While markets are still digesting the news that the UK voted to leave the European Union, the country has thrown worldwide markets into turmoil. Equities, currencies and fixed income are likely to have a volatile ride for the next two months until a new Prime Minister is chosen and Article 50 is invoked. There are many different scenarios being played out but the hope of a new election and a second referendum may be wishful thinking.
What we do know is that this state of limbo will continue until negotiations begin. As for the derivatives world, the International Swaps and Derivatives Association (ISDA) tried to reassure participants by issuing a statement saying that the UK vote won’t have an immediate effect on the legal certainty of existing contracts. It also said that “once the UK government serves formal notice of its intention to withdraw, the UK will continue to remain a member of the EU for at least two years. During that time, existing European treaties, directives and regulations will remain in force.”
In a separate memorandum, the Futures Industry Association (FIA) said Brexit will not have any impact on the legal certainty of existing contracts. “Given the importance of the UK derivatives markets, the strong likelihood is that the UK government will be focused on ensuring that current protections for derivatives and collateral arrangements continue in effect and that cross-border trading is not adversely affected,” it stated.
Looking farther down the road though is a different and unsettling picture with both trade groups warning that Brexit will have dramatic consequences for the world’s $550 trillion derivatives sector works. For example, these types of bespoke, complex privately-negotiated swaps trades are dependent on English commercial law and whether existing UK and EU regulations will continue to apply to derivatives and collateral arrangements post-Brexit will depend on negotiations with Europe.
The FIA also cautioned that if equivalence between the UK and EU was not granted then “this would effectively leave those counterparties with cross-border operations with a dual compliance burden and without an EU membership” and that the UK would “no longer be able to exert as much (if any) influence on the content of any relevant EU financial services regulation.”
Another question is what will happen to London’s dominant position in the world of euro denominated clearing. The City is home to four big clearing houses, owned by the London Stock Exchange Group, Intercontinental Exchange, the London Metal Exchange and the CME Group. Last year, Britain won a case against the European Central Bank which argued that euro clearing houses should be in the euro zone. The victory at the European Court of Justice’s General Court in Luxembourg, enabled the LSE’s LCH.Clearnet to keep its euro-denominated operations in the country.
Outside the EU and London would have little hope of keeping these activities. As the French president François Hollande reiterated at the end of the latest European summit – “The City of London should no longer be able to clear euro-denominated trades.” France and Germany will be clamouring for the business but as with everything post Brexit, it is too early to predict who will be the winner and whether the UK can hold onto its crown.
