There’s a lot of speculation and second guessing about the final form of Brexit and the impact on financial services. But on one thing we can be pretty certain: existing cross-border derivatives contracts between counterparties in the UK and the other 27 European Union (EU) member states will not suddenly become null and void after Brexit. In fact, parties should be able to continue to perform on their contractual obligations – including payments, settlements and collateral transfers – as before, irrespective of the form of the UK’s withdrawal from the EU.
Does that mean there’ll be no impact at all? No. As we flagged in an earlier post, legal analysis conducted by ISDA on six jurisdictions – France, Germany, Italy, the Netherlands, Spain and the UK – shows that some activities that may arise during the life of a typical derivatives trade might be affected. These activities, which include novations, some types of portfolio compression, the rolling of open positions and material amendments, could be classed as a regulated activity, requiring local permissions.
Assuming passporting between the UK and the EU 27 ceases to be available after Brexit, and firms do not have local permissions, then it could become more challenging for those activities to take place between the UK and the EU 27 – although the exact impact differs from country to country. Absent an exemption or an equivalence determination, it could mean that firms choose to transfer outstanding contracts to a locally authorized subsidiary in the relevant jurisdiction in order for those activities to take place without interruption, or otherwise seek a local license.
Either would be time consuming and no small undertaking. But it’s important that the two issues aren’t confused – difficulty in performing some activities like novations and compression is not the same as an inability to make payments or settlements. It doesn’t mean existing cross-border contracts would become invalid after Brexit. It does mean that all parties to EU 27/UK derivatives need to think about how their ability to manage positions might be affected post-Brexit.
This issue can be resolved as part of the withdrawal agreement, or otherwise through coordinated legislative action by the EU 27 and the UK that continues to allow all activities to be taken in relation to existing contracts. That would be equally beneficial to the EU 27 and the UK. For example, it will ensure that outstanding hedges between European pension funds and UK dealers, or between UK corporates and EU banks, can continue to be managed without interruption or the need to be transferred from one jurisdiction to another.