How businesses can prepare for Brexit

The UK's parliament has again rejected the deal setting out the terms of the withdrawal from the European Union (EU) that had been agreed between Prime Minister Theresa May and Brussels. If Parliament rejects the withdrawal agreement for a third time on or before 20th March the EU’s willingness to grant a postponement of the Brexit date becomes less certain. The risk of a disorderly Brexit would appear to have increased. Commerzbank is ready to support you in your preparation for every possible Brexit scenario, regardless of whether you are based in Germany or the UK.

Brexit − the potential options

Uncertainty continues over how and when the UK will exit from the EU. It is still unclear when a decision will be taken. Currently, Commerzbank's economists see the following options:

Parliament may well reject the withdrawal agreement for a third time

It is crucial that the British parliament accepts the withdrawal agreement at the third attempt, including the backstop arrangement, before the EU summit. The reason for this is that the justification for postponing the Article 50 deadline to June is to allow time to pass all the necessary domestic legislation. This is not impossible but there is no indication as yet that opponents of the withdrawal agreement have changed their views. If the British parliament rejects the plan, the government's plan for a short-term postponement would be called into question. After all, the EU has categorically rejected any postponement only for the purposes of renegotiating the withdrawal agreement.

In such a case, the EU would be likely either to offer no extension at all, or one which runs for much longer than the three months which the government is requesting. This would raise the prospect that the UK would have to take part in the European Parliament elections, which would be very unpopular domestically. This in turn would force parliament to reconsider the choice of a hard Brexit or the terms of the withdrawal agreement, both of which have been rejected in the past.

The UK withdraws its application to leave the EU

Another scenario, albeit an unlikely one, is for the UK to withdraw its application to leave the EU. According to a December 2018 ruling by the European Court of Justice, the UK can unilaterally cancel its invocation of Article 50 without the consent of the other member states and remain in the EU.

The risk of a hard Brexit has increased

Without an extension of the Brexit deadline beyond the middle of the year, there will be no time for the UK to reopen the decision to hold a second referendum (which is currently unlikely in any event). This has increased the probability that although the UK will not leave the EU on 29 March it will do so at the end of June without a withdrawal agreement. This scenario is the one that would potentially have the most far-reaching consequences, both for the UK and the EU particularly if it led to congestion at border crossings (notably at the Channel ports). The long-term effects on the economies of both the UK and the EU, as well as individual companies, could be severe.

The effects of a hard Brexit

Here's the good news: Even in the event of a hard Brexit, Commerzbank will be able to offer our clients an almost unchanged range of services within the current legal framework. "The basis for this is the so-called Temporary Permissions Regime (TPR) adopted by the UK," says Antje-Irina Kurz of Commerzbank's legal department. For a maximum of three years after the UK’s exit from the EU, the instrument will allow financial institutions from the EU to continue doing business in the UK under the same regulations as before Brexit. "However, as a prerequisite, financial institutions must register for the TPR or apply for a UK banking license before Brexit day," Kurz says. Commerzbank filed the relevant application in September 2018.

A hard Brexit will also not affect clearing via Central Counterparties (CCPs), which is important for certain hedging activities. With regard to this, the EU Commission has published an emergency plan and announced concrete measures which are likely to result in transitional regulations that would also cover the event of a hard Brexit. These regulation will enable CCPs such as the London Clearing House (LCH) to continue their services to EU banks for another twelve months. Neither the UK nor the EU desires any market frictions. In this context, the European Securities and Markets Authority (ESMA) and the Bank of England agreed in early February 2019 to recognise CCPs and central securities depositories (CSDs) in the UK, should there be a hard Brexit.

Outbound business (UK to EU) will, however, be restricted in the event of a hard Brexit.

The legal position for the provision of financial services from Commerzbank’s London Branch to EU-based clients after a hard Brexit is less accommodating. The London Branch will become a third country branch and cease to benefit from the EU financial services passport. This means that London Branch can continue to provide to EU-based clients only those services that are not regulated activities or for which grandfathering provisions have been implemented by the relevant EU country. We have been tracking the domestic preparations that a number of EU member states have been undertaking in the event that the UK leaves the EU without an agreement as to a transitional period. Given that the EU measures are implemented on a member state by member state basis, they do not have a uniform scope. Additionally, we note that a number of EU jurisdictions have not yet introduced draft laws. As a result, certain EU jurisdictions may not have implemented transitional relief at a national level prior to the UK’s anticipated departure.

Where transitional relief has been announced or proposed we note that:

  • it is time limited in a number of cases and will only provide assistance in respect of existing contracts and not new business;
  • the measures in different member states do not cover the same range of financial services and products;
  • a number of the draft measures reference “UK firms” or “firms which are authorised in the UK”. It is not clear whether these terms, particularly the latter, envisage the continued provision of products and services into the EU from the London Branch of an EEA credit institution such as Commerzbank.

Growing uncertainty

The prospect of a hard Brexit is causing growing uncertainty for companies who maintain business relations with the UK or who produce goods there. A recurring theme in customer consultations is the hedging of currency risks. "In my opinion, a hard Brexit will lead to a devaluation of the British Pound (GBP). A devaluation of GBP already occurred directly before and after the referendum over a withdrawal from the EU, and the cost of hedging currency options rose significantly" says Dr. Michael Braun, FX advisor at Commerzbank. He adds that the situation is still relatively relaxed at present. "However, once we have a clear tendency towards a hard Brexit, I expect a strong increase in option-volatility and an increase in hedging costs for currency options" Braun emphasises.

Stocktaking as a basis for currency hedging2

Generally, option-volatility for EUR-GBP had traded around 7-8 percent. However, recently it has risen to much higher levels. What can businesses do about this? "First of all, they should running an inventory," says FX advisor Dr. Braun. "To what extent does Brexit change the currency volumes I need to hedge? How much has been hedged already? They may also want to consider observing the market in order to bring forward certain hedges and end up in a phase in which the market is very stressed." He adds, "Talk to us. We can analyse risks and develop hedging strategies with you." In collaboration with experts from Research, Commerzbank offers information sessions via phone or video conference as an exclusive service to our clients. These focus both on fundamental developments with regard to Brexit as well as company-specific issues.

Good prospects for payment transactions

The outlook for the areas of payment transactions and cash pooling is decidedly more positive. Martin Cordes, head of Commerzbank's Payments Corporates & Innovation unit, expects few changes even in the event of a hard Brexit. The European Payment Council (EPC) has devised a graduated approach for the UK's withdrawal. If the UK leaves the EU but remains a member of the European Economic Area (EEA), UK financial institutions will remain part of the Single European Payment Area (SEPA) system. If the UK also leaves the EEA, there would be a transition period lasting several years. "Even in the event of a hard Brexit, UK banks may apply to remain within the SEPA system," Cordes says. Based on current circumstances, those applications would be approved.

If, contrary to expectations, there is no Brexit arrangement at all, Cordes also expects few implications. The provisions for international payment transactions would apply. This could have regulatory consequences, for example detailed payer data would have to be recorded, which may result in slightly higher transaction fees. However, Commerzbank clients would have an advantage, "We are the only institution to have been offering real-time conversion on international payment transactions for some time," Cordes says. Clients are no longer dependent on a reference price that is fixed once per day. Instead, they know the exact conversion rates applied to financial transfers at any given time.

Cash pooling − everything remains the same

Commerzbank expects no changes with regard to cash pooling, the intragroup balancing of liquidity via a finance management system that centrally pools the excess liquidity of all affiliated companies and balances liquidity shortages. The reason no changes are expected is that the practice is regulated individually by each country. It is not substantially dependent on European law.

Make provisions for delays in goods deliveries

For any international business transactions with the UK that are hedged by means of letters of credit, the contractual partners should factor in potential delays in deliveries in the event of a hard Brexit, since this could lead to customs and border checks. They should provide for appropriate contractual stipulations, such as set forth, for instance, by letters of credit.

These delivery delays may also result in a change in the number of days’ sales outstanding. This can have an influence on the creditworthiness of the customer. Higher supplier credits may lead to significant problems in the event of default. Commerzbank will gladly inform you about further credit mitigant options in addition to letters of credit.

The most severe consequences of a hard Brexit will be felt by businesses that are involved in the movement of goods between the EU and the UK. The resulting customs and border checks can cause delays as mentioned above – this may also result in delayed payments for the delivered goods. This in turn could cause liquidity shortages from suppliers. Because of this, Commerzbank offers our clients a so called immediate Brexit loan, an overdraft facility with a duration of up to six months. Customers who wish to apply for such a loan can get detailed information from their personal client advisor.

To avoid the inevitable chaos at the borders and the rupture of value chains, the British government published plans to impose tariffs only on agricultural imports during a transitional period and to wave through the vast majority of imports from the EU (87%) without imposing tariffs. A large-scale renunciation of tariffs would initially relieve Brexit of a large part of its hardship.

Changes to Entity Structures

Commerzbank will monitor political and regulatory developments and make changes to its operating model as well as legal and entity structures where required to continue servicing European-based clients post Brexit. However, Commerzbank will continue to operate as a bank headquartered in Germany with foreign branches. The majority of activities are already transacted and booked with Commerzbank AG Frankfurt . Commerzbank AG Frankfurt uses well-supported and well-maintained centralised Group systems. Consequently, any services will continue to be provided from existing entities and Commerzbank does not anticipate any changes to outsourcing arrangements as a result of Brexit.

Repapering of existing transactions/contracts

UK-based counterparties who are in the process of establishing in the EU should direct their repapering request to Commerzbank’s Brexit repapering email group BrexitRepapering@commerzbank.com, including details of affected positions and the intended repapering approach. Commerzbank also requires details of new entity structures for Know Your Customer (KYC) and onboarding purposes.

What will happen if a Brexit deal is agreed upon?

Even with all the current uncertainty, a Brexit agreement is still a possibility. The remaining EU member states have consented to the draft withdrawal agreement negotiated by the EU and the UK. If the 585-page document passes both the European and the UK Parliament, there would not be many changes initially. Both sides have agreed on a transition period until the end of 2020 that may be extended by a further two years. During this period, the UK would remain part of the European Single Market as well as the EU Customs Union. The transition period would also be used to regulate future relations between the two parties in detail.

After the end of the transition period, citizens of EU member states and UK citizens living in the EU would retain their current rights to residency, work, studies and family reunion. This ensures, for example, that German employees of German companies in the UK can keep on working there.

If an agreement came to pass, goods such as toys, clothing and cosmetics, but also drugs and medical products that require product authorisation, could still be sold after the end of the transition period.

1 From a legal perspective, “no deal” remains the default position absent approval of the deal between the UK and the EU.

2 Section on Stocktacking as a basis of currency hedging is not valid for Singapore.