EU-UK Brexit draft agreement and EU Commission communication on contingency plans

The last two days have been intense for Brexit; on 13 November, the EU Commission in parallel to finalizing a draft agreement with the UK released a communication on contingency planning in case the agreement is not enforced. Then on 14 November, the EU-Commission and Ms May on behalf of the UK government confirmed the finalization of the draft exit text to be submitted to Parliaments.

At this stage, despite the support for the withdrawal agreement between negotiators, it should be understood that the road to confirm it is still paved with risks of derailing it, the draft agreement should be voted by each Parliament, divisions in the UK are still very high, hence the outcome remain at risk.

If all is fine, from 29 March 2019, the UK will exit the EU but will remain subject to current provisions for customs, citizen rights… and this is important for the EU Commission, the budget contributions (approved in the past). That agreement, if confirmed, will offer both EU Remain and UK 21 months for the transition until the finalization of Brexit.

If it were not the case to validate the agreement, in way to hedge its actions the EU Commission released a communication about its contingency measures in case of no deal.

The contingency communication from the EU Commission provides evidence of what are the key and priority areas of concerns: there are transport, justice, energy, citizen rights and a small chapter on financial services.

Because the draft agreement is now sailing on the sea of political debate in the local Parliament, it might be worthwhile to focus on the emergency and contingency measures. The number of areas addressed is quite narrow and interestingly the EU Commission is of the view that financial institutions have largely prepared for the consequences of Brexit and that few if any concrete regulatory steps have to be taken in urgency.

Among the most prominent element from the communication is the clear message that no Member State or local authority should try to play on its own. Instead, reliance on EU bodies (i.e. EBA/ESMA/EIOPA or EU Commission) is more highly recommended. This is especially important for equivalence measures that should in selected areas (notably data exchange or derivatives) come right after Brexit date, whatever this means.

Contingency - A Financial services perspective

For a start, whatever happens, Brexit means Brexit that implies that the withdrawal of the UK will result in the loss of the right for financial operators established in the UK to provide services in the EU27 Member States under the EU financial services passports. Activities of EU/global operators in the UK will be subject to UK law only. This leads to an interesting perspective of the UK, until now under EU rules, and the perception of the UK as a bilateral partner to other third countries. Concretely, will UK rules be recognized on par with current EU rules by other third countries?

Even if the EU commission is of the view that many firms have already taken actions and built capacities in EU-Remain location through transfer of activities and capacity. It should be accelerated to be as prepared as possible for the 29March, to ensure business continuity. The EU Commission recognized that both in case of no deal Brexit and organized Brexit, there are high risks to financial stability in the European Union, but that these risks are only present in selected areas.

In case of no deal, the core focus of EU intervention is likely to concern the derivatives. In the view of EU commission not-cleared ʻover-the-counterʼ derivative contracts between EU and UK counterparts will, in principle, remain valid and executable until their maturity. EU Commission thinks that there does not appear to be generalized problems of contract performance in the case of a no-deal scenario. This understates the potential impact from some life-cycle events (for example contract amendments, rollovers and novation) and clients/counterpart information. On this background, the EU commission is likely to do nothing for OTC derivatives, which does not mean that there are no risks, nor that no preparation is required.

The views on the ETD and cleared derivatives is different and might require EU Commission intervention as the clearers and trading platforms are largely located in the UK, hence creating a potential for systemic risks. To prevent such cliff edge risk to arise the EU Commission should aim to act when necessary under strict conditionality within a limited duration. Should no agreement be in place, the EU Commission said it would adopt temporary and conditional equivalence decisions in order to ensure that there will be no abrupt disruption in central clearing and in depositary services. These decisions will be complemented by temporary recognition of UK-based infrastructures, which are therefore encouraged to pre-apply to the European Securities and Markets Authority (ESMA) for recognition.

Equivalence and collaboration

The European Supervisory Authorities are encouraged to start preparing cooperation arrangements with UK supervisors to ensure that the exchange of information related to financial institutions and actors is possible immediately after the withdrawal date in the case of a no deal scenario. This focus from EU Commission is on the data exchange for supervisory purposes, what might not solve concrete ground issues, like UCITS status, trading flows under MIFID II or PSDII.

In conclusion, the Brexit withdrawal agreement now in front of Parliament is a positive step to an ordered Brexit, if voted; but it should not hide the fact that post-Brexit things will change. As fallback the contingency plans should kick in, with few places for financial services besides the ETD, hence still at this stage, the key message is to be prepared! Equivalence or other temporary regimes are not an option to build a resilient future.

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