Prime Minister Theresa May faces an uphill battle in pushing her Brexit deal with the European Union through the British parliament. With that in mind, the financial industry and regulators continue to prepare for an exit from the EU without a deal or transition period. The U.K. and EU are laying out contingency plans to protect financial stability and calm markets in the event of a no-deal Brexit that leaves no time to adjust.
1. Why is this such an important issue for banking?
Because Brexit imperils the longstanding working relationships between the City of London financial district and firms on the European continent. Earlier hopes of maintaining full access through so-called passporting rights or a sweeping agreement between regulators came to nothing. U.K. banks and insurers have started applying for EU licenses and shifting operations inside the bloc, as firms on both sides of the English Channel work to avoid a cliff-edge plummet into uncharted territory on the morning after Brexit.
2. What’s the current plan to avoid chaos?
EU officials in Brussels pledged on Nov. 13 that the bloc’s firms will be able to continue using critical financial-market infrastructure based in the City of London even in a hard Brexit. This includes access to London Stock Exchange Group Plc’s clearing unit, the most important clearinghouse for for the multitrillion-dollar interest-rate swaps market. The plan would also cover central securities depositories, which settle trades in equities. Ireland has relied on a U.K.-based firm called Crest to settle trades since the 1990s. U.K. officials, meanwhile, have spent the last year laying out a system of temporary permissions for firms wishing to do business in Britain. Both sides have said they are working to establish cooperation arrangements in time for Brexit.
3. So is everything under control?
Not yet. The industry doesn’t welcome the no-deal situation at all and has long pressed for a extra time to adjust. Banks, while welcoming the EU’s recent planning, can’t rely on it until it’s complete. The EU’s plan to preserve access to U.K. clearinghouses, for example, needs additional approval by the bloc’s policy makers. The European Commission vows that it can be “swiftly deployed,” but if it isn’t, banks could find themselves in breach of regulations that require them to use only recognized venues to clear derivatives. And banks warn that the sheer volume of the business makes it impossible to transfer all positions to a venue in the EU in time. Also, traders in British stocks would have to redirect dealings in important securities inside the EU if the commission in Brussels doesn’t recognize the U.K.’s rules as equivalent.
4. Which areas still require work?
The Bank of England estimates that 30 trillion pounds ($38 trillion) of over-the-counter derivative contracts may face complications, along with millions of insurance policies. There are concerns over the flow of data across the Channel and whether EU banks will be able to count debt issued under English law to meet a requirement intended to end bailouts by taxpayers.
5. What happens to existing contracts between U.K. and EU firms?
They won’t necessarily become invalid the day after Brexit; the problem is the activity needed to service them. Some so-called life cycle events, such as extending the maturity of a trade, could require an EU license -- which U.K. firms are about to lose. The industry says that grandfathering existing contracts would be the preferred fix. Short of that, national EU regulators may be pressed to grant temporary licenses to British companies, mirroring what U.K. regulators are already preparing to do. But authorities in France, the Netherlands and elsewhere currently lack the power to do so. The European Commission, the EU’s executive arm, says there isn’t a need to pass contingency measures related to existing over-the-counter derivatives contracts.
6. What’s the problem with debt issued by EU banks?
They’ve often relied on London’s capital market to issue debt, or at least sold securities under English law because it was universally accepted by international buyers. They also did so when issuing bonds that can be used when they run into trouble, which is a regulatory requirement to protect taxpayers from paying for future bank failures. Without any steps by authorities, a big chunk of banks’ issuance could cease to be counted toward these requirements. In the worst case, firms would be forced to re-issue the debt under different conditions. The authority responsible for banks in the euro area has signaled that it may grant firms more time to fulfill their requirements if they face a shortfall because of Brexit.
7. Can’t data still flow between the U.K. and the EU?
Not necessarily. Under the EU’s new data-protection rules, firms can’t simply send personal information outside the bloc. Regulators have warned banks to check where the data they handle is stored and to take “mitigating actions” if needed. The commission in Brussels has said that the bloc’s framework provides plenty of tools to deal with cross-border data flows, and that it doesn’t plan to issue the kind of broad “adequacy decision” that British lawmakers have called for and which would recognize the British rules as equivalent.
8. What could a no-deal Brexit mean for capital requirements?
In theory at least, an EU bank’s exposure to a non-EU country such as post-Brexit U.K. requires more capital behind it. In a similar vein, the U.K. government has warned British firms that they may no longer be allowed to treat EU sovereign debt as risk-free if there is no Brexit deal. Both sides could decide that exposures in each others’ jurisdiction don’t present increased risk, which would extend the status quo. In the EU, this step also would fall to the European Commission, which has in the past issued such equivalence decisions for countries including Brazil, China and Saudi Arabia.
--With assistance from Nicholas Comfort.
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