Has Christmas come early for UK CCPs?

20 December 2018

With 100 days to Brexit and no clear route to an agreement, it is perhaps unsurprising that the European Commission (EC) announced a number of measures should there be no agreement with the UK. 
In October we set out some of the risks from a no deal scenario to the centrally cleared derivatives market in this blog. So it is welcome that the EC has announced that UK Central Counterparties (CCPs) will be granted temporary equivalence under EMIR for 12 months in a no deal scenario. UK Central Securities Depositories (CSDs) will be granted a temporary equivalence period of 24 months under CSDR. The EC has also confirmed temporary 12 month measures to facilitate the novation of bilateral contracts between UK and EU-27 entities. 
Will these announcements fill UK CCPs, CSDs and other capital markets participants with festive cheer? Short-term relief will perhaps be the more likely reaction. Absent a temporary equivalence decision UK CCPs would have been forced to issue termination notifications to their EU clearing members before the Christmas break, something that could have caused turmoil in the derivatives market and significantly impacted those EU firms. This decision should have averted this risk, for now. However, a more permanent arrangement is likely to be required, e.g. via a full equivalence decision, to avoid the recurrence of this risk in 12 months.
The announcement does not prejudge any future permanent decision on equivalence under EMIR, and the EC states that a precondition for a permanent arrangement is an agreement between the UK and EU on the wider long-term relationship. The decision is also contingent on ESMA having access to all the information it requests on UK CCPs. While we would expect the BoE to be open to collaborative information sharing, the risk of such an all encompassing requirement may be that it becomes a de facto form of 'shadow supervision’, meaning UK CCPs are inundated with information requests. ESMA and the BoE have welcomed the announcement, with ESMA suggesting it expects to be able to conclude such an agreement on information sharing by the end of January.
The temporary equivalence granted to CSDs in the UK is also likely to be a source of relief, particularly in Ireland, where securities are currently settled in the UK via CREST (something that would not be possible post-Brexit without an equivalence decision or other agreement). The longer time frame may also mean that a permanent arrangement can be found. 
The EC has confirmed proposals from ESMA which would remove the requirement for  non-centrally cleared derivative contracts to be centrally cleared and subject to the initial margin requirements in EMIR, when they are novated between a UK and EU entity within 12 months of Brexit. Many financial institutions are also in the process of novating non-centrally cleared contracts from a UK entity to a EU-27 entity. This is proving to be a huge undertaking given the time required to re-negotiate legal terms, including membership and onboarding of clients of new EU27 entities to CCPs. For those firms these announcements will therefore reduce some of the operational hurdles associated with migration of contracts. The provisions fall short in addressing the risk that in a no deal scenario UK firms will be unable to meet certain legal obligations of any contracts that cannot be transferred to an EU27 licenced entity in time, posing a risk for firms and clients, including regulatory and litigation risks. Some EU countries, such as Germany, have however indicated that they will legislate to unilaterally remove this risk.
What do these announcements mean for financial services firms planning for Brexit? First, the very fact that they are still necessary just over three months from Brexit is worrying. And it should be noted that risks associated with data transfers and contract continuity for insurance contracts and uncleared derivatives, have not been addressed the EC. Time is running out to reach an agreement and firms must continue to prepare for the UK leaving the EU on 29 March 2019. So confirmation of the measures taken is welcome. While they will not fully mitigate the risk of a no deal Brexit to financial markets, removing the cliff edge risk around central clearing is particularly welcome from a short term financial stability perspective. 
The EC highlighted that the private sector needs to work on contingency measures to address no deal risks, since the measures communicated by the EC only mitigate financial stability risks in those areas where preparedness actions from market operators alone are clearly insufficient. 
Finally, in its communication the EC echoed warnings made by both ESMA and the FCA this week around the importance of financial services firms communicating fully and transparently with clients on changes being made due to Brexit. Robust client outreach programmes are challenging when time is so short, but it is vital that firms undertake these, in order to mitigate reputational risks and even conduct risks in the future. 


Andrew Gray

Andrew Gray | Partner
Profile | Email | +44 (0)20 7804 3431

Connor MacManus

Connor MacManus | Senior Manager
Profile | Email | +44 (0)20 7213 8555



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