Static Data – unsexy, but imperative to workflows

| 23-04-2018 | treasuryXL |

We live in the world of Big Data – we are told that there is so much potential that can be unleashed by embracing Big Data. This can lead to business efficiency, increased revenue, reduced expenditure, earlier identification of fraud etc. But for all this to reach fruition, we need to rely on the most basic building block – Static Data. Many companies have grand ideas of how to maximise revenue with data streams, yet fail to grasp the essential need for good, sound, structured Static Data.

Definition

This is data that remains constant (mostly) during the lifetime of its use; once input and recorded it becomes static and is used as reference data. The most logical example would be the data on relationships – when a company starts trading with a new supplier, a new record needs to be added to the bookkeeping system.

Types of data include:

  • Legal name of counterparty
  • Short name
  • Legal address
  • Telephone number
  • Fax number
  • Email
  • Contact persons
  • IBAN
  • BIC Code
  • KvK number
  • BTW number

Once the Static Data has been input it should only be changed by authorized staff. Dynamic data – the lifeblood of Big Data – can later be input (trades, invoice numbers, delivery dates, amounts etc.), but it needs good Static Data to make the data consistent. The complete data set for a counterparty must always be unique – there can not be 2 entities with the same set of data.

The structure of the data is also important – it could quite easily be the case that a company has one large client with the same bank details, but relationships with 5 different divisions. It is therefore essential that the correct protocols are in place for consistent data – whilst the legal name will be the same the importance of the short name becomes evident.

When it goes wrong

Inter company communication does not always involve use of a bookkeeping system. If staff start referring to a counterparty by another name than is in the system or use a name that is in the system but not the name they mean, problems can occur. Incorrect bookings arise which can lead to incorrect exposure levels or limits being breached. It can also be that a legal entity in a different country is referenced as they have offices in more than 1 country and issues such as VAT (BTW) can suddenly appear.

The need for secure Static Data is very high – the consequences of errors should never be underestimated. Data entry should be undertaken by people who do not enter any other data into the systems – in other words it should not be undertaken by the same staff that work in debtor and creditor administration.

Furthermore, a clearly defined protocol needs to be implemented to determine when and how Static Data can be changed.

In a little more than 1 month from now, GDPR comes into effect. The urgency to understand Static Data and to appreciate its significant contribution to daily operations has never been greater.

If you have any questions, please feel free to contact us.

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The Bank of England – a fintech company?

| 20-04-2018 | treasuryXL |

The Old Lady has a long history – the second oldest central bank, who has always kept the market in check. Whilst the financial Big Bang of 1986 changed the landscape in the Square Mile, her power and influence are still very evident. On Wednesday, she surprised the banking market by granting direct access to her interbank payments system to a Fintech company. This means that they can process their payments without having to use a commercial bank as an intermediary. What is the motivation for this step and what are the consequences?

Transferwise is a peer-to-peer money transfer service with its main head office in London, whilst being based in Estonia. Turnover per month reached in excess of EUR 1 billion in May 2017. They have developed a money transfer systems that reduces the amount of cross border payments but trying to match supply and demand in different countries. By reducing the actual number of cross border payments and using mid-rates for FX calculations, they are able to offer a competitive alternative to traditional bank transfers.

They have now be granted direct access via the Faster Payments Scheme to the Real Time Gross Settlement system run by the Bank of England. Allowing direct settlement will lead to reductions in costs whilst, at the same time, speeding up the money transfers. This means that Transferwise can compete evenly with large commercial banks.

The Bank of England stated “by stimulating competition and innovation, we anticipate increased diversity and risk-reducing payment technologies will reinforce financial stability while enhancing customer service.” Fintech is having a clear impact on the revenue of traditional banks in London. A survey by Accenture shows that non banks now account for 14 per cent of the annual revenue in the payment sector.

This is forcing banks to design and adopt new solutions – mainly built around the blockchain. What is remarkable is that the Bank of England appear to be taking a very proactive approach to how the payments market will develop in the future, and recognising the role that Fintech has to offer in this area. They are looking at ways to increase efficiency and transparency in financial markets.

The Bank of England is leading the central bank market in providing new solutions. A policy of first adoption could lead to a huge advantage in the payment transfer market. As these solutions are cross border, other central banks would do well to investigate this trend and come up with their own solutions as soon as possible.

It also provides a counterpoint to MiFID II, and shows how the payments industry could be structured in the future.

If you have any questions, please feel free to contact us.

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Letter of Credit – financing international trade

| 19-04-2018 | treasuryXL |

Cash Pooling

 

When a buyer and seller agree to enter into a transaction that is cross border, one of the most used instruments to facilitate this transaction is a documentary letter of credit (LC). This is an international recognised and accepted method that is governed by the rules and regulations of the International Chamber of Commerce. LCs are mainly used for international transactions, where the seller requires additional security and also where the law in 2 deferent jurisdictions are not the same. However, protection is also given to the buyer. Here is a quick guideline to how this instrument works.

Deal

A buyer and seller agree to a trade and, invariably due to the distance between them, the different laws, and the fact that they may have no previous trading relationship, the trade will take place under a LC. Upon agreeing the trade, the buyer will contact his bank and ask them to issue a LC (Issuing Bank). As the bank will provide a guarantee role in this transaction, they first need to ascertain if the buyer has sufficient funding to settle the transaction.

The letter of credit is then sent to the seller’s bank (Advising Bank). Within this document the terms and conditions of the shipment are detailed. The issuing bank lets the seller know what documents are needed to accept the import, together with such items as the latest shipment date.

The seller will arrange for the necessary documentation and shipment. Then they will approach their bank and present them will the documents and the LC. This is all sent to the Issuing Bank who then checks that the documentation meets the terms contained within the LC.

Upon approval by the Issung Bank the following steps take place:

  • Account of the importer is debited
  • Documents are released to the importer so that they can claim the goods
  • Payment is made as per the instructions of the Advising bank
  • Advising Bank credit the account of the seller

As the issuing bank has issued a guarantee, the in the event that all the documentation meets the criteria agreed upon, then they are obligated to make payment to the seller.

It is of course possible that there are discrepancies between the LC and the documents delivered. As the documents are delivered by the seller to their bank (Advising Bank), it is they who have the first task of checking everything. If discrepancies arise, the advising bank will endeavour to ensure that the documents amended. If the discrepancy can not be amended within the agreed time frame, then the documents will be forwarded to the Issuing Bank “in trust”. Sending documents in this way removes the guarantee on the original letter of credit, so caution is necessary. It is possible that despite the discrepancies, the buyer is still prepared to accept the shipment.

The list of necessary documents includes, but is not limited to:

  • Bill of exchange
  • Bill of lading or airway bill
  • Invoice
  • Cargo packing list
  • Certificates certifying to authenticity, inspection, origin
  • Insurance policy

Despite the guarantee from the Issuing Bank, there are always risks – default by any of the parties, legal risks, acts of war, documents not arriving on time etc. A letter of credit specifically deals with the documentation and not the goods itself.

This is one of the oldest and most trusted methods for arranging trade finance, and given the complexity with all the documents and the time it can take to cross the world, this is an area of banking that is very keen to explore the advantages offered by the Blockchain to accelerate the whole process.

 

If you have any questions, please feel free to contact us.

 

Data analysis – pros and cons

| 18-04-2018 | Lionel Pavey |

 

With the advent of computing and ever more powerful processing capabilities, we are living in a time where there is more and more data available within a company. Advocates of data mining speak of the advantages that can be obtained by analysing all the data and discovering trends within the data. But there is also the risk that we end up being swamped by the data overload – so much data, so little time. If we want to analyse all our data, what is it that we truly want to find? How can we interpret all the data and arrive at beneficial conclusions?


Treasurers and cash managers are long time users of data analysis – it is used to go from a macro level to a micro level for individual transactions. When designing a cash flow forecast it is essential to take the micro approach. There will always be peak days for outflows – wages are paid, normally, on 1 specific day of the month; on the last working day of the month there is large expenditure relating to taxes and social premiums. Additionally, if the company works with monthly subscriptions, there will be peak days for inflows as all the renewals take place. These “exceptional” items need to be input as hard data on the relevant working days to assist in presenting an accurate forecast.

Another application of data analysis is to interrogate the actual Days Sales and Days Purchasing Outstanding – DSOs and DPOs – that make up the cash conversion cycle. A lot of unnecessary working capital can be tied up in this process. Understanding the transactional characteristics of individual debtors and creditors can be very beneficial to freeing up working capital. Furthermore, it allows the company to review their relationships – is it worth maintaining certain contacts if they do not meet the agreed terms and conditions on their trade transactions.

It is also possible to conclude that certain clients could benefit from a more advantageous pricing policy. Rewarding those that comply leads to better relationships and the improvements in cash flow can help reduce external borrowing requirements.

When attempting to analyse data, it is imperative to first understand what you are looking for. Obvious metrics could be month on month sales or purchases, seasonal effects on turnover, new products, promotional offers etc. The act of analysing data, together with the awareness within the company that the data is being analysed, can lead to anomalies caused by people’s actions. Data input could be subject to a form of “window dressing” – entries are made before the end of the month and then corrected in the following month.

It is possible to conclude that there is a trend in the data – some people even look for these – that could lead to a false sense of conclusion. There is also the danger that 2 different streams of data are linked to each other because they show the same trends. When analysing data is it necessary to be open minded about the expected outcome. If people start analysing with a preconceived idea of what the outcome should be, human nature can intervene and the data is interpreted in a way that justifies the preconceived idea.

Data analysis is a technical discipline that can overlook the fundamentals. Before the CDO crisis of 2008, most banks agreed with the interpretation of the underlying data within the systems, without challenging the reality of the scenarios being presented. Even after the crisis started, the banks were unable to foresee the severe impact that it would have on the whole financial market. I have a curious leaning to analysing long term interest rates – I have collated data on Interest Rate Swaps since the inception of the Euro. Whilst I am able to spot long term trends, I have failed in ever calling the top or the bottom of the market.

When analysing data, it is imperative that the basic fundamentals of a company and its products is never forgotten, If sales are down, a more fundamental approach needs to be undertaken. Are our competitors cheaper, are their products better, is the economy in a downturn, are our products obsolete?

Analysis should always be undertaken, but the results must always be weighed up against the reality of the marketplace. It is too easy to draw conclusions – it gives the illusion that the analysis is good.

A lot of good things can come from data analysis, but it must not exclusively determine the actions that a company takes in its quest for growth and survival.

Lionel Pavey

Lionel Pavey

Cash Management and Treasury Specialist

 

Short term financing – lines of credit

| 17-04-2018 | treasuryXL |

Cash PoolingThere are many instruments that can be used to obtain short term funding. We have touched on some of them earlier in this series. This article is all about lines of credit. These are normally provided by banks of other financial intermediaries and help corporates with their short term funding needs. At first glance is might appear to be the same as a short term loan, but there are some clear differences. Normally, the financial institute that is the counterparty, will provide you with a line of credit – after appropriate inspection – which sets a specific limit on the amount of credit to be extended. Let us see how this works.

An agreed line of credit will contain, within its contract, a few simple terms:

  • The maximum amount that can be drawn
  • The minimum amount that can be drawn
  • The minimum and maximum tenor
  • If based on floating rates – the base will be specified
  • The additional margin rate above the index rate
  • The end date of the facility
  • The facility fee – usually expressed in basis points

Facility Fee

When a bank extends a line of credit, they are actually earmarking these funds in their books – they have a contingent liability. The facility fee can be seen as the cost of the arrangement. Normally the facility fee is paid monthly on the notional amount outstanding on the facility. In other words, if 70% of the facility was not being used, then a facility fee would be owed at the end of the month on a pro rata basis for this amount.

Drawdowns are communicated via the agreed channels and the bank credits the client. Lines can either be secured or unsecured – a secured line would attract a lower interest rate payable. Furthermore, normal corporate governance would apply in respect of bank compliance – agreed ratios must be maintained in order to keep the facility running.

The main advantage with a line of credit, is that the client has the flexibility to borrow exactly the amount that they require – given the contract conditions – and also have flexibility regarding the tenor. With a traditional loan, they would receive all the funds on the first day, irrespective of if they actually needed all the funds on that day.

Interest is only paid on the amount borrowed – not on the whole facility. For the balance, as mentioned earlier, a facility is payable. Due to its revolving nature, the facility can be used for many times during the agreed life of the facility. This gives the borrower enormous flexibility and ensures that they never need to borrow more than they actually require.

This product is normally used for operational issues, that are influenced by specific factors. It could be that a company is exposed to seasonal factors that result in a shortage of cash. A line of credit enables the company to smooth out these peaks and troughs and ease the bottlenecks restricting their operations. Additionally, due to the time lag inherent in many companies between delivering goods and receiving payment a line of credit ensures continuation of the daily operations.

The product can be renewed, but will be subject to a new inspection and, possibly, new terms and conditions at renewal. For companies that experience wide fluctuations in cash flows, this is a useful product to arrange their short term funding.

 

If you have any questions, please feel free to contact us.

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Repurchase Agreements – alternative short term funding

| 16-04-2018 | treasuryXL |

 

There are times when a corporate needs to borrow funds – this can be accomplished in a manner of ways. If the corporate actually held securities (Government paper, bonds etc.), it could consider entering into a repurchase agreement – better known as a Repo. This transaction entails a trade where the corporate sells securities at an agreed price and date to a counterparty and purchases them back at a future date for an agreed price. In return, the corporate receives cash – in essence, a Repo is a collateralised loan. Let us look at the working and reasons behind this money market product.

As a funding instrument, repos have been around for 100 years – originally used by the Federal Reserve to facilitate open market operations. As a repo is a collateralised loan, the interest rate is, normally, lower than for unsecured lending. The major factor is the type of collateral that is offered. This can normally be Government paper, but can also include other forms of bonds and securitised paper. The interest amount is not paid separately, but included in the final price upon redemption. The classic term for a repo is a “sell and buyback” – the paper is sold in exchange for a principal amount and bought back on the agreed future date. The counterparty that buys the paper is entering into a reverse repo.

By offering the paper as collateral, the lender is entering into a secured transaction – if the borrower defaults, the lender still holds the paper. The preference in the market is for high quality liquid securities, though markets can be found for more opaque paper. After the financial crisis, the demand for repo trading rose sharply as the interbank market was reluctant to extend unsecured funding to counterparties.

The paper falls into 2 distinct categories – specials and general collateral. A special refers to a specific security (recognised by its unique ISIN number) that is in demand. These are bonds that are normally being very heavily traded in the market and market makers need to cover their short positions by borrowing the paper. As such the rates on specials can be appreciably lower than on normal repos – and far below the rates on the interbank money market. In particular times of shortage, rates can even be negative.

General collateral is any paper that is accepted as collateral at that moment – it could be any German Government paper as this is deemed by market participants as being of equal value and standing. Most collateral is subject to a haircut – due to the additional work involved and the potential credit risk. This means that a bond with a face value of EUR 1 million can only be used as collateral to borrow EUR 950,000. Whilst these loans are collateralised, and often cover Government paper, the is always a specific credit risk.

For the buyer of a repo, they are lending funds and receiving collateral. One of the main players on the buy side are Money Market Funds. For the seller there is an opportunity to receive short date finance whilst pledging assets that they are holding in their portfolio.

Repos normally have a short tenor – from overnight to 3 months. They facilitate the short dated market and provide funding at attractive rates, and assist bond traders in covering their positions.

If you have any questions, please feel free to contact us.

 

 

Cashless society – the backlash

| 13-04-2018 | treasuryXL |

Last week an article appeared on the BBC website about the current situation in Sweden. They have embraced the world of digital payments – cash payments in the retail sector now amount to only 15% of the total, compared to 40% in 2010. But against this resounding success, there is a growing unrest among the elderly and other groups perceived as vulnerable. The majority of the banks in Sweden have stopped customers from withdrawing or paying in cash at the banks. So, what are the consequences in a cashless society and how will digital money perform in the future?

75% of Swedes claim that they hardly use cash anymore – they take advantage of digital payments via cards, mobile phone and online facilities. The counter argument is that as long as people have the right to use physical cash and it is permitted by law, the people should be free to choose their method of payment. Those people that are protesting are normally seen as the elderly who have yet to embrace the culture and are still adverse to using digital technology. There are also many elderly who have no access to a computer at home who are now facing additional costs in a cashless society.

The crux of their argument that it should not be more expensive to enter into transactions if they decide not to use digital services. Riksbank (the Swedish Central Bank) adopted a cautionary stance in their annual report, stating that whilst progress was good, this must not result in a part of society from being excluded from the payment markets. Whilst the progress towards a cashless society looks inevitable, a survey in Sweden has shown that 70% of Swedes would still like the choice to pay with cash in the future.

If we move towards a completely cashless society, this will have a profound impact on the banking industry. Digital cash can be issued by the central bank directly to residents. It will not require the current level of intermediation that commercial banks currently provide to disperse money. Cash, as currently used, provides a certain level of anonymity – this trait would cease to exist if central banks issued digital currency. A fully digital currency would shorten the time needed for transactions to be settled and replace the plethora of existing settlements systems and exchanges.

It would appear that the biggest benefit would come in cross border payments – an area of banking that is still relatively slow and expensive to implement.

Cash is still king, but it would appear that it is starting to be seen as an old fashioned and inefficient means of settlement in an increasingly digital world.

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Buy now, pay sooner – dynamic discounting

| 12-04-2018 | Lionel Pavey |

 

We live in a time of very low interest rates which translates to lower funding costs. However, at the same time, obtaining credit is becoming more difficult as banks are reluctant to lend in the ways that they did years ago. This is caused by the need for additional financial buffers to comply with all the regulatory issues that surround modern day banking. Credit is still available via other avenues – look at P2P lending for example. When all else fails, it is necessary to look at one’s own internal supply chain to see how financing can be facilitated. Here is a report on the practice of dynamic discounting.

Dynamic discounting

As a corporate is common to purchase goods and services on the basis of receiving an invoice and paying at a later date. It is normal to see invoices stating that payment must be made within 30 days of the invoice date – not the acceptance date. As an incentive to pay the invoice early many companies offer a discount – the classic example is called 2/10 net 30. Breaking down this code shows that a 2 per cent discount is offered on the face amount of the invoice if it is paid within 10 days of the invoice date, otherwise payment is expected within 30 days.

Whilst 2 per cent might not sound very tempting, we need to look at the mathematics that lie behind this:
On an invoice for EUR 1,000 this means a discount of EUR 20. If we decided not to use the discount and only pay after 30 days we would have held onto our EUR 1,000 for an extra 20 days – this being the difference between the early payment date and the standard payment date. At present, we might make 1 per cent interest per annum on our bank account. The interest earned on EUR 1,000 for 20 days at 1 per cent, would reward us with EUR 1.11 – or, put in other words – EUR 18.89 less than if we paid early.

Why offer a discount?

• The supplier wants to lower their banking costs and improve their ratings
• The supplier needs the money
• Banks are not willing to lend money to the supplier
• The supplier is worried about their level of exposure to credit risk and counterparty risk
• It gives a supplier a useful insight into the business practices of their clients – if they calculated the advantage of taking the discount and declined, could there be inherent problems with the financial health of the client

Also, generating your own internal supply chain finance operation lessens the reliance you have on external funding from banks or factoring agencies.

A more modern adaptation of this practice is the development of discounts that are truly dynamic and work on a sliding scale. The highest discount is given for the fastest payment, and then progressing down in stages till the original invoice settlement date. This gives buyers an opportunity to still receive a discount, but not being tied down to the original 10 day period.

Irrespective of the financial gains offered by discounting, a more important aspect is positive growth in the working relationship between supplier and client. By supporting each other the bonds of trust increase and can lead to new and better opportunities together.

If you are interested to know what the effect of these changes can be on a coupon payment and calculation, please contact us for more detailed information.

Lionel Pavey

 

Lionel Pavey

Cash Management and Treasury Specialist

 

Basis Swap – how to convert your exposure

| 10-04-2018 | treasuryXL |

At the moment, there is a growing movement within interbank markets to replace all the existing interbank offer rates that are used to price a myriad of financial instruments. The motivation for this movement has been the revelation that these indices have been fraudulently priced by banks delivering inaccurate prices for the daily fixing. At the moment the markets are first looking at secured overnight lending indices – but these are not complimentary to all the existing instruments that regularly reference a longer tenor on an unsecured basis. These can lead to problems with the asset and liability management of a portfolio – not just for banks, but also for corporate clients.

So, what is a basis swap and how does it work?

A basis swap is an interest rate swap where both legs reference a floating rate – either in the same currency or on a cross currency. Examples would be a 3 month Euribor exposure against a 6 month Euribor exposure, or 3 month USD Libor versus 3 month GBP Libor. In a normal positive yield curve the interest rate for a longer tenor is higher than for the shorter period – 3 month USD Libor is 2.33746% and 6 month USD Libor is 2.47219%. There are 2 main reasons for the difference in price – the tenor is longer, therefore the risk of repayment is lengthened and the individual credit rating of the counterparty is also affected.

Before the financial crisis of 2008, basis swaps were traded, but not given much attention. Their primary function was for transforming the asset and liability management in the same currency. It was actively used in the cross currency market where a bank might raise long term funds in Japanese Yen, but needed to convert the proceeds into USD. Furthermore, the consensus at the time was that 1 master curve could be built to price all products – this used short dated deposits, 3 month interest rate futures and long date interest rate swaps to build the single curve.

This meant that a 6 month deposit was built on the basis of a 3 month deposit and a 3m v 6m FRA (Forward Rate Agreement) . In such an instance there would be no arbitrage possible and the market did not really look at the basis risk. But the basis risk was inherent and certain market players exploited this misconception – particularly banks that received fiduciary funding via Switzerland.

Today, there is far more awareness of the basis risk. 3 month Euribor is -0.329% and a 3v6m EUR FRA is -0.33/-0.31%. However the 6 month Euribor is 0.270% (we will leave you to do the calculation)

As a longer tenor has a higher interest rate (in normal market conditions) a basis swap referencing a 3 month versus 6 month payment would see the 3 month period being quoted as flat rate plus a premium, and the 6 month period being shown as a flat rate. A typical quotation for a 1 year EUR basis swap referencing a 3 month against 6 month Euribor would be priced around at about 5 -6 basis points premium. This means if you were to pay the shorter period of 3 months you would pay the base of 3 month Euribor plus 5-6 basis points every 3 months for 1 year, against receiving the 6 month Euribor flat every 6 months.

This product allows you to transform your position, but also gives insight into how the market sees the continuous 3 month and 6 month curves, together with their inherent basis risk.

An interest rate swap curve that references a 6 month floating leg, will normally be built from an interest rate swap curve built off a 3 month floating leg, with an adjustment for the 3m v 6m basis swap to reflect the higher price on a 6 month curve.

 

1 year to Brexit – the banking exodus?

| 09-04-2018 | treasuryXL |

If all goes as stated, then the United Kingdom will be leaving the European Union on 29th March 2019. There has been fierce competition within the EU to entice banks away from London and to settle within the Euro zone. In London there is a fear that there will be a banking exodus –  an industry that has prospered and made London a global centre. At till now banks have been able to sell their services into Europe via London, that this is envisaged to change. So, how are the major European cities faring in their campaigns?

What is at stake?

The scenarios of job losses are varied – 10,000 job in banking, 20,000 in further financial services. Others speak of job losses totaling more than 200,000. The large US investment banks retain more than 80 per cent of their European staff in London. The main target appears to be the Euro clearing role – a settlement service mainly in financial derivatives denominated in Euro’s that is now performed in London.

The Netherlands has certainly tried to attract interest from foreign banks and has many good qualities. Most of the population speak English, and there is a good infrastructure. Tax incentives are offered to qualified foreign workers, together with a global port in Rotterdam. The Netherlands Foreign Investment Agency is actively engaging with foreign companies, extoling the virtues of the country. Recently, Unilever took the decision to place its headquarters in Rotterdam – even though they have had a head office there for close on 100 years. Whilst there is already an appreciable physical presence of foreign banks on Dutch soil, there have yet to be any big announcements about a bank moving from London to Amsterdam or Rotterdam.

Germany, and specifically Frankfurt, have also been hard at work. The economy minister for the state of Hesse, claims that more than 20 financial institutions have chosen for Frankfurt. As of today, their names have not all been revealed. Frankfurt is an established financial centre, though discernably smaller than London. As well as banks, there are also regional corporate treasury centres, prime brokers, legal services and other ancillary groups.

Paris – that has been chosen for the European Banking Authority – is also in the picture but does not appear to be attracting the financial institutions. If banks follow the London model, then they would rather be closer to the central bank – the ECB – and that is headquartered in Frankfurt.

Relocation of the financial industry from London to Europe will be good for local employment. It is not just the direct banking industry that will be of benefit to the local communities. The support services are very significant and must also be factored into any equation.

With now less than 12 months to go till Brexit, the race will be heating up to woo the banks as the prize is very enticing and the gains to local economies very large!!

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