US banks lined up yesterday to provide a litany of warnings on the risks arising from the UK's exit from the European Union. Citigroup, which has more exposure to European markets than any other US bank, warned shareholders of "significant uncertainties" in European financial markets due to Brexit. Similarly, Bank of America cited "complexities and variables" surrounding Brexit as finding fair value of assets has become more challenging. JP Morgan CEO Jamie Dimon is warning that a decision to keep its European finance hub in London after Brexit could cause higher trading expenses for its European operations.
US banks have $919 billion of exposure to the UK, far more than any other country in the world.
Expensive Hoops to Jump Through
London enjoys its position as a global financial center in large part due to the seamless access that banks there have to the rest of the EU. This financial mechanism, called "passporting", allows a bank headquartered in one EU nation to conduct business in any other EU nation without the need to establish a subsidiary or get regulatory approval.
If banks keep their headquarters in London, they will have to set up a second headquarters and a capitalized subsidiary bank in an EU country to access the Single Market. JP Morgan CEO Jamie Dimon: “It will create one-time costs, and it will probably create a lot of duplicate costs. And those duplicate costs, and I hate to say this, will eventually [be paid for] by the customers in Europe. If you build a system where your costs are much higher, people have to build it into how they price their products and services.”
Forming a subsidiary in another EU country for US banks will take millions of dollars in expenses. Leasing new offices, transferring staff and hiring new staff, and most of all, capitalizing the new subsidiary bank. The bare minimum is €5 million euros according to EU law, but most EU nations have requirements far higher. On top of that, getting approval of financial regulators in the new host country can take anywhere from a few months to years.
Banks aren't the only ones affected by the Brexit. Hundreds of managed funds will see easy access to the EU cut off. Stuart Alexander, CEO of London fund manager Gemini Investment Management, said that the UK losing passporting privileges would destroy London's role as a global financial center. “It would kill it. You’d have to go back to the old regime of a U.K. fund management company going into Frankfurt and saying, ‘Please, Mr. Regulator, will you authorize this fund for distribution in your country?’” he said.
In addition to non-EU banks using London as an access point for EU markets, London's role as the world's largest global financial hub attracts international trade by banks in the rest of the EU. The loss of passporting in the UK due to a Brexit will bring more difficulty and higher expenses to European banks.
In a move to ease the substantial financial blow to EU banks from moving operations to the mainland, the Bank of England has said that their existing London operations can be reclassified as branch subsidiaries with no extra expense or new regulatory approval. However, there is some fine print to follow. The offer only applies to investment banks. They will not be able to engage in retail banking in Britain from these headquarters-turned-subsidiaries. The offer also is only good if the nation hosting the bank's new headquarters has regulations on a par with the UK.
EU Is Ground Zero
While income from domestic operations shield US banks from the worst of a Brexit contagion, European and British banks will take the full brunt of the financial upheaval. The downturn could be the final straw for Italy's teetering banking system. Cascading bank failures in Italy will quickly leap borders and cause an EU-wide banking crisis.
The EU banking system is already under increasing stress due to the negative interest rate policies of the European Central Bank. Commerzbank, Germany's second-largest, recently reported negative interest rates cost them €71 million in revenue. Total net revenue was down 32%. Adding insult to injury, EU megabanks Deutsche Bank and Credit Suisse were both removed from Stoxx 50, Europe's version of the Dow Jones Industrial Average.
While plans are doubtless being made by every bank with exposure to the UK or the EU, no one really knows the deadline (including the people who are supposed to lead Brexit negotiations). While US banks are in far better shape than their European counterparts, the expense of making the wrong move (or the right move at the wrong time) can stress revenue and profits to unacceptable levels.
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