Yves here. We’ve flagged some of the loud warnings by high profile players like Airbus and BMW about the havoc continued Brexit uncertainty, as well as a hard or crash out Brexit. What is interesting about Don Quijones’ post is the degree to which banks have been complacent about taking serious Brexit preparation steps. On the one hand, we’ve read many press reports about how banks were looking into and applying for licenses, as well as looking at various major EU cities for more office space. Our PlutoniumKun reported that a favorite gym had become a casualty to Brexit, since the (former warehouse?) building in which it was located was being razed to build an office tower.
On the other, as Don Quijones indicates, a lot of firms have apparently taken initial steps but dawdled on the follow through.
I’m also not sure what to make about the Bank of England squealing about derivative contracts. I find it hard to take the figures they are tossing about at face value, simply because a significant proportion will expire before Brexit date and would presumably be replaced by agreements that would not be exposed to Brexit. Further, I’d expect ISDA or bank lobbyists to have been making noise before the Bank of England started sounding alarms.
Having said that, as we learned when Lehman failed, most derivative agreements have options in how they get settled (usually cashed out in some form) and you can be assured whoever has latitude in how the contract will be closed out will use that power to his advantage. I wish someone who was closer to the current state of play would identify what types of contracts might cause trouble if they could not be settled or novated neatly, and how big the economic (as opposed to notional) exposures might be there. I’m sure there is a real issue here, but I’d like to see the problem dimensioned much better than it has been so far.
Finally, a story in openDemocracy exposes something that clear has to exist but we haven’t seen much of, which is groups that see profit opportunities in Brexit and have been lobbying for it. And I don’t mean fuzzy headed “Oh, the UK can be the new Singapore” enthusiasts.
OpenDemocracy discusses the fracking industry as keen to escape EU environmental regulations:
In January I wrote about how the fracking industry could take advantage of a dirty Brexit. But it goes further than direct lobbying and trying to hijack the Brexit narrative. Companies are also enlisting the help of PR agencies who are hiring former ministerial and even prime-ministerial advisors to lobby for them.
The post continues to name quite a few names….
By Don Quijones, Spain, UK, & Mexico, editor at Wolf Street. Originally published at Wolf Street
Construction and infrastructure giant Ferrovial has announced it is moving its international HQ from the UK to low-tax haven Amsterdam because of Brexit. The Spanish firm, which owns a quarter of the UK’s busiest airport, Heathrow, and runs its US, Canadian, Polish and UK operations from Oxford, says it needs to keep within EU legislation after the UK leaves the EU.
Airbus issued a stark warning at the end of last week that it may also consider abandoning the UK over Brexit, its strongest alert yet over the potential impact of Britain’s departure from the EU. A withdrawal without a deal would force it to reconsider its long-term position, potentially putting thousands of British jobs at risk, it said.
At the same time investment in Britain’s car industry has shrunk by half to the lowest figure since the financial crisis, according to figures from the Society of Motor Manufacturers & Traders (SMMT). In the first six months of 2018 investment in new models and factory improvements clocked in at £347.3 million, compared to £647.4 for the same period in 2017. BMW has warned that it will close all its UK plants in the event of a hard Brexit.
What companies, both domestic and foreign, want is greater clarity regarding the UK’s future relations with the EU as the cut-off date for reaching a preliminary agreement on Brexit terms grows ever closer. “Exit” day is scheduled to begin on March 29, 2019, at 11 p.m. GMT. That’s 274 days away, and there’s scant sign of any progress on key sticking points such as the Northern Ireland border, the so-called “passporting” of UK financial services, and a future aviation agreement between the UK and the EU.
Whatever the reasons for the potential departures from the UK, one of the things the recent constitutional crisis in Catalonia threw into stark relief is just how fickle and fearful money is, and just how quickly companies — even local ones — will up sticks if political developments in a particular region jeopardize their operations.
International banks and asset managers with large London-based operations are now scrambling to augment their EU outposts to mitigate the loss of passporting rights which enable them to offer financial, advisory and trading services to corporate clients across all EU states with just one local licence. JPMorgan is reportedly looking to expand its office space in Milan, where it already has around 250 staff, while Goldman Sachs is planning to double the number of staff in Frankfurt, which currently stands at 400.
Bank of America is merging its London-based subsidiary with its Dublin-based Irish entity, which will become its main EU base. It has also said it will expand its investment banking activities in Paris and shift some of its London-based back-office operations to Dublin. It is also transferring three of its most senior UK-based bankers to Paris in one of the most senior Brexit staff redeployments to date by a major bank, according to Reuters.
But moving key operations and staff across the channel is a costly, complex undertaking. Many companies would still prefer to play a waiting game, and most of the moves that have taken place so far have involved small parts of firms’ operations. But according to the European Banking Authority (EBA), which itself is relocating from London to Paris, time is running out. In an opinion paper released on Monday, it warned that City of London authorities and many UK-based banks were far from ready for a no-deal scenario.
“Financial stability should not be put at risk because financial institutions are trying to avoid costs,” the paper says. In a remarkable coincidence Monday also saw a separate warning from the ECB that any banks that haven’t submitted their licence applications for operating in the Eurozone by the end of the month could find themselves without a permit by the time of Brexit.
It didn’t take long for the City of London to hit back. On Wednesday the Bank of England warned that unless the EU accepted a temporary permissions regime for financial services, up to £29 trillion worth of financial contracts could be declared void in the event of a no-deal Brexit. Derivatives contracts could come to an end without fresh legislation from the UK and EU, the central bank’s financial policy committee said.
“UK and EEA parties may no longer have the necessary permissions to service certain uncleared over-the-counter (OTC) derivative contracts with parties in the other jurisdiction,” the bank’s financial stability report said. “Based on latest data, this could affect around a quarter of contracts entered into by parties in both the UK and EEA, with a notional value of around £29 trillion, of which around £16 trillion matures after March 2019.”
For the moment the EU — and in particular, the ECB — seems more interested in trying to gain a larger share of financial clearing, a lucrative business dominated for years by London. As we previously noted, the clearing business is the jewel in the crown of the City of London’s financial services industry. As such, it will not give it up lightly.
But as the clock continues to tick down, the war of words across the Brexit negotiating table is growing increasingly bitter and the potential for ugly consequences, intended or otherwise, increases. By Don Quijones.
After scandals and collapses, and a pile of off-balance-sheet government debt, the UK revisits the logic of outsourcing. Read… Multi-Decade Outsourcing Boom Comes to Sticky End in the UK
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I was down in Dublins docklands yesterday, the main development area for new offices – there are numerous cranes on the horizon, and several new open development sites. Because of the weakness of Irish banks very few of these are speculative developments (they aren’t giving developers money for them) – in other words, they are almost certainly pre-sold or let. But there is relatively little information available on who the clients are – I think that after the initial flurry of announcements various banks and IT companies are keeping their cards close to their chests. I also don’t know if its significant, but the well known celeb and banker hangout in London, The Ivy is opening a huge new Dublin branch. Its on the highest rent street in Dublin, and its got a huge number of covers for a Dublin restaurant, so clearly someone thinks they’ll have business.
On the other hand, I’ve seen little evidence of increased demand for outer suburban offices, the type that would be used for back office operations. If they are moving out of London, they are not moving to Ireland.
According to the Irish Central Bank, in their most recent Brexit task force report (p.21):
As for fracking – I’ve no doubt this is seen as an opportunity for Brexit. The main legislative impediment to fracking in the UK are committments under EU Directives, particularly the Groundwater Directive , although this is just one of a series of interrelated environmental directives that provide statutary objectives for national governments which is causing a huge headache for the exploration companies, mostly with regard to achieving ground and surface water quality targets. The Poles avoided this by simply ignoring EU law – unfortunately for their industry, the geology proved unco-operative.
Its not mentioned in that article, but one of the most promising geological bodies for fracking lies smack in the middle of the border in Ireland. And the water for fracking operations would have to come from a series of lakes and rivers that also cross the border. The Republic is on the verge of a blanket ban on fracking, so if the UK decided to go full forward on fracking their half of the geology (or even trying the milkshake approach), then there would be all sorts of complications.
I think back office stuff will remain in London because of the available workforce, infrastructure and domain and organizational knowledge already in place. It will especially beneficial if the pound crashes “bigly”.
As for fracking, well I guess here we have the solution as to what will replace the manufacturing once it is fgone from the Midlands, the North East and elsewhere. Fracking to replace the manufacturing and legalized cannabis farms to replace agriculture.
I think the back office will move. Office space is too expensive in London to keep those giant towers if you don’t need them. Back office can move anywhere! The people will move as well…what choice will they have. Additionally with automation, many will be made redundant.
The office space will likely be cheaper after Brexit.
Yes, I should have caveated with “for now”.
Off Topic Alert!
Having had the displeasure of witnessing a project where part of the business case was headcount reduction from 50 down to 1, 6 months after go live, they went back to the board to ask for a headcount increase to the 50. The automation solution did some of the things they needed but it just threw up a different set of hoops.
So automation, I’m quite sure will not deliver anywhere near the benefits that are claimed for it.
Software Development: Cheap, fast and good: Choose 2 (If you are lucky).
Would that be the unicorn of efficiency gains – Robotic Process Automation (RPA) by chance?
Expat,
Most back office workers for the larger global investment banks are already based outside of London and have been for quite some time – Morgan Stanley is a classic example of this fact, so, and given back office staff can be located anywhere, it makes little sense to disrupt the proven infrastructure that already exists within the UK, whilst Brexit, lets hope, will result in lower Commercial rents as some businesses move operations to EU member state territory.
Does the City of London think its derivatives exposure is a weapon it can blackmail the EU and ECB with?
Such use would certainly implicate the Fed as well.
Suppose no new legislation addresses the City’s L19T post Brexit exposure, or say the EU passes laws to impose whatever costs contracted in the City on the City: what happens?
Disheartening to hear about the fracking. I am trying but I don’t know enough to understand all the twists and turns. Yves posted a link back in May – a quote from it I’ve put on the inside cover of my day book, I guess you’d call it – “Chip Fletcher U. of Hawaii : Just recognize that we are moving into a new climate, and our communities are scaled and built for a climate that no longer exists.”
I read that – Our economies are scaled and built for a climate that no longer exists. It has become my prior whenever I read any of the updates now.
Whenever I read most things, actually. Interesting tint. Whether clarifying or not, I suppose I’ll have to wait and see. But the rising economic nationalism sometimes strikes me as an unconscious attempt at adaptation. Everyone knows, but it’s too big to acknowledge openly.
https://www.nakedcapitalism.com/2018/05/gaius-publius-communities-scaled-built-climate-no-longer-exists.html
southern appalachian,
Fracking is abhorred by most in the UK, so, I’d expect mass disobedience as they try to roll it out further – the middle class who live in the areas where fracking is expected to take place don’t want it and have a track record of organising protests – environmentalists don’t mind serving jail time for their causes and those who are ultimately criminalised are treated as hero’s by the UK public as long as no deaths or injuries are involved – if I was an investor aware of these facts i’d avoiding the fracking businesses like the plague based on the fact Middle England will actually fight on this issue.
CDR. Respect. And thanks for the insight about the culture toward fracking in the UK. Here in Australia, as you probably know, it’s a big deal also. But people are more willing to accept the propaganda – ‘jobs’ blah blah. Australians, surprise surprise, are more naive generally I suspect. There is a ‘lock the gate’ campaign for some years now, the idea being coal seam gas prospectors will let themselves into your property without permission, and if they find a vein worth exploring legally they are allowed to persue it because ‘you let them in’. Physically obstructing their access ‘Locking the Gate’ & with a sign, prevents this occurring. Off topic anyway. thanks everyone
I work in insurance, therefore I have only passing acquaintance with EU securities markets regulations. My assumption regarding the OTC derivatives issue would be that this has to do with the clearing obligation under EMIR (https://www.esma.europa.eu/regulation/post-trading/otc-derivatives-and-clearing-obligation). According to the ESMA website, two out of 6 central counterparty clearing institutions (CCPs) reside in the UK and it would be interesting to see how much of the outstanding volume of OTC derivatives is supposed to be cleared through them.
Here is also the latest ESMA report on trends, risks and vulnerabilities:
https://www.esma.europa.eu/sites/default/files/library/esma50-165-538_report_on_trends_risks_and_vulnerabilities_no.1_2018.pdf (some data on derivatives markets is available from p. 89 onwards).
My dear Ms Velika, thank you so much for this information, most enlightening, and esp for spelling out the acronyms.
I can’t see how Brexit can modify or nullify derivatives contracts written for settlement in London and under English Law, etc. Chinese banks write derivative contracts with Brazilian companies while neither has a presence in Europe.
Is May saying that all EU entities will be barred from using London banks to make payments, forbidden from writing contracts in English using English Law, and having to cancel anything and everything that refers to England? Essentially, May is saying, “If you don’t give in to our totally stupid demands, we will unilaterally cancel all your contracts and force all banks with offices in London to tear up their contracts.”
LOL
That would constitute Force Majeure which would not nullify the derivatives contracts but would simply mean the parties would have to agree to new terms such as settlement in Zurich or NY, English law in some other court, etc. The ISDA’s have provisions for these sorts of things (e.g. if London burns down again.)
It’s a hollow threat.
This is what the Bank of England had to say on the matter in its latest Financial Stability Report:
UK and EEA parties may no longer have the necessary permissions to service certain uncleared over-the-counter (OTC) derivative contracts with parties in the other jurisdiction. Amending existing contracts and/or undertaking other ‘lifecycle events’ could constitute regulated activities in some EEA member states and in the UK. Such lifecycle events include: rolling open positions, exercising options and trade compression. Lifecycle events are common in servicing derivative contracts. Some — such as trade compression — may be required by regulators. Based on latest data, this could affect around a quarter of contracts entered into by parties in both the UK and EEA, with a notional value of around £29 trillion, of which around £16 trillion matures after March 2019.
Another hiccup is that rulings by English courts won’t be automatically recognized anymore in the rest of the EU.
Why wouldn’t English court rulings be recognized? They are currently recognized and enforceable worldwide (for the most part). I was not aware that High Court rulings depended on bilateral treaties between a country and the EU. Any barristers or lawyers out there who can comment?
Intra-EU recognition of judgments depends on an EU directive, so the UK becomes unplugged after Brexit day. Exclusive jurisdiction contracts are covered by the Hague Convention 2005, but the EU is the signatory so the UK is again unplugged.
The only judgments treaty to which the UK is party in its own right is the Brussells Convention 1968. Parties can also rely on private international law. Creaky stuff, and quite a threat to England’s business in international commercial dispute resolution.
OK, perhaps private international law is creaky but it is applicable and enforceable. I work on court cases and arbitrage in commodity disputes involving UK, EU and other domiciliations. The decisions are enforceable. I know that ISDA’s are different and going forward companies might show preference for another jurisdiction, but they would still be enforceable under English law and existing inter-nation treaties. No?
Not so sure about enforceable,but they might be recognized, but even tends depend treaties with others
High court and arbitrage decisions are enforced generally. I have worked on both in London involving companies domiciled all around the world. As I said earlier, maybe financial ISDA’s are different.
How would that be so? A countries rulings are only enforceable in that states area of control without other treaties or laws. However some countries dominate certain transactions to the point that you may as well treat them as global.
I was in London two weeks ago. I was quite surprised at the view I saw from the top of the Shard; construction cranes in every direction out to the London horizon . It looks like the city is on a huge building spree – much more so than most major cities I have visited lately. Thus, the London building frenzy does not jibe with the frequent mention of business relocations across the Channel.
If everyone is fleeing, who will fill all that new office space? One might expect a real estate sinkhole to open up just as they take down the scaffolding around Big Ben.
Tom you’re absolutely right. Cranes everywhere at the moment.
My personal view of things is that the banks are most certainly making plans and are simply waiting to decide which ones to execute. Unfortunately the signals from the negotiating table have been *ahem* not particularly illuminating.
A major issue will come though when credit appetite tightens up next year. The banks will be stuck with risky loans. PR concerns may limit repossession and court orders, but for how long? The zombie companies reliant on cheap debt and cheap EU labour are up [family blog] creek with no paddle. Exporters reliant on EU revenues. SME (small to medium enterprise) suppliers exposed to the
paninter EU supply chains of larger corporates.Particularly in the current climate where interest rates have stayed low, pricing has sharpened, and returns are harder and harder to maintain. Will we begin to see silly short term initiatives that introduce riskier assets onto the banks books precisely at the wrong end of the economic cycle?
Winners and losers, yes. But be afraid, be very afraid.
Therw have been Cranes everywhere for some years now. A few years back I walked from Paddington to Hackney along the Regent’s canal, and counted over 100 cranes.
Cares in London are like dandelions, they sprint up everywhere.
There is an awful lot of money laundering going through London including into real estate. This is also and especially true for Dubai and Singapore, places where no questions are asked about real estate.
The single biggest cost to any criminal enterprise is money-laundering. If you build a tower for $300 million and sell it for $150 million three years later, it is NOT a loss. It’s a very cheap money-laundering scheme.
Also the time-line on these big projects is very long, the contracts and financing are locked in (at least that is the plan) for years, so construction of office towers cannot turn on a dime. Or 10p, as the case may be.
Does the BoE warning say that 29 trillion pounds of notional value derivatives constitutes just *25%* of derivatives written with English counterparties? Does that mean that the total is nearly 120 trillion pounds? I recognize that much (most?) of that is currency and interest rate swaps but I’m reminded that during the GFC it was estimated that the notional values of the total CDS market with 60 trillion $US. I’ve been convinced that the CDSs were the blasting caps that exploded the CDO dynamite that blew up the world economy in 2007-8, and have been wary of them every since. What is the current notional value of bespoke CDS contracts in 2018? How many of them are written on Chinese bank debt? How much is written with CHinese bank/hedgefund counterparties? Is this the next AIG?
P
Notional value doesn’t mean much for most derivatives. What you care about is the net value.
Roughly 1/3 of CBOE options contracts just expire. They are neither closed nor exercised. So that alone tells you that notional value has major issues as a risk statistic.
13,000 British citizens making sure that they have dual-nationality sounds like a tiny number to me, but the BBC reporter was pretty breathless about it.
Surge in Britons getting EU nationality
There can be numerous problems with derivatives closeout, which basically all boil down to “read the docs very very carefuly”. It can range from whethere there was a “loss Amount” or “Market Quotation” or the ambiguous “close-out amount” in the doc, and what is/isn’t allowed under those (like some elements of XVA are under some, which can be then handily manipulated and thus disputed) to what, if any netting there was, and how exactly that’s supposed to work (again, depending on the exact wording of the docs).
For small amounts no-one’s going to be too much upset – except that of course if you do small amounts across a lot of clients.. (you may get LIBOR-like situation).
In other words, it’s reading a lot of docs, very very carefuly, and then possibly challenging valuations in the courts, which can drag out for a long long time (the classic post GFC was that more sophisticated players already used OIS curves for discounting, while the others used LIBOR – usuall 3M Libor for everything, ignoring basis, which tended to be non-existent pre-crisis. The valuation differences on large portfolios could be very significant).
It’s not helped that IIRC the English courts rulings on this are not exactly one-way, but rahter a bit of a mess (not helped by Lehman’s bankruptcy).
TBH, it’s pretty hard to say how exactly it will work out in the OTC market. It’s much easier in CCP market, as there it’s very standardised (well, compared to OTC), and if needed, all contract could be moved almost overnight (in theory, in practice it would be of course much much longer process).