Banks Stretched for Brexit Testing

The UK government insists a deal will be done that will ensure continuity for large British and EU financial firms trading in global financial markets in London. But it is far from clear that EU markets regulators and central banks are equally optimistic, and there is a clear definition of a what a “hard Brexit” would mean. If the UK cuts all ties with the EU and operates outside of the European Economic Area (EEA), UK-licensed financial entities immediately lose a number of rights. Currently, banks operating under a UK banking licence enjoy free access to the market (via passporting of rights), meaning UK-licensed banks are entitled to trade on equal terms with their EU counterparts. “The impact of losing the passporting of rights would be extremely disruptive and take effect immediately. It would affect trading relations and the mobility that we have to access the European market,” explains Kinsuk Mitra, Head of Risk & Compliance Solutions for financial services at HCL Technologies, the global IT services company. Under this scenario, the UK would be considered a “third country jurisdiction” by EU regulators and in order to process transactions, the European Securities and Markets Authority (ESMA) would have the discretion to decide whether a UK bank counterparty has standards that comply with EU MIFID II regulatory standards and whether it is entitled to equivalence with an EU institution. Furthermore, the London Clearing House, the leading central counterparty clearing house (CCP) for capital markets in London – in particular the interest rate swaps market – could automatically lose its beneficial qualifying CCP status under EMIR regulations. This means its status as a low risk and low-cost entity for clearing could be lost immediately. This all adds up to a real possibility that – overnight – German, French and other EU asset managers could be forced to move the management and trading of client assets away from London. Most leading corporate and investment banks, including Deutsche Bank, Morgan Stanley, HSBC, Société Générale, Bank of America, UBS and Citigroup have said they will move at least some operations away from London. Manish Malhotra, Head of QA – Financial Services, Europe, said for QA Financial that his financial services clients are mostly testing for Brexit by testing the performance of a small number of business-critical applications; using these as a proxy for a large-scale transition. “Large foreign banks which are using London as their EU legal entity will be impacted most [by Brexit],” said Malhotra. “They are creating very small use cases to determine whether and how they would implement the large-scale transition.” Neotys’ Performance Testing Territory Manager for UK & Ireland Graham Perry expressed a similar view, stating that contingency plans are being drawn, but banks see the transition out of London as a long-term process, rather than a watershed moment set for March 2019. Read more: UK and EU Agree on Banks’ Access After Brexit, Times Says “In the case of loss of passporting rights, London’s position as Europe’s financial epicenter will slowly erode, rather than a majority of trades shifting over European cities in a single day,” said Perry. “Having said that, there are moves afoot to assess the feasibility of moving to European cities.” “The move will happen over time. For major American banks like Goldman Sachs, for example, the only reason they’re in London is to use the UK as a gateway into Europe. If the UK loses passporting rights, they can easily move everyone over to [other major European cities]. There will be a tipping point in this process and that’s when the major part of performance testing will actually start.” They key systems challenge for HSBC is load testing, said the bank’s Head of Brexit, Slim Zargouni. He is working with quality assurance teams across the bank in preparations for the planned relocation from London to Paris of HSBC’s corporate banking business for EU customers. The key challenge will be ensuring that the bank’s network applications run from France will be able to handle increased volumes. Whatever happens by March 29th 2019, it is imperative that financial firms test their trading, risk and collateral management systems to ensure they can deal with what would be – for London and the UK – the nightmare scenario. “Increasingly, it’s a question on hoping for the best, but preparing for the worst,” says the head of quality assurance at one leading UK bank. “One thing’s for sure, moving trading books will be a massive exercise, and systems need to be tested,” said HCL’s Kinsuk Mitra. “The full testing lifecycle, from unit, system, integration, regression and stress testing, will need to take place. Old and new systems will need to be tested in parallel and results will need to be checked to see that the same positions remain albeit rebooked into a new location and booking entity.”