01 December 2017

Bloomberg: Brexit may leave banks on the hook for impossible contracts

He’s not alone. Andrew Bailey, head of the U.K. Financial Conduct Authority, said “contract continuity” is among the biggest potential disruptions in a no-deal, no-transition Brexit. Both Bailey and McFarlane, who also chairs London’s banking lobby, testified before lawmakers Wednesday. Bank of England Governor Mark Carney and European Central Bank President Mario Draghi have also expressed concern about the issue and the lack of time left for a fix.

A week ago, data from the European Banking Authority showed the scope of the issue, and that money is already on the move partly for this reason. European banks have slashed their U.K. assets by $425 billion, driven by a 35 percent drop in derivatives exposures. Insurance policies are affected too, with Carney saying that about 20 billion pounds of insurance liabilities in Britain could be affected without swift action.

The issue arises because one side or the other of a contract can meet its obligations only thanks to an authorization that’s set to disappear once the U.K. leaves the European Union in 2019. That may result in a firm being obliged by contract to do something that regulation forbids. Impossibility generally doesn’t work as a defense against non-fulfillment of a contract, said Simon Gleeson, a regulatory partner at Clifford Chance LLP in London.

 “A bank which enters into a contract which becomes illegal to perform by reason of Brexit may well be liable in damages for its non-performance to the counterparty,” said Gleeson. “Dealing with this is so much in everyone’s interest that I’m amazed it hasn’t been addressed.”

McFarlane’s testimony on Barclays’s Brexit planning ranged from well-trodden ground on derivatives clearing to the details of shifting operations abroad. “The jobs lost are -- in a trade scenario -- they’re insignificant,” McFarlane said. “They’re not the most important thing. The most important thing is that we may have to repaper hundreds of thousands of contracts into the EU.”

An aggregate 1.28 trillion euros of bank assets, including loans, securities and derivatives, may need to be re-booked from the U.K. to the EU following a hard Brexit, unless alternative arrangements can be reached, according to a study carried out for the Association for Financial Markets in Europe, the lobby group for Europe’s wholesale financial markets.

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