ISDA and some other European trade bodies have updated and re-issued their October 2018 paper, “The impact of Brexit on OTC derivatives” (not yet on its website). Given the current impasse on a free trade agreement and the absence of completed equivalence declarations, the possibilities of “cliff-edge” disruption to the derivatives market are largely as they were back in 2018, save to the extent that the quantum of affected contracts may have been reduced (if this has indeed happened to a material extent). Readers will remember that back in March the Bank of England issued its own cliff edge paper, and will know the main issues well, but by way of a reminder, some of them are:
- EU27 firms’ inability to continue to use the UK CCPs “would create huge operational challenges associated with migration of thousands of contracts and their related collateral to alternative CCPs (if this is feasible). This would give rise to higher costs (including but not limited to a significant increase in the capital requirements of EU institutions under CRR in respect of their exposures to UK CCPs after the end of the transition period envisaged by CRR), increased systemic risk and distorted competition…”. Valdis Dombrovskis announced earlier in July that a temporary equivalence decision would be forthcoming. The key date is the end of September, because the terms of membership of the UK CCPs require them to give 3 months’ notice to any EU27 firms to which they could not provide clearing services without breaching EU law.
- exchange-traded derivatives on UK markets would become OTC and so count towards the EMIR clearing threshold.
- the derivatives trading obligation would prevent them trading with UK parties on UK trading venues, and if the UK responds in kind, UK and EU27 contracts can only be done on venues outside the EU and the UK that already benefit from an equivalence declaration – i.e. Singapore and the USA.
- exposures to UK firms will become third country exposures and so subject to higher capital requirements under CRR.
The obvious solution is to make the equivalence determinations, and renew the 2019 no-deal novation RTS which lapsed after the Withdrawal Agreement came into effect - and yet politically it seems it can only be done at the last minute. Failure to do it would seem counter-productive, as the German Bankenverband, and doubtless many others, have noted, but the example of the Swiss Stock Exchange shows that one should not assume that what might seem like common sense will prevail.