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Brexit (1)

02 March 2016
Richard Kemmish

Lets keep a sense of perspective here, whilst it is always tempting to link current affairs to our own little niche interests, hopefully no-one will vote on Brexit on the basis of its impact on the UK covered bond market and, probably, no-one’s decision to buy a UK covered bond will be based on the probability of the UK’s exit. But, anyway.

Some investment banks have attempted to analyse the possible credit impact of Brexit on UK covered bonds. Whilst it is true that there will probably be some macro-economic effects and some impact on the credit of the banking system, the structure of the covered bonds themselves is more than up to the task of mitigating these, if they are negative. And it is more or less impossible to judge from the research available whether the impact will be positive, negative or neutral. A couple of points of GDP growth either way aren’t going to change the cover pool’s credit materially.

As to the legal aspects, Allen and Overy have recently published a helpful guide to what could happen. But any realistic post-Brexit scenario is likely to mean that the things that they refer to as possible problems won’t happen, the publication is more of a checklist of what the UK will probably do. For example, the UK will have to pass national legislation that will replace most of the existing regulations (directives already have to be implemented by enabling legislation that’s the difference between regulations and directives). The Basle rules will continue to apply to British banks, the Capital Requirements Regulations are just the way in which they are implemented currently in the UK.
Whereas A&O are correct to highlight the regulations which will need to be converted into English law I, for one, don’t see any realistic risk of these not continuing to apply in practice post-Brexit, give or take a bit of parliamentary drafting.

But what are the effects of the regulations? Twofold, firstly on the credit worthiness of the bonds themselves, for example we know that the bank resolution rules are a major driver of bank creditworthiness now. Will they be fully transposed into English law, post-Brexit? Probably.

Secondly, they effect whether British bonds will still be eligible investments for European investors. Maybe I’m being naïve to belittle a risk that others see but surely the UK will join the EEA? In which case EU investors would continue to be allowed to apply the same regulatory treatment that currently get, as with Norwegian covered bonds for example. The other conditions, such as the definition of eligible assets or the need for a special supervisory regime, are already in place under English law, so no change likely there.

On balance, I don’t think there will be any immediate effect either way on the credit worthiness of British covered bonds, or on their current regulatory treatment for EU investors. But that is only half of the debate – see my next post for the other half.

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