Joe Egerton: Fixing the exit date: A terrible gamble
14 November 2017
The proposal to amend the European Union Withdrawal Bill to specify the date and time on which the United Kingdom will leave the European Union – 11.00PM on 29th March 2019i- is a terrible gamble, writes Joe Egerton.
The gamble that the Prime Minister is taking is that whatever happens – including a breakdown in negotiations and the hardest of hard Brexits – by 11.00PM on 28th March 2019 the United Kingdom and the EU 27 will have taken all steps to avoid any catastrophic breakdown in arrangements in Europe. These include the UK, the EU and potentially individual member states passing any necessary legislation to preserve existing contracts (including their enforceability), to maintain arbitration mechanisms and maintain the legality of providing banking and insurance sectors across borders.
Neither the Bank of England (including the Prudential Regulatory Authority or PRA) nor the ECB know precisely what the value of derivatives held by banks and potentially affected by Brexit is. No stress tests have been conducted and none planned to find out whether the banks are adequately prepared for the hardest of hard Brexits on 29 March 2019. Actually nobody has tested to make sure that all the big banks have done enough to be sure that even a softer Brexit will not cause huge disruption.
The Bank of England has stated that there are:
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around £20 TRILLION of gross notional uncleared derivatives across the border held by UK firms they supervise
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they believe that the ECB’s estimate of £20 TRILLION going the other way is probably on the low side
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these, as the Bank has explained, are the figures for uncleared derivatives. “These are derivatives between banks and end users that do not have to go through clearing houses. The effort, since the global financial crisis, has been to put more of this activity through clearing houses, because it gives you better risk management, and there is probably about £70 trillion of these contracts sitting in clearing houses and the like. Some will run off before Brexit, but a large majority will stay. I assume there will be some questions on clearing houses later on, but they face a number of issues about permissions and authorisations, and they also face this life-cycle performance issue” (Deputy Governor Sir Jon Cunliffe).
The amendment will remove the present flexibility on the date on which the Treaties stop working.
If preparations are not complete by the point the UK leaves the EU then:
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A proportion of derivative and other banking contracts will become non-functional. Not all will but enough to cause a real risk of contagion – to quote Sir Jon Cunliffe again “Sub-prime losses of $360 billion turned into $2.7 trillion-worth of losses for the financial system, in part because those losses knocked banks over, and once you start knocking banks over, you get credit drying up, and that knocks small banks over.”
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UK insurance companies will be unable to pay on claims from non-UK EEA insureds and viceversa. Up to a quarter of UK car policies could be affected. This means a large number of motor claims will have to be settled by the driver rather than the insurer. Also the consumer friendly dispute resolution systems will no longer have legal underpinning.
Up to now, everyone has assumed that however hard the Brexit everyone will agree to the steps
needed to avoid these potentially catastrophic consequences. But one reason why that assumption could be made is that Article 50 allows for the Treaties to kept in force if some of the steps necessary have to be completed. Take away that flexibility and the risks of catastrophe clearly increase.
What is worse firms will have to evaluate their risk exposures on the assumption that the UK will
inevitably leave on 29 March 2019 even if the necessary steps to keep the financial system operating have not been completed. That means they will have to provide for this risk. That means there is a risk of a credit crunch and a substantial diminution in the capacity of the insurance markets occurring well before 29 March 2019.
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