Editorial Board

A Brexit Glitch That Could Hurt Europe

A disorderly departure would make it harder to wind down failing banks.

It's a matter of mutual interest.

Photographer: Ulrich Baumgarten/Getty Images

Few doubt that the British economy will be severely hurt if the U.K. leaves the European Union without a new agreement on trade and regulation. But there are risks for the EU, too. One that's received too little attention concerns bank resolution.

A cliff-edge Brexit could make it much harder for EU authorities to impose losses on investors in the event of bank failure. This, in turn, would put Europe's taxpayers at greater risk.

The EU's new resolution regime says that when a bank fails, its bondholders must share some of the burden through a so-called bail-in mechanism. Many bank bonds are written under British law. So long as the U.K. is in the EU, decisions by the EU's resolution authorities to impose losses on creditors will automatically apply. Once Britain leaves the EU, they won't.

The relevant EU authorities are aware. The Single Resolution Board, the agency responsible for failing banks, has warned European lenders that debt issued under British law may not comply with EU law after Brexit. Meanwhile, though, the SRB is asking banks to build adequate buffers of securities that can be subject to bail in, so the scale of the problem is growing.

In theory, after Brexit, banks could insert a clause into existing bond contracts saying the instruments were subject to the EU's resolution decisions. But investors might not agree to the change, because it would make them more vulnerable to losses.

The EU and the U.K. need to sign a cooperation agreement that would tell their courts to recognize resolution decisions taken in either jurisdiction. This would be to both sides' advantage. The EU would not see its bail-in arrangements crippled overnight, and Britain would retain more of its legal-services business, since banks operating in the EU could continue to issue bonds under British law.

Britain has far more to lose from a disorderly Brexit than the EU does. But close cooperation before and after Brexit is something the EU should want as well.

    --Editors: Ferdinando Giugliano, Clive Crook

    To contact the senior editor responsible for Bloomberg View’s editorials: David Shipley at davidshipley@bloomberg.net .

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