In a new paper (the "Paper"), ISDA and several foreign banking and securities dealers associations (collectively, the "associations") analyzed the potential adverse effects of a "no deal" Brexit scenario on OTC derivatives business under EU law; that is, in a situation in which (i) the UK withdraws from the EU without an agreement with the EU and (ii) there is no transition period for market participants.

In the Paper, the associations stated that a "no deal" scenario would create a "disruptive 'cliff edge' change" in EU regulatory requirements regarding OTC derivatives business. A "no deal" event would immediately affect EU27 firms and clients, as well as UK counterparty firms. The associations noted that, among other examples, EU27 firms may be unable to remain clearing members of certain UK CCPs if they are not recognized under the European Market Infrastructure Regulation when the UK's departure from the EU occurs. The associations urged the European Commission ("Commission") and other EU authorities to, in the event of a "no deal" scenario, (i) avoid a "disruptive hiatus" by ensuring that any mitigating actions take effect as soon as the UK leaves the EU and (ii) propose EU legislation that would adapt EU law prior to Brexit.

In addition, the associations advised:

  • the European Securities and Markets Authority ("ESMA") to consider -

    • "working with all 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"; and
    • "developing proposals to manage the transition to the reduced instrument scope under the MiFIR transparency and reporting regime in a way that reduces the adverse impact on EU27 investment firms and their clients and counterparties, in consultation with market participants";
  • the Commission, ESMA, the Single Resolution Board and EU27 to -

    • "eliminate or at least shorten any disruptive gap between Brexit and any mitigating action becoming effective"; and
  • EU regulatory authorities to -

    • provide "early transparency to market participants as to the mitigating actions that the authorities expect to take and any likely gap before those actions become effective after Brexit so that firms and their clients and counterparties can plan accordingly."

The associations warned that, in the absence of a regulatory commitment to take mitigating action, firms, their clients and their counterparties may be forced to take disruptive, risky, costly and potentially irreversible (and ultimately unnecessary) steps to seek to mitigate the adverse impacts. (In some cases, no such steps may be practically available to them.) The Paper also contains a grid summarizing some specific actions under various key European rules - such as CRR, MiFIR, UCITS, the Benchmark Regulation and others - that the associations consider necessary for mitigating the adverse impact of Brexit.

Commentary / Assia Damianova

The publication of this Paper is a stark warning that European regulators urgently need to address regulatory uncertainty, as ultimately EU banks will bear the cost of the potential disruption should Brexit occur without a deal. As separately reported by the Bank of England, some £41 trillion worth of derivatives contracts (that mature after March 2019) are at risk. London is at the heart of the global derivatives business: a reported $450 trillion of interest rate, FX, credit and commodity derivatives are cleared by LCH, ICE Clear Europe and LME Clear. Without access to those platforms, market participants face not just increased costs, but a potential disruption in the markets which poses a risk to the financial stability of cross-border financial services.

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