UK May End Zero Risk for EU State Debt

Britain will stop classifying debt issued by countries in the European Union as “zero risk” if it leaves the bloc without a deal, raising the prospect that banks may have to raise additional capital.

The change would automatically require British banks, and subsidiaries holding parts of their liquidity in European government bonds, to commit additional capital against the securities, according to the treasury, which outlined how it plans to address the future of financial services supervision after Brexit, Bloomberg reported.

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 European Union 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 Britain 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 banks from the bloc with British operations will “be subject to an additional layer of British-led supervision” because Bank of England supervisors from the Prudential Regulation Authority will view them as a standalone unit, according to the statutory instrument dated Aug. 21. 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.