Brexit’s unlikely headline-grabber: contracts
February 2018 | EXPERT BRIEFING | BANKING & FINANCE
Corporate restructuring, job relocations… contract remediation? In testimony before lawmakers in December 2017, Barclay’s chief executive John McFarlane revealed that renegotiation of “hundreds of thousands” of contracts is one of his chief Brexit concerns. He is not alone. Andrew Bailey, head of the UK Financial Conduct Authority (FCA), said “contract continuity” is among the biggest potential disruptions in a no-deal, no-transition Brexit. Bank of England governor Mark Carney and European Central Bank president Mario Draghi have also expressed concern about the problem and the lack of time left for a solution.
Their worries are well-founded. If left unmodified, these contracts could leave banks either unable to fulfil their contractual obligations or in breach of UK or European law. Brexit’s implications are broader and more complex than other regulatory changes requiring large-scale contract remediation like the General Data Protection Regulation (GDPR), margin reform, the Markets in Financial Instruments Directive II (MiFID II) or the Foreign Account Tax Compliance Act (FATCA). And even these ‘simpler’ mass repapering efforts have cost financial services companies hundreds of millions of pounds and placed significant strain on their legal, operational and technology infrastructure.
The 2017 deadline for margin reform was met with only 40-60 percent readiness, with nearly all large banks requiring additional weeks or months to bring contracts into compliance. Across the industry, the size and complexity of the effort required to remediate tens of thousands of derivatives agreements was widely underestimated, with many banks engaged in a last-minute scramble to secure skilled resources as requirements and budgets skyrocketed.
With potentially £1.12 trillion of bank assets needing to be re-booked from the UK to the EU and an estimated £26 trillion of uncleared OTC derivatives contracts exposure, the stakes could not be higher. The financial services sector needs a new playbook for contracting solutions, building on lessons learned from previous repapering exercises.
Get a grasp on your contract data now
The single most important element of preparation is assembling and readying data from impacted contracts. Historically, this is a pain point, with many companies struggling even to identify and locate contracts housed in disparate systems. For example, in discussions with over 100 large companies on GDPR readiness, more than 95 percent were struggling to identify and locate the scope of contracts to be repapered. This is despite GDPR being widely recognised as one of the most sweeping regulatory reforms in modern times, complete with a highly prescriptive set of contracts-related requirements, a fast-approaching May 2018 deadline and fines for non-compliance of up to 4 percent of annual global turnover.
Given regulatory fatigue, uncertainty surrounding Brexit and delayed decision making, banks may again find themselves in a frenzied race to the finish line. Regardless of what ultimately happens with the transition period, accurate and appropriate structured contract data will expedite repapering efforts whenever they are needed. Banks would be well served to get a firm grasp on this data now.
Take an integrated approach
Studying the recent margin reform repapering work done by the top 20 banks yields a valuable lesson on technology and the need for an integrated approach. The high volume nature of these efforts cries out for technology solutions, but with margin reform, some banks got burned by an overreliance on heavily-hyped tech tools. When those tools proved too inflexible to deliver promised results amid the often messy realities of imperfect contract data and heterogeneous client requirements, these banks had a limited number of strategies to fall back on. Conversely, the smart integration of technology, legal talent and legal operations into a comprehensive process proved to be a significant driver of success, and offered a robust alternative to a pure tech solution. As companies invest in Brexit preparations, an integrated approach is optimal.
Build in operational excellence
While renegotiating and rewriting contracts generally requires legal input, the massive scale of these requirements calls for a level of operational acumen not always abundant in lawyers or legal departments. Looking again to margin reform, banks that outperformed the average closely integrated legal and operational skill sets into a cohesive end-to-end process. Banks that struggled aligned them sequentially, with excellent lawyers providing upfront legal advice on templates and repapering language, handing subsequent negotiation tasks off to young graduates supervised by world class operations providers. No matter how high the quality of these individual components (legal and operational), success seemed to be driven more by aligning them side-by-side into multiple scalable teams where legal and operational inputs were combined to enable swift response to the variety and ever-changing set of requirements.
The good news on Brexit is that banks appear to be preparing earlier than ever before. Effectiveness of that preparation and ever-better execution of a successful contract repapering strategy will be critical to the least turbulent transition possible.
Chris DeConti is the executive vice president of global solutions at Axiom. He can be contacted by email: firstname.lastname@example.org.
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