European governments risk a Brexit blow to their finances if the UK crashes out of the EU without a deal, an outcome that would jeopardise their access to the London-based banks that help sell their bonds.
Investment banks play a key role in helping governments raise money from investors by pricing, warehousing and selling debt, a role known as primary dealing.
Most EU countries prohibit bankers based in so-called “third countries” — those outside the trading bloc — from helping to sell bonds. If the UK were to leave the EU without a deal at the end of March, it would assume “third country” status, meaning the London-based bankers who have been the chief support for EU countries selling debt could no longer advise on sales.
“The prevailing view is that primary dealerships in European government bonds will need to be based in the EU27 after Brexit,” said a regulatory adviser at a financial industry trade body. “Servicing [governments’] debt management offices is a regulated activity.”
While some EU countries, such as France, have extensive domestic networks to distribute their newly issued debt, plenty do not. More than a dozen other countries including Italy, Austria, the Czech Republic, Ireland, the Netherlands and Portugal have historically relied heavily on the City’s extensive network of banks and trading venues to sell their debt. Banks like Morgan Stanley, Barclays, Merrill Lynch and UBS act as dealers for many periphery countries.
The risk that EU governments would lose access to City banks is another illustration of the stakes as Westminster prepares to renew debate on Prime Minister Theresa May’s deal, which parliament is scheduled to vote on in the week starting January 14.
Given the uncertainty over the outcome, countries are pushing for investment banks to move operations to the EU by early this year, as the next primary dealership contracts — which are often a year long — begin.
The concern has been accentuated after Brussels last month proposed limited measures to ensure continuity for markets in the event of a “no-deal” exit. “It seems to be as far as the politicians are prepared to push it,” said Sam Tyfield, a lawyer at Vedder Price in London.
Losing access to London-based banks could push up the cost for countries of raising finance. Dutch regulators have warned Europe would have fewer, but probably more expensive, alternatives.
“It is very important for all the traders [in a bank] to sit together for transparency of risk management,” said one banker. “A fragmentation of our trading operation will reduce our ability to provide liquidity to the market.”
The picture is further complicated because institutions’ access to EU markets from London after Brexit relies on approval from national regulators. The Netherlands, for example, plans to allow investment firms in the City to access their markets. But regulations in Italy forbid the same dealers sat in London from supplying prices to critical trading infrastructure like MTS, the bond trading venue moving to Milan.
“London is still the centre of liquidity for the trading of euro debt and particularly periphery debt and therefore a huge proportion of periphery nations’ primary dealerships are based in London,” one London-based primary dealer said.
“If we are required to move traders to where they are not today, that would be a big impact on euro [government bond] liquidity just at a time when those sovereigns need it most; it may even be difficult for us to bid in auctions from London.”
Periphery countries such as Italy, which have large volumes of debt to sell and limited domestic capital markets infrastructure, risk being particularly badly affected, according to bankers who spoke to the FT. Italy already faces a significant financing challenge, needing to sell a chunky €260bn of debt next year.
