit agreement is still a possibility. The remaining EU member states have consented to the draft withdrawal agreement negotiated by the EU and the UK. If the 585-page document passes both the European and the UK Parliament, there would not be many changes initially. Both sides have agreed on a transition period until the end of 2020 that may be extended by a further two years. During this period, the UK would remain part of the European Single Market as well as the EU Customs Union. The transition period would also be used to regulate future relations between the two parties in detail.
After the end of the transition period, citizens of EU member states and UK citizens living in the EU would retain their current rights to residency, work, studies and family reunion. This ensures, for example, that German employees of German companies in the UK can keep on working there.
If an agreement came to pass, goods such as toys, clothing and cosmetics, but also drugs and medical products that require product authorisation, could still be sold after the end of the transition period.
The effects of a hard Brexit
Here's the good news: Even in the event of a hard Brexit, Commerzbank will be able to offer our clients an almost unchanged range of services within the current legal framework. "The basis for this is the so-called Temporary Permissions Regime (TPR) adopted by the UK," says Antje-Irina Kurz of Commerzbank's legal department. For a maximum of three years after the UK’s exit from the EU, the instrument will allow financial institutions from the EU to continue doing business in the UK under the same regulations as before Brexit. "However, as a prerequisite, financial institutions must register for the TPR or apply for a UK banking license before Brexit day," Kurz says. Commerzbank filed the relevant application in September 2018.
A hard Brexit will also not affect clearing via Central Counterparties (CCPs), which is important for certain hedging activities. With regard to this, the EU Commission has published an emergency plan and announced concrete measures which are likely to result in transitional regulations that would also cover the event of a hard Brexit. These regulations will enable CCPs such as the London Clearing House (LCH) to continue their services to EU banks for another twelve months. Neither the UK nor the EU desires any market frictions. In this context, the European Securities and Markets Authority (ESMA) and the Bank of England agreed in early February 2019 to recognise CCPs and central securities depositories (CSDs) in the UK provisionally, should there be a hard Brexit.
Outbound business (UK to EU) will, however, be restricted in the event of a hard Brexit.
The legal position for the provision of financial services from Commerzbank’s London Branch to EU-based clients after a hard Brexit is less accommodating. The London Branch will become a third country branch and cease to benefit from the EU financial services passport. This means that London Branch can continue to provide to EU-based clients only those services that are not regulated activities or for which grandfathering provisions have been implemented by the relevant EU country. We have been tracking the domestic preparations that a number of EU member states have been undertaking in the event that the UK leaves the EU without an agreement as to a transitional period. Given that the EU measures are implemented on a member state by member state basis, they do not have a uniform scope. Additionally, we note that a number of EU jurisdictions have not yet introduced draft laws. As a result, certain EU jurisdictions may not have implemented transitional relief at a national level prior to the UK’s anticipated departure.
Where transitional relief has been announced or proposed we note that:
- it is time limited in a number of cases and will only provide assistance in respect of existing contracts and not new business;
- the measures in different member states do not cover the same range of financial services and products;
- a number of the draft measures reference “UK firms” or “firms which are authorised in the UK”. It is not clear whether these terms, particularly the latter, envisage the continued provision of products and services into the EU from the London Branch of an EEA credit institution such as Commerzbank.
The renewed postponement of the Brexit date is causing growing uncertainty for companies which maintain business relations with the UK or produce goods there. A recurring theme in customer consultations is the hedging of currency risks. "In my opinion, a hard Brexit will lead to a devaluation of the British Pound (GBP). A devaluation of GBP already occurred directly before and after the referendum over a withdrawal from the EU, and the cost of hedging currency options rose significantly" says Dr. Michael Braun, FX advisor at Commerzbank. He adds that the situation is still relatively relaxed at present. "However, once we have a clear tendency towards a hard Brexit, I expect a strong increase in option-volatility and an increase in hedging costs for currency options" Braun emphasises.
Stocktaking as a basis for currency hedging*
Generally, option-volatility for EUR-GBP had traded around 7-8 percent. However, recently it has risen to much higher levels. What can businesses do about this? "First of all, they should running an inventory," says FX advisor Dr. Braun. "To what extent does Brexit change the currency volumes I need to hedge? How much has been hedged already? They may also want to consider observing the market in order to bring forward certain hedges and end up in a phase in which the market is very stressed." He adds, "Talk to us. We can analyse risks and develop hedging strategies with you." In collaboration with experts from Research, Commerzbank offers information sessions via phone or video conference as an exclusive service to our clients. These focus both on fundamental developments with regard to Brexit as well as company-specific issues.
Good prospects for payment transactions
The outlook for the areas of payment transactions and cash pooling is more positive. Martin Cordes, head of Commerzbank's Payments Corporates & Innovation unit, expects few changes in handling even in the event of a hard Brexit. British banks have applied to the European Payments Council (EPC) to remain in the SEPA payment transaction system, an application which the EPC agreed to as its meeting of 7 March 2019. This means that SEPA payment transactions can continue to be handled. Commerzbank will meet the extended regulatory requirements by completing the payer data in credit transfers. Companies with direct debit collections from debtors in Great Britain must, as principals, provide the payer data and can prepare themselves accordingly here by entering the address data for the corresponding clients in the SEPA file today. Slightly higher fees could also be incurred as a result.
Provisions like those for third countries also apply to international payment transactions – detailed payer data have to be recorded. However, Commerzbank clients would have an advantage, "We are the only institution to have been offering real-time conversion on international payment transactions for some time," Cordes says. Clients are no longer dependent on a reference price that is fixed once per day. Instead, they know the exact conversion rates applied to financial transfers at any given time.
Cash pooling − everything remains the same
Commerzbank expects no changes with regard to the handling of cash pooling, the intragroup balancing of liquidity via a finance management system that centrally pools the excess liquidity of all affiliated companies and balances liquidity shortages. The reason no changes are expected is that the practice is regulated individually by each country. It is not substantially dependent on European law.
Make provisions for delays in goods deliveries
For any international business transactions with the UK that are hedged by means of letters of credit, the contractual partners should factor in potential delays in deliveries in the event of a hard Brexit, since this could lead to customs and border checks. They should provide for appropriate contractual stipulations, such as set forth, for instance, by letters of credit.
These delivery delays may also result in a change in the number of days’ sales outstanding. This can have an influence on the creditworthiness of the customer. Higher supplier credits may lead to significant problems in the event of default. Commerzbank will gladly inform you about further credit mitigant options in addition to letters of credit.
The most severe consequences of a hard Brexit will be felt by businesses that are involved in the movement of goods between the EU and the UK. The resulting customs and border checks can cause delays as mentioned above – this may also result in delayed payments for the delivered goods. This in turn could cause liquidity shortages from suppliers. Because of this, Commerzbank offers our clients a so called immediate Brexit loan, an overdraft facility with a duration of up to six months. Customers who wish to apply for such a loan can get detailed information from their personal client advisor.
To avoid the inevitable chaos at the borders and the rupture of value chains, the British government published plans to impose tariffs only on agricultural imports during a transitional period and to wave through the vast majority of imports from the EU (87%) without imposing tariffs. A large-scale renunciation of tariffs would initially relieve Brexit of a large part of its hardship.
Changes to Entity Structures
Commerzbank will monitor political and regulatory developments and make changes to its operating model as well as legal and entity structures where required to continue servicing European-based clients post Brexit. However, Commerzbank will continue to operate as a bank headquartered in Germany with foreign branches. The majority of activities are already transacted and booked with Commerzbank AG Frankfurt . Commerzbank AG Frankfurt uses well-supported and well-maintained centralised Group systems. Consequently, any services will continue to be provided from existing entities and Commerzbank does not anticipate any changes to outsourcing arrangements as a result of Brexit.
Repapering of existing transactions/contracts
UK-based counterparties who are in the process of establishing in the EU should direct their repapering request to Commerzbank’s Brexit repapering email group BrexitRepapering@commerzbank.com, including details of affected positions and the intended repapering approach. Commerzbank also requires details of new entity structures for Know Your Customer (KYC) and onboarding purposes.
* Section on Stocktacking as a basis of currency hedging is not valid for Singapore.