02 July 2024
When the UK voted to leave the European Union in 2016, seismic shifts took place across the banking sector. With Brexit came new regulatory and operational challenges that required significant adaptation, as banks and financial institutions suddenly faced rafts of new rules and requirements.
Not only did they have to adjust and create new entity structures and review their legal agreements, they also had to update specific terms around currencies, interest rates and jurisdictions, adding to the complexities of cross-border banking. Regulators in the EU and US were keen to ensure that risk management and other key functions were co-located within their regions, making the regulatory environment more complex and fragmented for global banks. This also led to greater complications in the entity structures and relationships between Globally Systemically Important Banks (G-SIBs).
Recent delays to the timing of the Basel III endgame in the EU and US highlight issues around creating equal regulatory standards. They’ve proven how difficult it is to create a level playing field between banks, and the impact an unequal one has on their ability to create strategies for efficient capital use, making a strong case against regulatory arbitrage.
This unlevel playing field also has other impacts. For example, after Brexit, the UK established its own sanctions regime, requiring banks to ensure their contracts complied with UK-specific sanctions, which could differ from the EU or OFAC regulations in the US. Additionally, variations in capital rules for foreign exchange (FX) trading have caused some banks to give up significant market positions.
Brexit was not the cause of this regulatory hiatus. However, it has certainly contributed to the complexity that banks and financial institutions are still grappling with.
Handling these regulatory and relationship changes is still mostly an analogue process, involving an army of lawyers and data operations staff to keep the wheels turning. An interbank relationship may involve 10-15 entities, creating over 25 pairings. Each pairing has multiple agreements, making it almost impossible to understand the full implications of current terms.
Fortunately, technology can solve this problem as it opens up a pathway to digitised and automated legal and regulatory risk management. AI-driven tools can rapidly scan vast numbers of counterparty contracts to find references to specific laws and regulations, saving significant time and effort compared to a manual review. By taking advantage of an industry clause library of terms, banks can amend contracts to align with relevant laws and regulations, ensuring updates are both competitive and optimised. Finally, updating contracts systematically and quickly helps banks avoid legal risks, disputes, and penalties, putting them on the front foot of future regulatory change.
Brexit was supposed to allow the UK to create its own regulatory path, but the reality has been different. London’s role as a bridge between the US and Europe has diminished, and now regulatory competition is increasing between jurisdictions, creating a tougher environment for all banks including the UK’s global players. The legal framework that underpins this complexity has weakened over time. As a result, many important contracts between large banks that were signed 30 years ago have been simply patched up with ‘sticky plasters’ to make do for the time being.
That being said, the future may be brighter than it looks. The squeeze on capital is forcing banks to think more systematically about counterparty credit risk and how they manage data on a consistent basis. If the industry sees a benefit in using standard data formats for things like netting, credit risk or termination rights, it could lead to a much safer financial environment. Perhaps regulatory fragmentation might actually encourage banks to work together, using advanced technology to achieve better alignment.
