The UK will stop classifying debt issued by EU countries as “zero risk” if it leaves the bloc without a deal, raising the prospect that banks could have to raise additional capital.
The change would automatically require UK banks, and subsidiaries holding parts of their liquidity in European government bonds, to commit additional capital against the securities, said the UK Treasury, which outlined how it plans to address the future of financial services supervision after Brexit.
Supervisors would look at the creditworthiness of the various governments when deciding on weightings, potentially hurting lenders who have significant bond holdings from weaker nations.
A bank found holding too many of the penalized securities could be forced to either raise capital or sell its holdings in a market roiled by Brexit.
British banks would find themselves similarly penalized by EU supervisors, because mutual recognition rules would no longer apply. The changes would also make it more difficult for EU lenders to maintain trading desks in the UK, because it would require them to commit additional capital.
“It’s a bizarre decision,” said Owen Callan, a Dublin-based analyst at Investec PLC, adding that some market-making would become “prohibitively expensive to do out of London.”
Leaving the EU means that banks from the union with UK operations would “be subject to an additional layer of UK-led supervision” because Bank of England supervisors from the UK Prudential Regulation Authority (PRA) would view them as a standalone unit, the statutory instrument dated Aug. 21 said.
The change was reported earlier by Global Capital.
“It remains to be seen what liquidity requirements the PRA will impose on EU banks operating in London. In a worst-case scenario this could be very penal,” said Etay Katz, a partner at Allen & Overy LLP in London.
It is a major surprise that no transitional period is foreseen, he said, adding that a transition would have allowed the banks to model the impact of the changes and “come to terms with any adverse capital and liquidity consequences” by restructuring their holdings.
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