The 5 biggest risks Brexit poses to Europe’s financial markets

A dealer on the trading floor of IG Index reacts in London May 7, 2010.

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A dealer on the trading floor of IG Index reacts in London May 7, 2010.
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Reuters/Paul Hackett

  • Brexit could fundamentally alter the UK and EU’s relationship when it comes to financial services.
  • Major financial institutions on both sides of the channel are tied together by 40 years worth of incredibly complex regulation.
  • Ensuring that these regulations still apply, and serve all parties well, provides major risks to the markets, a report from the Association for Financial Markets in Europe says.

LONDON – With just 15 months until Britain formally leaves the European Union, it is still hugely unclear what the relationship between the UK and the rest of the continent will look like after Brexit.

Uncertainty over the future agreement is a major drag on certain sections of the UK’s (and to some extent the EU’s) economy, with businesses delaying investments until they have a clearer picture of what Brexit actually means for them and their businesses.

Nowhere is that uncertainty more profound than in the financial services sector, which relies heavily on cross-border cooperation.

Much has been made of the fact that when Britain exits the European Single Market it will be forced to relinquish its financial passport – a set of rules and regulations which allow UK-based finance firms to trade with and sell their services into Europe – but other issues remain for financial firms on both sides of the channel.

In a report released this week, the Association for Financial Markets in Europe (AFME), a Brussels-based lobbying group, highlights five areas of risk to Europe-wide financial services, which the AFME’s chief executive, Simon Lewis says provides a “summary of some of the most significant cliff edge risks that need to be avoided through transitional arrangements and further action.”

“In order to maintain financial stability, EU and UK policymakers should urgently clarify actions to mitigate these cliff edge risks,” Lewis adds.

1. Data sharing

  • “Restrictions on sharing of personal data between the EU27 and the UK as a result of Brexit could severely disrupt the ability of businesses to continue to transfer personal data post Brexit,” the AFME’s report says.
  • Data sharing is an area of concern previously flagged by the Bank of England, which in September said that the failure to secure an agreement on data sharing after Brexit could pose risks to financial stability.

2. Continuity of derivatives contracts

  • “When the UK leaves the single market, existing passports enabling UK-based firms to engage in regulated activity in the EU27 (and vice versa) will cease,” the AFME said. “This creates important questions for businesses regarding the continuity of services under existing cross-border contracts.”
  • This could have a particular impact on the OTC derivatives markets, with AFME estimating that as many as a quarter of all cross-border trades could be affected.
  • Euro derivative clearing has been a major point of contention between the UK and EU in the past, with EU authorities fighting to force clearing to occur in the eurozone, rather than in London.

3. Jurisdiction

  • The legal rules that apply to financial services firms and contracts, and which jurisdiction they come from, is another major risk, the AFME says.
  • “There is a very significant volume of financial services contracts where the parties have chosen the jurisdiction of the English courts,” the report notes.
  • “It is therefore important to provide clarity that continued recognition will be provided to the choice of jurisdiction throughout the UK and EU and that judgments of the courts of a Member State and of the UK will continue to be enforced throughout the UK and EU27.”

4. Recognising clearinghouses

  • Central counterparties, or CCPs, are a major part of European financial market infrastructure, with their main role being to help facilitate trading done in European derivatives and equities markets.
  • Ensuring that a framework is in place to enable major EU banks to use UK CCPs – many of Europe’s biggest clearing houses are based in Britain – is a major concern for the AFME.
  • “EU27 banks could find themselves in breach of regulation for maintaining positions in UK CCPs that would no longer be authorised or recognised under EU regulation,” its report says.EU27 banks may also be required to hold a significantly increased amount of regulatory capital against positions in UK CCPs.

5. Financial failures

  • The Bank Recovery and Resolution Directive (BRRD), put in place to prevent taxpayer bailouts, provides for the automatic recognition of resolution actions throughout the EU,” the AFME says.
  • “Without an intergovernmental agreement, the automatic recognition would no longer apply as between the UK and EU27 following Brexit, which could create issues for financial institutions.”