Brexit a massive threat to markets
THE BANK of England (BoE) governor Mark Carney has warned that time was running out to remove the threat that Brexit poses to trillions of pounds of derivative contracts, stepping up pressure on the EU to act.
Unless the EU follows the UK government in putting in place temporary workarounds, there could be havoc in financial markets when Britain leaves the bloc next March, the bank said in its Financial Stability Report, presented in London by Carney.
Firms may find themselves unable to service trillions of pounds of contracts from derivatives to insurance policies.
The BoE yesterday noted that the UK has announced some steps toward a solution, including a pledge to grant interim permissions if necessary, and highlighted that as yet, the EU has not reciprocated.
The issue of “contract continuity” is particularly pressing with regard to uncleared derivatives direct transactions between two regulated parties, typically banks, the BoE said.
“The EU has not yet indicated their solution to these fundamental issues, which would be expected to have more material impacts on the costs and availability of finance on the continent in the unlikely event of a disorderly Brexit,” Carney said. “This can’t be solved by the private sector.”
Many major UK and EEA counterparties are required to clear contracts authorised under EU legislation that could be complicated by Brexit. Outstanding cleared over-the-counter derivative contracts that could be affected amount to around £67 trillion (R1.2 quadrillion). Around £27bn of insurance liabilities in the UK could also be affected, if insurers are unable to service contracts without local authorisation.
The governor added that there are just nine months left to fix the matter. The BoE has been warning periodically about the issue of cross-border contracts. Firms will struggle to fix the problems on their own, so policy makers need to step in, the central bank says.
No improvement
The BoE’s latest assessment of Brexit risks shows no improvement from March. About £29trln of uncleared derivative contracts are at risk, along with 10 million UK insurance policyholders and another 38 million in the EU.
The government’s promised temporary permissions regime should ensure UK policyholders of EU insurers are not hit, but as things stand, UK firms’ customers in the EU may be hurt.
Apart from Brexit, the BoE judged UK domestic risks to be standard, and held the countercyclical capital buffer requirement for banks at 1 percent.
From next year, the BoE plans to stress test lenders for their resilience to cyber attacks. The Financial Policy Committee will set out its “impact tolerance”, the length of time it will accept a disruption to the economy from an attack. This might involve payments services or disruption to derivatives trading.
The stress tests will be set to assume a “severe but plausible” scenario, and will be piloted next year. – Bloomberg