The impact of a hard Brexit on the financial services industry
BY MICHAEL ROBERTSON With little over a month until the UK is scheduled to leave the European Union, JDX continues to monitor some of the key challenges which could impact financial services companies in the event of a ‘no-deal’ Brexit.
Many firms will have assessed their readiness for Brexit on the basis of having a transitionary period after 29 March, but we now have to strongly consider a cliff-edge outcome where the UK effectively crashes out of the EU with no formal agreements in place around key areas such as financial services.
Regulatory bodies and legal experts are frantically working to transition EU regulations into UK statute. However, lack of clarity around the future implementation of regulations has enormous implications – if we take EMIR as an example, what will happen to the margining and clearing exemptions for central counterparties, clearing houses and trade repositories?
In addition, under MiFIR there will be a transfer of functions from ESMA to UK regulators which means UK bodies such as the FCA and PRA will have new responsibilities and need to make clear rules and guidelines available for ongoing support.
If we look at derivatives in general, there are questions around the application of mandatory clearing and margin requirements. What role will the UK play in the upholding of mandatory clearing, minimum margin requirements and reporting to a centralised trade repository as part of the ongoing commitment to reform derivatives markets?
Trade flow impacts
On the issue of margin, companies need to consider what would be eligible collateral post Brexit. European central counterparty clearing houses would presumably prefer euro-denominated collateral, which could downgrade or even make UK collateral ineligible. Market fragmentation could lead to more OTC activity outside of London. Until numbers increase at certain clearing houses, there could also be an increase in member default contributions.
There are still question marks as to whether certain trade events/contractual obligations will be valid post-Brexit. Events such as the exercising of an option, rolling of an open position, amendments, novations and portfolio compressions all remain subject to confirmation as to whether any additional regulatory requirements may be applicable.
In addition, with the UK no longer an EU member, there could be considerations over the use of non-authorised benchmarks. There will likely be a transitionary or adjustment window to avoid losing access to benchmarks but use of benchmarks post-Brexit will depend on obtaining approval by way of Equivalence, Endorsement or Recognition, each representing a set of unique challenges to achieve.
These issues have implications for infrastructure where – if the benefits of regulations such as EMIR are no longer available, UK-based operators of trading or clearing settlement systems are going to have to consider how they will service EU-based firms.
The EU has granted temporary recognition for UK clearing houses so they don’t lose access to the market after 29 March, but much will depend on the transitional period granted as to whether EU firms will find themselves having to migrate legacy transactions with the associated operational risks.
A recent ISDA symposium focusing on the impact of a hard Brexit referred to ongoing uncertainty diverting resources away from other regulatory compliance agendas. Regardless of the current lack of clarity around the UK’s future relationship with the EU, firms cannot afford to take their eyes off the ball.
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