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Post-Brexit Risk Transfer Trades …. Something To Bank On?

If there is one thing that’s clear at the current stage of Brexit negotiations, it’s that things are not clear. The majority of financial institutions have yet to fully determine their post-Brexit preferences for business functions, trades and technology. Even the institutions that have either made public announcements about their plans or where intentions have been “leaked”, the practical realities of relocating are not well understood.

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Speculation is rife. What practical actions can financial institutions focus on while exit negotiations continue?

One area that is guaranteed to change is the booking models used by institutions with multiple legal entities. Most trading desks already book trades to multiple legal entities (LE’s). The use of this approach is likely to widen. Reasons for this will vary, but include:

  • New legal requirements resulting from the Brexit ‘deal’;
  • Fragmented regulatory requirements and variations between jurisdictions;
  • Political incentives driving new business behaviour, across multiple asset classes and clients;
  • Client requirements and expectations.

As Legal Entity structures evolve, one of the key challenges for adoption of the future state will be efficient and effective risk management. One of the traditional tools has been the risk transfer trade or “back to back”. The goal of such trades is to immediately pass the market risk associated with a new trade to another legal entity. This allows a business to transfer the risk of a trade from a UK entity, for example, to an EU entity with identical trade economics, for the purposes of risk aggregation and capital efficiency.

Whilst the extent to which risk transfer trades are used to overcome 3rd country challenges generated by Brexit will depend on the final exit agreement, it’s a very good bet that a significant volume of new trades will be generated to carry out these back to back functions. In some cases, this is expected to double or even triple the trade volumes within a given trading book.

The dramatic increase in volumes will have significant ramifications for the underlying technology that supports risk transfer bookings:

  • Booking model: Will risk transfer trades be manually booked or automated? If manually booked, does the business have enough middle office staff to accommodate this increase? Has a new booking model been agreed with product control, finance and risk functions within the organisation? For more complex trades, has the impact of the back to backs been accommodated in the overall risk aggregation of the packages?
  • Technology constraints: Do existing trading platforms have the additional capacity to grow 100% between now and the Brexit effective date (including any transition period)? What about 200%? Additional risk transfer trades are often accompanied by the creation of new trading books adding incremental fixed workload to system batches, market data cuts and processing times.
  • Venue connectivity: investment institutions must determine how to structure venue connectivity for EU entities that do not (currently) have venue memberships. A number of options exist but institutions should determine if existing physical infrastructure (circuits, servers etc.) are appropriate or if new memberships must be physically separated. Alternatively, institutions may decide to use a new entity as a client of an LE that already has venue membership. This might have booking advantages but could lead to negative foul of market perception.

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In both cases, headroom and capacity play an important role, whether in terms of human resources or IT. Preparatory activities can be performed ahead of the final regulatory and legal decisions required for full Brexit clarification, such as trade compression, system capacity upgrades and staff onboarding and training. These will allow organisations to be as well prepared as possible to move quickly to book risk transfer trades once the landscape becomes clear.


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The author

Matt Gall

Matt Gall

PARTNER, LONDON

Matt leads the firm’s Business Transformation practice, focusing on the execution of strategic front-to-back change. He brings more than 25 years’ experience across the full technology life cycle, bridging business and technology functions in the delivery of strategic capital markets programmes.

matt.gall@citihub.com