Brexit Puts Trillions of Pounds of Contracts at Risk, BOE Says

  • Impairment to servicing could disrupt market functioning
  • Tens of thousands of counterparties could be affected

The Bank of England said an agreement is needed as part of the Brexit process to protect the “long-term validity” of 20 trillion pounds ($27.1 trillion) of existing derivative contracts.

The BOE’s Financial Policy Committee said on Monday that after the U.K.’s withdrawal from the European Union, it will be “complex and difficult” for financial firms themselves to tackle the risks to continued servicing of contracts between counterparties in the U.K. and the remaining 27 EU countries.

“Impairment to the servicing of these contracts could disrupt market functioning and make it more expensive for firms and households to insure against risks,” the BOE said in a statement.

Tens of thousands of counterparties -- about a quarter of both U.K. and EU client uncleared derivative contracts -- could be affected, the BOE said in a statement. The continuity of insurance contracts and the free flow of personal data could also be affected, the central bank said.

Firms may lose the permissions they need to carry out “regular ‘life cycle’ events” in derivatives contracts, such as trade compression, the BOE said. 

“The two-way nature of derivatives means both U.K. and EU firms doing cross-border business may require appropriate permissions,” the BOE said. “A comprehensive solution is therefore likely to require the development and passage of legislation in both jurisdictions in order to protect the long-term validity of existing contracts.”

Scott O’Malia, head of the International Swaps and Derivatives Association, said “it’s important that provisions are put in place that allow U.K. and EU counterparties to perform on their existing contractual obligations.”

Accounting Rules

The BOE also said the introduction of new international accounting standards known as IFRS 9 will “support financial stability,” and will not alter the necessary level of loss- absorbing capacity for the banking system.

The FPC will take steps to ensure that the interaction of IFRS 9, which will apply to most banks in the U.K. as of Jan. 1, with the 2017 stress test “does not result in a de facto increase in capital requirements.”

“The FPC and Prudential Regulation Committee encourage firms to use any internationally agreed transitional arrangements as they adjust to the new regime, provided the arrangements are broadly similar to those currently being considered,” the BOE said.

The FPC confirmed its recommendation to the Prudential Regulation Authority to set the minimum leverage-ratio requirement for banks at 3.25 percent, with central bank reserves removed from the leverage exposure measure.

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