The Association for Financial Markets in Europe (AFME) has published a short paper highlighting some of the potential cliff edge risks that Brexit could create for market efficiency and financial stability.

The AFME reports that its members are concerned about the potential risks that Brexit can create for market efficiency and financial stability, in particular focusing on potential ‘cliff edge’ scenarios. The AFME paper highlights a number of important cliff edge risks that need to be considered and addressed, and proposes some potential solutions.

The AFME recognises that not every problem that is expected to arise from the UK’s withdrawal from the EU can be classified as a ‘cliff edge’ risk. The AFME therefore uses the following definition of ‘cliff edge risk’ in its paper: “A cliff edge risk is an issue that is expected to create (market) disruption or material impediments to business activities on the day of Brexit if no legislative or regulatory intervention is undertaken.”

The AFME paper discusses cliff edge risks concerning:

  • cross border personal data transfers;
  • continuity of contracts;
  • choice of jurisdiction, recognition and enforcement of judgments;
  • access to market infrastructure – recognition of central counterparties; and
  • recognition of resolution actions.

In relation to continuity of contracts the AFME states that its preferred option is for the grandfathering of cross-border contracts at Brexit, allowing them to be serviced until maturity. This should preferably be done by an EU-UK agreed solution to avoid having to create nationally differing solutions. The AFME mentions that an EU-wide solution could be similar in form to that adopted through Council Regulation (EC) No. 974/98 to address uncertainty around the introduction of the euro.

The AFME also notes that the recognition of resolution actions and resolution stays across jurisdictions is important for cross-border resolution to be effective. At present the Bank Recovery and Resolution Directive provides for the automatic recognition of resolution actions throughout the EU. Absent an intergovernmental agreement for the mutual recognition of resolution actions, automatic recognition would no longer apply between the UK and the EU27 on Brexit. Ending automatic recognition creates certain issues including:

  • the potential requirement for EU27 banks to amend contracts governed by English law to include contractual recognition of bail-in and resolution stays or having to re-issue them; and
  • uncertainty regarding the continued eligibility of English law governed capital and debt instruments issued by EU27 banks to meet loss-absorbing capacity requirements.

The AFME states that the EU and UK should agree to the mutual recognition of resolution actions. Absent such agreement, resolution authorities should engage with relevant firms and consider appropriate and proportionate arrangements to address existing liabilities.

View Brexit: Key cliff edge risks in wholesale financial services, 22 January 2018