Germany calls for action to avoid mayhem in derivatives market
THE German regulator Bafin has read the riot act to complacent EU officials in Brussels, demanding urgent action by the EU side to avert mayhem in the vast derivatives market after Brexit.
Germany’s shift in policy is a crucial gesture of support for the Bank of England, which has been warning for months that £100 trillion of interest rate swaps and other derivatives could be left in limbo if there is no post-brexit arrangement.
The European Commission has so far stuck to their line that this is a problem for banks and financial companies to sort out for themselves even if there is a broader Brexit deal. It has brushed aside vehement pleas from European, US, and Asian banks that this is impossible. The chain reaction from broken contracts could lead to a global financial shock.
Bafin’s president, Felix Hufeld, said warnings by the industry must be taken seriously. “It is almost impossible to fix that problem exclusively just by one side of the stakeholders involved, let it be the industry itself or individual supervisors,” he told Bloomberg at a forum in Frankfurt.
Mr Hufeld said there had to be “a solution on the political level” to avert serious disruption, entailing some sort of legislative or regulatory structure.
Britain has taken unilateral measures to ensure that European banks and firms can continue operating in the City and will be able to service UK clients after Brexit. This will guarantee “contract continuity” on a temporary basis, even if there is a loss of passporting rights. The EU side has yet to reciprocate. It requires action by both sides to avert chaos.
Bafin and the Bank of England are now effectively aligned on the same side against Brussels, a sign that Germany is starting to impose its views as the Brexit deadline looms.
Other states have yet to respond. The French regulator (AFM) warned in July that there could be “business continuity risks” after Brexit, with Londonbased banks and firms unable to carry out normal procedures needed to service a derivatives contract. It fears an upset in euro clearing and central data repositories.
While AFM said steps must be taken to avoid endangering the “financial stability of the EU as a whole”, the issue has been allowed to fester.
The move by Germany’s Bafin is a major development. It offers further comfort that the worst cliff-edge dangers of Brexit are being tackled one by one, if very late in the day. Regulators in the nuclear industry have already led the way with an EU-UK arrangement extolled as a model of good sense.
Global banks and hedge funds are sensing the change and starting to alter their ultra-bearish view of sterling and UK assets. Several are betting that the post-chequers political storm in Britain has passed and that a Brexit deal is closer than headlines suggest. Veteran traders dismiss the deluge of “no-deal” documents as political theatre, largely intended to chill appetite for a revolt by Tory MPS and party members.
“Last Thursday we went long on sterling, arguing markets have overplayed Brexit and other political risks,” said Hans Redeker, currency chief at Morgan Stanley. Everybody is on the other side of the trade.” He expects the pound to reach $1.50 against the dollar in the next 18 months, from $1.30 today.
“We think Emmanuel Macron’s push for a new structure of ‘concentric circles’, with Europe and the euro at the core and the UK in the second ring, is significant,” he said. “Europe doesn’t want confrontation.” The Japanese
bank Nomura is betting on a 6pc rise in sterling against the euro to 0.85, arguing that a last-minute deal with the EU is likely and that Theresa May will scrape through the “meaningful vote” on Brexit, perhaps with the help of Labour MPS defying their own whips.
Jordan Rochester, the bank’s currency strategist, said: “We think a
‘Last week we went long on sterling, arguing markets have overplayed Brexit and other political risks’
Chequers type of agreement or some form of it will go through. Right now the market is very focused on the negative tail risks, but just one headline of negotiation progress could lead to a substantial short squeeze.”
Mr Rochester said the British economy is holding up reasonably well, the current account deficit is improving, and sterling is undervalued by up to 14pc. “If there are any signs of a Brexit deal, this could unleash a boom in investment,” he said. The European Commission’s latest economic sentiment index suggests that Britain has shaken off its spring blues. The UK gauge has recovered sharply over the last six months and reached 110 in August, higher than in France, Italy, or Spain. The eurozone index is still robust but has dropped to an eight-month low of 111.5.
Worries remain. Bank of England data show that overseas investors ditched UK Government bonds at a record pace in July, selling a net £17.2bn of gilts.
The hope is that this exodus reflects the moment of peak angst around Chequers when it looked as if the Government might fall, pitching the UK into election turmoil. “It was a month of massive political uncertainty as Boris Johnson resigned,” said economist David Owen at Jefferies.
The leakage from gilts is potentially worrying since the UK needs constant inflows of capital to cover a current deficit of 3.9pc of GDP. The Bank’s Governor, Mark Carney, has said in the past that the nation is uncomfortably reliant on “the kindness of strangers”.