UK's post-Brexit ambitions could hold financial regulators back — and let banks off Libor hook
11 November 2019, by Fiona Maxwell
As London's financial sector faces an uncertain future post-Brexit, the UK government has called on regulators to ensure it retains its attractiveness — and that means enforcers might think twice before using their toughest weapons.
Such pressure to tread softly might hold regulators back from incentivizing financial institutions to adopt new requirements. That could prove a particular hindrance as they try to get companies to move to new benchmark rates, after a string of bank rate-rigging scandals.
Banks are concerned that regulators will punish them with capital surcharges for Libor exposures, as a global effort is under way to shift banks on to alternative, "risk-free" rates.
The end of 2021 is the cutoff date stipulated by UK regulators for financial institutions to move from Libor to an alternative benchmark in their contracts. But the Bank of England recently found an increase in firms' exposure to the scandal-ridden rate — something the supervisor said there is “no justification for,” in a committee meeting record.
At the same time, banks feel the shift is made difficult by the timeline for transition and the different approaches adopted in various jurisdictions. In letters to senior regulators — at the European Commission, the BoE and UK's Financial Conduct Authority, among other agencies — a financial industry working group pointed out problems with timing and dealing with legacy Libor-linked contracts.
Despite this pushback, the BoE has threatened to use “further potential policy and supervisory tools” to prevent institutions from increasing their Libor exposures. And those tools, banks fear, could turn out to include a financial deterrent to get them to make the switch.
But Brexit might get them off the hook.
The need for the UK to encourage trade and competitiveness post-Brexit could prompt regulators to hold off from using capital surcharges, through for example increasing risk weights for Libor exposures, as a tool to influence conduct at UK banks.
If they did impose surcharges, this would place an extra burden on financial institutions. And that would mean UK firms were not on a level playing field with their EU and US competitors.
On Nov. 4, before Parliament was dissolved for the upcoming general election, Chancellor Sajid Javid wrote to financial regulators. He laid out recommendations for them based on the government's economic policy, which they should have regard to, or bear in mind, as they go about their duties. Such letters are commonly sent by the Treasury Department at least once each Parliament, and the last one was sent in March 2017.
The 2017 letter, as does the current one, presented regulators with a new challenge: having regard to the “competitiveness” of UK institutions — as opposed to "competition," which is one of the BoE's secondary objectives.
Encouraging competitiveness is widely seen as a response to London’s imminent position as a financial center outside the EU.
The government “wishes to ensure that the UK remains an attractive domicile for internationally active financial institutions, and that London retains its position as the leading international financial center,” Javid wrote in letters to the BoE and to the FCA.
How that might translate into policymaking and regulation has not been explained. As a central bank and a financial services authority respectively, the BoE and the FCA are meant to be apolitical, nongovernmental institutions that see financial stability as their main aim. But they are also accountable to lawmakers.
The BoE’s Financial Policy Committee has said it will consider further policy or supervisory tools regarding Libor deterrents in the fourth quarter of this year, just weeks before the UK is set to leave the EU, after the two sides agreed to delay Brexit day until Jan. 31, 2020.
The question is whether the use of capital surcharges could potentially go against the “competitiveness” aim and therefore make regulators hesitate. In other words, Brexit might stop policymakers from increasing banks’ cost of capital, because it could make the banks anticompetitive in comparison to their overseas counterparts at a time when government policy is to make London an attractive financial center.
The threat from the BoE to consider additional tools could in itself be enough to scare the banks into action. Regulators wrote to chief executive officers at the largest bank and insurers in September 2018, requiring them to appoint a dedicated senior manager to oversee the transition.
That senior manager will be regulated under the UK Senior Managers regime, resulting in regulatory enforcement in the case of non-compliance. This enforcement could involve the use of financial sanctions or the removal of a senior banker’s license.
This means an individual executive at a financial institution — rather than the company itself — might end up taking the fall for slow adoption of new benchmarks. That could be a win-win solution — scaring institutions into submission, while at the same time sticking to government policy.