A year after Britain left the EU, the UK’s big banks are facing a scenario that was far from the vision of Brexit’s architects: their EU rivals could soon be able to lend more cheaply to British corporates than they can.
The EU’s banks are getting a helping hand because of the bloc’s decision to break with some of the final parts of Basel III, the globally agreed capital rules. This will allow EU banks to use less capital when they make loans to corporates without a credit rating, reducing their lending costs. Before Brexit, the UK’s banks would have benefited from the same relief.
“It’s a big issue,” said a senior executive at a large UK bank. “There’s a risk . . . that BNP can lend to a load of higher quality UK corporates at cheaper rates than UK banks . . . Open markets only work if everybody is playing by global rules.”
Corporate lending is just one of the areas of possible post-Brexit divergence the City of London is watching with trepidation in 2022 as the EU and the UK advance new financial regulations at a pace not seen since the immediate aftermath of the 2007-08 crisis.
Work in progress in both jurisdictions includes fleshing out plans to overhaul markets regulation, detailing how the UK will implement the latest Basel banking accords and creating new digital asset and anti money laundering regimes in the EU.
“Divergence is not going to happen through a roll back of historic rules, it’s going to come from the different approach to rulemaking,” said Simon Gleeson, lawyer and partner at Clifford Chance. Banks say different rules in the EU and UK will push up administrative costs for companies trying to comply with two regimes.
A key area of concern for finance executives, industry groups and advisers is the latest package of global banking rules agreed in Basel in 2017. The EU in November published hundreds of pages for implementation. British banks must wait until the second half of 2022 to see if the Bank of England will give banks the same relief on corporate and business lending. A person familiar with the plans said the BoE’s Prudential Regulation Authority would consult industry and take their concerns into account.
Still, UK banks and their advisers are bracing themselves for tougher treatment on capital generally than their peers in the EU, with particular concerns around business lending.
“The new Basel treatment of corporate lending is problematic as most corporates outside the US do not have credit ratings, which will make lending to them more capital consumptive for banks [applying the Basel rules],” said Simon Hills, director of prudential regulation at the UK banks’ lobby group UK Finance.
“If the PRA does not adopt the same approach as the EU with respect to unrated corporations, then EU banks may be able to lend more cheaply to UK corporates, hollowing out their traditional UK corporate lending focus,” he added.
The UK bank executive nonetheless has sympathy for the competing interests the PRA is trying to balance.
The authority has a new secondary mandate to consider growth and competitiveness, which would nudge the regulator towards giving UK banks the same reliefs as the EU, to preserve a level playing field. But prudential and political concerns weigh heavily against this course of action.
“The UK will 100 per cent not follow suit” on relief to unrated corporates, said one seasoned UK financial regulation expert, who described the EU approach as “unsound” from a banking policy point of view. “Politically the UK could never say we are following the EU and not the global standard,” they added.
Since London continues to allow banks to sell into the UK from the EU even as Brussels erects borders, banks say EU lenders will be able to do business in the UK more cheaply than their British counterparts. The situation could drag on until 2032, when the EU’s relief is set to expire.
“The UK regulator is still making up its mind about [whether to extend the same relief],” said Hills. He hopes the UK will ensure a “level playing field” for its banks and those based in the bloc.
London has also yet to announce whether it will follow the EU in delaying implementation of the entire Basel package until 2025, leaving UK banks with less certainty than their EU counterparts.
They will also have to adapt to the potential uncertainty of having a national regulator that can constantly refine rules. “One of the good things that EU membership did for the UK is it solved the problem that we previously have, which was generally known as a ‘restless regulator’,” said Gleeson.
In the EU, regulations take a long time to pin down, are typically highly detailed and become permanent in complex primary law once agreed. But an advantage of this approach is that “they can’t go around changing it”, said a senior policy executive at a large UK bank who is lukewarm about the promise of “more agile” UK policymaking.
In other areas, however, the EU is taking a more restrictive approach than London, which could give the UK a competitive advantage.
One of these is around digital assets, where a Brussels package, markets in cryptoassets, or MICA, lays out proposals that would, among other things, greatly constrain banks’ dealings with cryptocurrencies. If the EU agrees those plans, it is “probably” a competitive advantage for the UK, Gleeson believes.
The EU is also creating a single anti money-laundering authority, AMLA, which Chris Woolard, former interim head of the UK’s Financial Conduct Authority, said “might make the European market more efficient . . . or it might be yet another body that banks and others have to deal with”. Money laundering falls under a variety of regulators in the UK, including the FCA, HMRC, the National Crime Agency and the Serious Fraud Office.
Trading is another area of reform. The UK has already introduced some new measures in niche areas, including a special regime for listing companies that want to raise money to make opportunistic investments, known as SPACs, and announced a series of other reforms to make listing in London more attractive.
Market regulation is another potential area for divergence as the EU reviews its landmark Mifid II package and the UK advances its Wholesale Markets review.
A senior lobbyist at a large international bank said both UK and EU regulators could improve market efficiency and reduce costs, “even if that means different rules in different places”.
“Once it was decided that equivalence was no longer on the cards, a pipe dream, there was no point in consistency and convergence,” he said. “Now, the approach is to get the best deal possible in each jurisdiction.”