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Honor Your Derivative Contracts — Or Else, Warns Regulator

The head of the U.K. financial regulator has warned of instability should the E.U. refuse to deliver on existing derivative contracts after March 2019.

  • By Joe McGrath

Investors may have to redraw £12 trillion of derivatives contracts if policymakers cannot agree on terms for when the U.K. leaves the European Union, the Financial Conduct Authority boss has warned.

In a speech at the Future of the City dinner on Monday evening, FCA chief executive, Andrew Bailey, said £12 trillion in cross-border derivatives contracts will still be in place after March 2019, when the U.K. is to leave the bloc. The cost of redrawing these common derivative contracts will fall on investors unless the E.U. agrees to recognize U.K. clearing contracts after the breakaway date.

“When the U.K. departs from the E.U., unless action is taken, a wide range of financial contracts between U.K. and E.U. counterparts could cease to be serviceable,” he said. “It would affect individuals, businesses, economies, and financial stability.”

Current rules dictate that the companies issuing such contracts must be authorized in the same country or in another country that is approved to “passport in” under the Single Market rules.

Passporting permits European firms to offer their investment services in other European countries through a reciprocal regulatory arrangement. However, the European Union has, so far, maintained that it would be unfair to allow the U.K. to continue to have this right, without also committing to the free movement of people and remaining part of the Customs Union.

On Monday morning, the Financial Timescited a Downing Street source saying that the U.K. was “categorically leaving the Customs Union.”

This latest warning comes six months after financial services firms called on the FCA to do more to clarify its position on regulatory affairs post-Brexit.

[II Deep Dive: U.K. Fund Firms Seek Clarity from Regulator on Brexit]

During Monday’s address at the headquarters of law firm DLA Piper, Bailey said that the mutual recognition of regulatory standards was vital to the public interest.

“The public interest is paramount, in terms of the framework for open markets,” he said. “The big point here is that, if, as a response to Brexit, the European Union wishes to change the status quo, it would amount to a decision to close market access, not a decision about whether to open it. It would also be a decision to disconnect the E.U. from the benefits of global markets.”

Warnings that derivatives users may have to redraw contracts have been circling since the U.K. voted to leave the European Union in June 2016.

Last year, former Citigroup banker and British politician Susan Kramer told Institutional Investorthat insufficient thought had been given to the consequences of losing passporting rights.

The International Swaps and Derivatives Association, whose standardized contract rules many derivatives arrangements, urged caution in a statement to II

“It’s important to note that existing cross-border derivatives contracts between UK and EU counterparties will not suddenly become void after Brexit — these parties should still be able to perform on their contractual obligations, including payments, settlements, and collateral transfers,” said Scott O’Malia, ISDA’s chief executive. “We welcome the fact that both UK and EU authorities are aware of the issue, and we hope it can be resolved as part of the withdrawal agreement to allow all activities to be taken in relation to existing contracts.”

The U.K.’s Investment Association, which represents the interest of British fund managers, declined to comment on the content of Monday’s speech.

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