On 12 April 2018, the Joint Committee of the European Supervisory Authorities (ESAs) published a report for the second half of 2017 which outlines the following risks as potential sources of instability:
- sudden repricing of risk premia as witnessed by the recent spike in volatility and associated market conditions;
- uncertainties around the terms of the UK’s withdrawal from the EU; and
The report also reiterates the ESAs warning to retail investors investing in virtual currencies and raises awareness for risks related to climate change and the transition to a lower-carbon economy.
Chapter 3 of the report discusses risks related to the UK’s decision to leave the EU. Key points include:
- the impact of the UK’s withdrawal observed to date varies across the financial sector. Concerning securities markets, the structural impact of the UK’s decision to withdrawal appears to be limited. In terms of registrations, clear-cut trends are not yet observable, neither for the fund industry nor for financial market infrastructures and individual financial instruments;
- relatively few firms have enacted contingency planning that has led to structural changes such as relocation. However, increased relocation activity can be expected closer to the withdrawal date, since market participants need to be ready by March 2019 in case of no transition period;
- in the banking sector, exposures towards the UK differ greatly across banks. On average, a steady reduction of exposures of EU27 financial institutions towards the UK has been observed since the UK referendum in June 2016. This results mainly from a decrease of EU banks’ exposures to derivatives contracts towards the UK;
- market participants need to prepare for the risk of reduced access to market infrastructure and contract continuity upon the UK’s withdrawal from the EU. Financial institutions are responsible for ensuring that they are able to fulfil their contractual obligations under all circumstances, not least with respect to derivatives, liquidity provision and swap contracts EU27 parties have entered into;
- the European Banking Authority December 2017 Risk Assessment Questionnaire shows that, while only 10% of respondents expect material negative implications to their business should withdrawal negotiations end in a disorderly or inconclusive fashion, more than one third of banks are concerned about the continuity of financial contracts in such a scenario; and
- it is important that EU financial institutions and their counterparties, as well as investors and retail consumers prepare appropriate mitigating actions in a timely manner, to prepare for the UK’s withdrawal from the EU. The earlier ESA opinions provide important guidance for financial institutions in this regard.