Europe’s leading central bankers are at loggerheads over one of the biggest economic judgments facing the continent: does a disorderly Brexit pose a financial stability risk?
Mark Carney, Bank of England governor, fears a messy and severe Brexit could be a “Jenga” moment that leads to the collapse of the legal architecture the underpins financial flows, hurting the City of London’s European customers even more than the UK itself.
Mario Draghi, meanwhile, is largely unfazed. The European Central Bank chief has told negotiators from the remaining 27 EU nations that he is unworried about a highly mobile financial services industry that is used to adapting to new circumstances. Far from a stability threat, Brexit costs will be containable — and concentrated in Britain.
Whether bluff or negotiating bluster, these arguments will shape the balance of power in Brexit talks, and potentially determine whether the UK remains the EU’s main financial centre even from outside the bloc.
What are the potential risks?
Mr Carney’s argument centres on hedging. The fear is that without a post-Brexit market access deal, European banks and businesses would find it harder to tap Europe’s dominant derivatives market located in the City and find essential products to manage their balance sheet risks.
European companies rely on “deep hedging markets” to shield themselves from risks, Mr Carney told UK lawmakers last month. If banks and businesses on the continent suddenly found themselves cut off from the City, and so from these services, it could cause “unforeseeable moves in markets,” he said.
A hard Brexit could also drain market liquidity, raise doubts over the validity of cross-border insurance contracts and generate alarm by obscuring financial exposures.
Economic ructions from sudden shifts in capital flows are another worry. A House of Lords committee recently concluded that the sheer interconnectedness of the UK-EU financial system “presents serious difficulties” in even gauging the impact of dramatic legal changes.
Instability would come in part from the difficulty of meeting the EU’s own financial rules post-Brexit. These require some types of interest rate swaps and derivatives to be traded on regulated markets and passed through clearing houses. If London were cast into the regulatory wilderness, European companies would need to scramble for new solutions to fulfil their obligations.
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