Up until about a week ago, most financial institutions felt UK and EU regulators had done an impeccable job minimising the risks facing the industry should there be a no deal Brexit. For instance, the Financial Conduct Authority (FCA) announced in 2018 that it would set up a temporary permissions regime (TPR) enabling EEA investment firms to continue passporting into the UK for a limited period under a no deal outcome, thereby curtailing disruption.
Shortly thereafter, multilateral MOUs (memoranda of understanding) were formalised between the FCA and various EU national regulators allowing the funds’ industry to continue operating just as it has been – under a no deal scenario, putting to rest any fears managers had about the future of delegation. Other MOUs were signed covering centralised clearing and settlement in what should also help facilitate continuity and market stability.
So far, so good, but cracks are beginning to emerge between the UK and EU, evidenced by the recent dispute about share trading obligations, in what could be a worrying sign of things to come. While experts have spoken extensively about the immediate impact of Brexit, some banks and fund managers are beginning to look further down the line, analysing the potential implications of future divergences between UK and EU regulators.
At a de minimis, this could result in duplicative reporting manifesting, adding to firms’ costs and eating into their resources. Other concerns are more serious though. If the UK were to deviate from EU rules completely, domestic financial institutions risk being excluded from the EU altogether. Limited access to EU markets is not the industry’s biggest fear though.
Systemic risks could also arise as a result of the UK’s departure. European regulators have made it no secret they want greater oversight of the risk management practices and policies at third country, systemically important CCPs. The UK – which clears most of the euro denominated trades in the market – is on guard, conscious about EU regulatory over-reach. Despite this oversight ostensibly being to protect markets, it could have the opposite effect.
For example, EU regulators could instruct UK CCPs on how they implement margin calls, something which has alarming implications. Italian banks – struggling under their huge exposures to non-performing loans – suffer a collective credit event, sending the economy into tailspin. If European regulators get their way, they could be within their rights to tell a UK CCP to lower its margin calls on Italian CDS (credit default swaps), in order to protect the Italian economy. By doing so, European regulators would potentially be sacrificing the financial stability and risk management integrity at a UK CCP.
It is clear institutions are prepared for the short-term Brexit risks, although many are now rightly concerned about what happens next. As one expert dryly put it, the Brexit negotiations were probably the easy part. If UK and EU regulators seriously diverge moving forward, the risks and costs to the financial services industry could be massive.