ISDA, EU Industry Bodies Warn of ‘Cliff Edge’ Effects ‘No Deal’ Brexit

New paper proposes steps that can be taken now to mitigate potentially systemic consequences of the UK leaving the EU without a withdrawal agreement and transition period in place.

ISDA (the International Swaps and Derivatives Association) along with a number of European financial industry groups have jointly published a paper warning of the disruptive impact of a ‘hard’ Brexit on derivatives markets.

The paper describes the “cliff-edge risks” and the EU regulatory requirements that would apply to OTC derivatives in the event of a ‘no deal’ Brexit, along with the immediate adverse impacts on firms and clients both in the EU and the UK.

Under a ‘no deal’ Brexit, the UK would become a third country under EU law, resulting in a variety of regulatory requirements that would immediately restrict the ability of EU firms to transact derivatives with UK entities and infrastructures, potentially with systemic consequences. This could occur suddenly if the UK leaves without a withdrawal agreement and transition period in place, the paper said.

For example, EU counterparties would be unable to act as clearing members at UK CCPs (central counterparties), and would not be able to clear products for themselves or their clients until UK CCPs are recognised by the EU.

“The resulting migration of thousands of contracts to EU-recognized CCPs – if even possible – would result in higher costs and would pose significant operational challenges. A migration of this scale has never before been attempted.”

The paper points out that EU law gives the authorities the power to take mitigating action – for instance, by adopting equivalence decisions or approving applications for recognition – but there is a risk that these actions may not happen until after the UK has become a third country. The industry bodies say the perceived risk of such a hiatus would be likely to cause severe market disruption months in advance of Brexit.

Several recommendations were made on steps that can be taken now to address the risk of a ‘cliff-edge’ Brexit, including authorities beginning to accept applications and adopt advance formal decisions that take effect on 29 March 2019.

ESMA (the European Securities and Markets Authority) should additionally consider working with relevant CCPs, trade repositories, credit rating agencies and benchmark administrators in advance of Brexit to facilitate applications for recognition, endorsement or registration in the event of a no-deal scenario, the paper says.

The European Commission should consider proposing legislation to create a temporary regime deferring the impacts and allowing time for necessary actions to be taken after Brexit. The UK has already announced that it plans to create temporary permissions and recognition regimes to minimise disruption to UK markets in a hard Brexit scenario, the paper notes.

Market participants should also be provided early transparency about possible mitigating actions authorities expect to take and any likely gap before those actions become effective after Brexit, so firms and their clients and counterparties can plan accordingly.

“In the absence of transparency, market participants may be forced to take disruptive, risky, costly and potentially irreversible (and ultimately unnecessary) steps to mitigate adverse impacts (where mitigation of such impacts is possible) far in advance of Brexit.”

The full paper is available here.

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