Insurers, Banks Warned to Prepare for Market Turmoil on Brexit Day

July 26, 2018 by

The Bank of England is war-gaming with lenders and insurers for potential market turmoil on Brexit day.

Sam Woods, the central bank’s top supervisor, said contingency planning for Britain’s withdrawal from the European Union will be similar to its preparations for the Scottish independence referendum in 2014 and the U.K.’s Brexit vote two years later, which sent the pound plunging against the dollar. “Because of the times we live in, that’s become standard business for us,” he said.

New rules on capital and liquidity introduced since the financial crisis mean banks are better prepared for mayhem in the markets, Woods said. “The only question is whether we need a little bit of an overlay nearer the time,” such as “getting data flowing in a more real-time way” so the supervisor can stay on top of a fast-moving situation, he said.

Woods spoke on Wednesday in a wide-ranging interview at Bloomberg’s London headquarters that also covered potential job losses in U.K. finance and concerns about concentration in the markets for auditing and cloud-computing services.

Woods reiterated the BOE’s view that last year’s stress test showed banks are strong enough to weather a disorderly Brexit on its own, because the adverse scenario was even more severe, comprising meltdowns in the U.K. and global economies and a stiff charge for misconduct. And while the regulator could require firms to strengthen even further, the question arises “to what degree of Armageddon do we want to capitalize our banks,” he said.

U.K. banks and insurers aren’t fully ready for the operational changes that Brexit will bring, and even the largest are still “mid-stream,” Woods said. Overall, this work is “going fine,” he said. For EU firms doing business in Britain, the U.K. government’s intention to provide temporary authorization to EU firms so they can continue doing business even without a transition period, set out in draft legislation yesterday, provides a crucial backstop.

The BOE has been saying for more than two years that it doesn’t want to end up as a ruletaker after Brexit. In this regard, Woods said the government’s plan for Britain’s future relationship with the EU, a so-called white paper issued earlier this month, went in the right direction.

“We’ve said fairly consistently that trying to oversee the financial stability of a financial services sector 10 times GDP without any say in the rules does not seem like a very appetizing prospect,” he said. “My read of the white paper is that it’s 100 percent consistent with that comment.”

Other highlights of the interview with Woods include:

  • Finance Jobs. Woods said the number of U.K. finance jobs lost to the continent by Brexit day may be “slightly below” the BOE’s estimated range of 5,000 to 10,000. “The span of our estimates has been reducing as we get closer” to the withdrawal date, he said. It’s impossible to predict with accuracy how many jobs may ultimately be lost, because so much depends on Britain’s future relationship with the EU, he said.
  • Auditing. The domination of the auditing market by a small number of firms is “a bit of a worry that we have,” Woods said. “What we observe from where we sit is that for a subset of our firms, basically the biggest ones, they don’t seem to have an enormous diversity of supply, especially when it comes to rotation.”
  • The Cloud. The U.K. can’t adopt an agenda of “IT nationalism” regarding firms’ use of the cloud, though for particularly sensitive information “there’s a higher concern around them being offshore,” Woods said. The PRA hasn’t yet had to confront the “difficult question” of a big chunk of the U.K. banking system’s “sensitive innards” being managed by one or two providers outside the country, he said. “My sense is you might want to be a bit uneasy.”
  • Bonus Cap. The BOE is taking a minimalist approach in assisting the government with the massive work of converting EU law into U.K. rules, Woods said. The goal is for the rules to work, and for firms to have clarity on day one. The BOE isn’t putting much work now into planning deeper changes to the rules – including removing long-standing bugbears such as the bonus cap for bankers – because this depends fundamentally on what deal is struck on Britain’s future relationship with the EU, he said.
  • U.S. Template. The so-called temporary permissions regime created by the government as a backstop against the possibility of a no-deal Brexit will bring about 160 companies under the purview of Woods’s Prudential Regulation Authority. About half of the companies are banks and the remainder are insurers.Unless there are special arrangements in the exit deal, the PRA will probably supervise them with the template that it uses with U.S. authorities, including the Federal Reserve, he said.

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